10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 25, 2005

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number: 0-15086

SUN MICROSYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Delaware	94-2805249
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

4150 Network Circle, Santa Clara, CA 95054

(Address of principal executive offices with zip code)

(650) 960-1300

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).    YES  x    NO  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    No  x

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Outstanding at November 1, 2005
Common Stock - $0.00067 par value	3,414,250,999

INDEX

PART I – FINANCIAL INFORMATION
Item 1.	Financial Statements:	3
	Condensed Consolidated Statements of Operations	3
	Condensed Consolidated Balance Sheets	4
	Condensed Consolidated Statements of Cash Flows	5
	Notes to Condensed Consolidated Financial Statements	6
	Report of Independent Registered Public Accounting Firm	18
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	44
Item 4.	Controls and Procedures	45
PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	46
Item 6.	Exhibits	47
SIGNATURES		48

2

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SUN MICROSYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in millions, except per share amounts)

	Three Months Ended
	September 25, 2005			September 26, 2004
Net revenues:
Products	$	1,704		$	1,676
Services		1,022			952
Total net revenues		2,726			2,628
Cost of sales:
Cost of sales-products (including stock-based compensation expense of $2(1))		966			1,004
Cost of sales-services (including stock-based compensation expense of $7(1))		558			551
Total cost of sales		1,524			1,555
Gross margin		1,202			1,073
Operating expenses:
Research and development (including stock-based compensation expense of $17(1))		439			416
Selling, general and administrative (including stock-based compensation expense of $24(1))		828			670
Restructuring charges		12			108
Purchased in-process research and development		60			—
Total operating expenses		1,339			1,194
Operating loss		(137	)		(121	)
Gain (loss) on equity investments, net		13			(4	)
Interest and other income, net		44			31
Loss before income taxes		(80	)		(94	)
Provision for income taxes		43			39
Net loss	$	(123	)	$	(133	)
Net loss per common share-basic and diluted	$	(0.04	)	$	(0.04	)
Shares used in the calculation of net loss per common share-basic and diluted		3,407			3,343

⁽¹⁾ For the three months ended September 25, 2005

See accompanying notes.

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SUN MICROSYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in millions)

	September 25, 2005		June 30, 2005
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	1,508	$	2,051
Short-term marketable debt securities		993		1,345
Accounts receivable, net		2,087		2,231
Inventories		551		431
Deferred and prepaid tax assets		285		255
Prepaid expenses and other current assets		713		878
Total current assets		6,137		7,191
Property, plant and equipment, net		1,901		1,769
Long-term marketable debt securities		2,032		4,128
Goodwill		2,466		441
Other acquisition-related intangible assets, net		1,288		113
Other non-current assets, net		650		548
	$	14,474	$	14,190
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt and short-term borrowings	$	512	$	—
Accounts payable		1,091		1,167
Accrued payroll-related liabilities		836		713
Accrued liabilities and other		1,060		1,014
Deferred revenues		1,507		1,648
Warranty reserve		251		224
Total current liabilities		5,257		4,766
Long-term debt		603		1,123
Long-term deferred revenues		549		544
Other non-current obligations		1,410		1,083
Stockholders’ equity		6,655		6,674
	$	14,474	$	14,190

See accompanying notes.

4

SUN MICROSYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in millions)

	Three Months Ended
	September 25, 2005			September 26, 2004
Cash flows from operating activities:
Net loss	$	(123	)	$	(133	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		143			164
Amortization of other acquisition-related intangible assets		46			18
Stock-based compensation expense		50			5
Purchased in-process research and development		60			—
Loss (gain) on investments, net		(13	)		4
Changes in operating assets and liabilities:
Accounts receivable, net		449			606
Inventories		67			47
Prepaid and other assets		203			31
Accounts payable		(174	)		(252	)
Other liabilities		(484	)		(366	)
Net cash provided by operating activities		224			124
Cash flows from investing activities:
Purchases of marketable debt securities		(454	)		(1,377	)
Proceeds from sales of marketable debt securities		2,818			1,310
Proceeds from maturities of marketable debt securities		75			292
Proceeds from sales of equity investments, net		9			—
Purchases of property, plant and equipment, net		(48	)		(56	)
Purchases of spare parts and other assets		(20	)		(12	)
Payments for acquisitions, net of cash acquired		(3,150	)		—
Net cash provided by (used in) investing activities		(770	)		157
Cash flows from financing activities:
Proceeds from issuance of common stock, net		3			15
Principal payments on borrowings and other obligations		—			(250	)
Net cash provided by (used in) financing activities		3			(235	)
Net increase (decrease) in cash and cash equivalents		(543	)		46
Cash and cash equivalents, beginning of period		2,051			2,141
Cash and cash equivalents, end of period	$	1,508		$	2,187
Supplemental disclosures of cash flow information:
Interest paid (net of interest received from swap agreements of $20 and $36, respectively)	$	20		$	13
Income taxes paid (received) (net of refunds of $137 and $3, respectively)	$	(76	)	$	43
Supplemental schedule of noncash investing activities:
Stock and options issued in connection with acquisitions	$	89		$	—
Net issuance of nonvested stock awards (restricted stock)	$	64		$	—

See accompanying notes.

5

SUN MICROSYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. DESCRIPTION OF BUSINESS

Sun Microsystems, Inc.’s (Sun) business is singularly focused on providing network computing products and services. Network computing has been at the core of our offerings for the 23 years of our existence and is based on the premise that the power of a single computer can be increased dramatically when interconnected with other computer systems for the purposes of communication and sharing of computing power. Together with our partners, we provide network computing infrastructure solutions that comprise Computer systems (hardware and software), Network Storage systems (hardware and software), Support Services and Client solutions and Educational services. Our customers use our products and services to build mission-critical network computing environments to operate essential elements of their businesses. Our network computing infrastructure solutions are used in a wide range of technical, scientific, business and engineering applications in industries such as telecommunications, government, financial services, manufacturing, education, retail, life sciences, media and entertainment, transportation, energy/utilities and healthcare.

In addition, with the recent acquisition of Storage Technology Corporation (StorageTek), we have broadened our system strategy by offering our customers a complete range of storage products, services and solutions including StorageTek’s Information Lifecycle Management (ILM) products, where we enable businesses to align the cost of storage with the value of information. StorageTek helps customers gain control of their storage environments by reducing the time, cost and complexity of their storage infrastructures.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Fiscal Year

Sun’s first three quarters in fiscal year 2006 end on September 25, 2005, December 25, 2005, and March 26, 2006. In fiscal year 2005, the quarters ended on September 26, 2004, December 26, 2004, and March 27, 2005. The fourth quarter in all fiscal years ends on June 30.

Basis of Presentation

The accompanying condensed consolidated financial statements (Interim Financial Statements) include the accounts of Sun and its subsidiaries. Intercompany accounts and transactions have been eliminated. We completed our acquisitions of StorageTek and SeeBeyond Technology Corporation (SeeBeyond) as of August 31, 2005 and August 25, 2005, respectively. As a result, our condensed consolidated financial statements for the quarter ended September 25, 2005 included the results for StorageTek and SeeBeyond for the last 25 days and 31 days of the quarter, respectively.

These Interim Financial Statements have been prepared in accordance with generally accepted accounting principles in the United States (U.S. GAAP) for interim financial information and the rules and regulations of the Securities and Exchange Commission (SEC) for interim financial statements and accounting policies, consistent, in all material respects, with those applied in preparing our audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2005, filed with the SEC on September 13, 2005 (2005 Form 10-K). These Interim Financial Statements are unaudited but reflect all adjustments, including normal recurring adjustments management considers necessary for a fair presentation of our financial position, operating results and cash flows for the interim periods presented. The results for the interim periods are not necessarily indicative of the results for the entire year. The condensed consolidated balance sheet as of June 30, 2005 has been derived from the audited consolidated balance sheet as of that date. The information included in this report should be read in conjunction with our 2005 Form 10-K.

As described in our 2005 Form 10-K, we restated certain financial statements and other information for each of the first three quarters of fiscal 2005, with respect to our accounting for taxes and certain pre-tax accounting adjustments recorded throughout fiscal 2005.

Computation of Net Income (Loss) per Common Share

Basic net income (loss) per common share is computed using the weighted-average number of common shares outstanding (adjusted for treasury stock and common stock subject to repurchase activity) during the period.

Diluted net income (loss) per common share is computed using the weighted-average number of common and dilutive common equivalent shares outstanding during the period. Dilutive common equivalent shares consist primarily of stock options. Due to our net loss for all periods presented, all of our outstanding options were excluded from the diluted loss per share calculation because their inclusion would have been anti-dilutive.

If we had earned a profit during the three months ended September 25, 2005 and September 26, 2004, we would have added 4 million and 13 million common equivalent shares, respectively, to our basic weighted-average shares outstanding to compute the diluted weighted-average shares outstanding.

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Recent Pronouncements

In October 2004, The American Jobs Creation Act of 2004 (the Jobs Act) was signed into law. The Jobs Act creates a temporary incentive for U.S. multinationals to repatriate accumulated income earned outside the U.S. at an effective tax rate of 5.25%. On December 21, 2004, the Financial Accounting Standards Board (FASB) issued their staff position, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (FSP 109-2). FSP 109-2 allows companies additional time to evaluate the impact of the law and to record the tax effect of repatriation over several interim periods as they complete their assessment of repatriating all or a portion of these unremitted earnings. Should we decide to repatriate these earnings, which as of June 30, 2005, did not exceed $1,095 million of cumulative net undistributed earnings, a one-time charge to our results of operations would be recorded. In addition, as a result of our acquisition of StorageTek in the first quarter of fiscal 2006, we acquired an additional $120 million of unremitted earnings that, if repatriated, would also result in a one-time charge to our results of operations.

In December 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) 123 (revised 2004), “Share-Based Payment” (SFAS 123R). SFAS 123R requires measurement of all employee stock-based compensation awards using a fair-value method and the recording of such expense in the consolidated financial statements. In addition, the adoption of SFAS 123R requires additional accounting related to the income tax effects and disclosure regarding the cash flow effects resulting from share-based payment arrangements. In January 2005, the SEC issued Staff Accounting Bulletin No. 107, which provides supplemental implementation guidance for SFAS 123R. We selected the Black-Scholes option-pricing model as the most appropriate fair-value method for our awards and will recognize compensation cost on a straight-line basis over our awards’ vesting periods. We adopted SFAS 123R in the first quarter of fiscal 2006. See Note 9 for further detail.

The adoption of the following recent accounting pronouncements in the first quarter of fiscal 2006 did not have a material impact on our results of operations and financial condition:

• SFAS No. 151, “Inventory Costs—An Amendment of ARB No. 43, Chapter 4” and

• SFAS No. 153, “Exchanges of Nonmonetary Assets—An Amendment of APB Opinion No. 29.”

• EITF Issue No. 05-06, “Determining the Amortization Period for Leasehold Improvements”

In May 2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections” (SFAS 154), which replaces Accounting Principles Board Opinions No. 20 “Accounting Changes” and SFAS 3, “Reporting Accounting Changes in Interim Financial Statements — An Amendment of APB Opinion No. 28.” SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the earliest practicable date, as the required method for reporting a change in accounting principle and restatement with respect to the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 and is required to be adopted by Sun in the first quarter of fiscal 2007.

3. BUSINESS COMBINATIONS

During the three months ended September 25, 2005, we acquired Tarantella, Inc. (Tarantella), SeeBeyond and StorageTek as described below. Each acquisition has been accounted for as a purchase business combination. Certain aspects of the purchase price allocations for SeeBeyond and StorageTek are preliminary and have been made using initial estimates of value. Adjustments to these will be included in the allocation of the purchase price if the adjustment is determined within the purchase price allocation period. The operating results of each business purchased are included in Sun’s consolidated statement of operations from the date of each acquisition. Pro forma results of operations have not been presented for Tarantella and SeeBeyond because the effect of these acquisitions was not material to Sun on either an individual or on an aggregated basis.

Tarantella

On July 13, 2005, we acquired all of the outstanding shares of Tarantella, a publicly held company based in Los Gatos, California, (OTC: TTLA.OB) by means of a merger pursuant to which we paid cash for all of the outstanding shares of capital stock of Tarantella. In addition, all outstanding options to purchase Tarantella common stock were converted into options to purchase shares of our stock. Tarantella is a leading provider of software that enables organizations to access and manage information, data and applications across virtually all platforms, networks and devices. We acquired Tarantella to enhance our thin-client product offerings and strengthen our utility computing strategy.

7

We purchased Tarantella for approximately $25 million in cash and $1 million in assumed options and transaction costs. The total purchase price of $26 million was allocated as follows (in millions):

Goodwill	$	19
Other intangible assets		12
Tangible assets acquired and net liabilities assumed		(5	)
Total	$	26

SeeBeyond

On August 25, 2005, we acquired all of the outstanding shares of SeeBeyond, a publicly held company based in Monrovia, California (NASDAQ: SBYN). Under the terms of the agreement, SeeBeyond stockholders received $4.25 per share in cash for each SeeBeyond share. In addition, certain SeeBeyond stock option holders received cash equal to the difference between $4.25 per share and the exercise price of certain employee stock options and certain other outstanding options to purchase SeeBeyond common stock were converted into options to purchase shares of our stock. SeeBeyond provides business integration software via its Integrated Composite Application Network (ICAN) suite, which enables the real-time flow of information within the enterprise and among customers, suppliers, and partners. This acquisition strengthened our software portfolio and created a complete offering for the development, deployment and management of enterprise applications and Service Oriented Architectures.

We purchased SeeBeyond for approximately $362 million in cash, $9 million in assumed options, and approximately $5 million in transaction costs. The total purchase price of $376 million was allocated on a preliminary basis as follows (in millions):

Goodwill	$	252
Other intangible assets:
Customer base and other		53
Developed technology		34
Tangible assets acquired and net liabilities assumed		26
In-process research and development		11
Total	$	376

The net liabilities assumed included approximately $12 million of preliminary acquisition-related restructuring costs associated with the integration of facilities and activities of SeeBeyond.

StorageTek

On August 31, 2005, we acquired all of the outstanding shares of StorageTek, a publicly held company based in Louisville, Colorado (NYSE: STK). Under the terms of the agreement, StorageTek stockholders received $37 per share in cash for each StorageTek share and certain holders of StorageTek stock options received cash equal to the difference between $37 per share and the exercise price of such options. In addition, certain other outstanding options to purchase StorageTek common stock were converted into options to purchase shares of our stock. StorageTek engages in the design, manufacture, sale, and maintenance of data storage hardware and software, as well as the provisioning of support services worldwide. StorageTek helps customers gain control of their storage environments by reducing the time, cost and complexity of their storage infrastructures. We acquired StorageTek in order to offer customers a complete range of products, services and solutions for securely managing mission-critical data assets. The total purchase price of $4,082 million was comprised of (in millions):

Cash paid to acquire the outstanding common stock of StorageTek	$	3,987
Fair value of StorageTek options assumed		80
Acquisition-related transaction costs		15
Total purchase price	$	4,082

The fair value of options assumed was determined using a price of $3.76, which represented the average closing price of our common stock from two trading days before to two trading days after the June 2, 2005 announcement date and was calculated using a Black-Scholes valuation model with the following assumptions: weighted average remaining expected life of 2.7 years, average risk-free interest rate of 3.8%, average expected volatility of 44.8% and no dividend yield.

Acquisition-related transaction costs include investment banking, legal and accounting fees, and other third-party costs directly related to the acquisition.

8

Preliminary Purchase Price Allocation

The preliminary allocation of the total purchase price of StorageTek’s net tangible and identifiable intangible assets was based on their estimated fair values as of August 31, 2005. Adjustments to these estimates will be included in the allocation of the purchase price of StorageTek, if the adjustment is determined within the purchase price allocation period of up to twelve months. The excess of the purchase price over the identifiable intangible and net tangible assets was allocated to goodwill. The total purchase price of $4,082 million has been allocated as follows (in millions):

Goodwill	$	1,754
Other intangible assets		1,122
Tangible assets acquired and liabilities assumed:
Cash and marketable debt securities		1,204
Other current assets		505
Non-current assets		334
Accounts payable and accrued liabilities		(539	)
Other liabilities		(347	)
In-process research and development		49
Total purchase price	$	4,082

Other intangible assets

We have estimated the fair value of other intangible assets through the use of an independent third-party valuation firm that used the income approach to value these identifiable intangible assets which are subject to amortization. These estimates are based on a preliminary valuation and are subject to change upon management’s review of the final valuation. The following table sets forth the components of these other intangible assets at September 25, 2005 (dollars in millions):

	Preliminary Fair Value		Accumulated Amortization			Net Book Values as of September 25, 2005		Weighted Average Useful Life (in years)
Customer base	$	540	$	(17	)	$	523	4
Developed technology		516		(11	)		505	4
Trademarks		55		—			55	16
Other		11		—			11	3
Total intangible assets	$	1,122	$	(28	)	$	1,094

Customer base represents the expected future benefit to be derived from StorageTek’s existing customer contracts, backlog and underlying customer relationships. Developed technology, which is comprised of products that have reached technological feasibility, includes products in all of StorageTek’s product lines, principally their tape and network products. Trademarks represented trade names and trademarks developed through years of design and development.

Tangible assets acquired and net liabilities assumed

We have estimated the fair value of certain tangible assets acquired and liabilities assumed. Some of these estimates are subject to change, particularly those estimates relating to deferred taxes and acquisition-related restructuring costs. We currently have provided a full valuation allowance on the acquired deferred tax assets. Adjustments to these acquired deferred taxes may be required upon the merger of the acquired foreign legal entities into a combined legal entity structure. Our acquisition-related restructuring liabilities are based on an integration plan which focuses principally on the elimination of duplicative activities and facilities as discussed in Note 6.

In-process research and development

Of the total purchase price, approximately $49 million has been allocated to in-process research and development (IPRD) and was expensed in the first quarter of fiscal 2006. Projects that qualify as IPRD represent those that have not yet reached technological feasibility and have no alternative use. Technological feasibility is defined as being equivalent to a beta-phase working prototype in which there is no remaining risk relating to the development.

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The value assigned to IPRD was determined by considering the importance of each project to the overall development plan, estimating costs to develop the purchased IPRD into commercially viable products, estimating the resulting net cash flows from the projects when completed and discounting the net cash flows to their present value. The revenue estimates used to value the purchased IPRD were based on estimates of the relevant market sizes and growth factors, expected trends in technology and the nature and expected timing of new product introductions by StorageTek and its competitors.

The rates utilized to discount the net cash flows to their present values are based on StorageTek’s weighted-average cost of capital. The weighted-average cost of capital was adjusted to reflect the difficulties and uncertainties in completing each project and thereby achieving technological feasibility, the percentage of completion of each project, anticipated market acceptance and penetration, market growth rates and risks related to the impact of potential changes in future target markets. Based on these factors, discount rates that range from 13% - 15% were deemed appropriate for valuing the IPRD.

The estimates used in valuing IPRD were based upon assumptions believed to be reasonable but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur. Accordingly, actual results may differ from the projected results.

Pro forma results

The unaudited financial information in the table below summarizes the combined results of operations of Sun and StorageTek, on a pro forma basis, as though the companies had been combined as of the beginning of each of the periods presented. Sun’s results of operations for the quarter ended September 25, 2005 include the results of StorageTek for the last 25 days of the quarter. The unaudited pro forma financial information for the three months ended September 25, 2005 combines Sun’s results for this period with the results for StorageTek for the period from July 2, 2005 to August 31, 2005. The unaudited pro forma financial information for the three months ended September 26, 2004 combines Sun’s results for this period with the StorageTek’s results for the three months ended September 24, 2004. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of each of the periods presented. (in millions, except for per share amounts)

	Three Months Ended
	September 25, 2005			September 26, 2004
Revenues	$	2,912		$	3,118
Net loss	$	(256	)	$	(247	)
Net loss per share – basic and diluted	$	(0.08	)	$	(0.07	)

4. GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS

Information regarding our goodwill is as follows (in millions):

Balance as of June 30, 2005	$	441
Goodwill acquired during the period		2,025
Balance as of September 25, 2005	$	2,466

We are currently assessing the allocation of goodwill acquired through our acquisitions of StorageTek and SeeBeyond to our operating segments and expect to complete our assessment by the end of the fiscal year.

Information regarding our other acquisition-related intangible assets is as follows (in millions):

	Gross Carrying Amount						Accumulated Amortization									Net
	June 30, 2005		Additions		September 25, 2005		June 30, 2005			Additions			September 25, 2005			September 25, 2005
Developed technology	$	437	$	559	$	996	$	(339	)	$	(25	)	$	(364	)	$	632
Customer base		55		593		648		(48	)		(19	)		(67	)		581
Trademark		6		57		63		(6	)		—			(6	)		57
Acquired workforce and other		82		12		94		(74	)		(2	)		(76	)		18
	$	580	$	1,221	$	1,801	$	(467	)	$	(46	)	$	(513	)	$	1,288

Amortization expense of other acquisition-related intangible assets was $46 million and $18 million for the three months ended September 25, 2005 and September 26, 2004, respectively.

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Our acquisition-related intangible assets are amortized primarily over periods ranging from one year to five years on a straight-line basis.

Estimated amortization expense for other acquisition-related intangible assets on our September 25, 2005 balance sheet for the fiscal years ending June 30, is as follows (in millions):

Remainder of 2006	$	284
2007		334
2008		316
2009		263
2010		53
Thereafter		38
	$	1,288

5. BALANCE SHEET DETAILS

Inventories

Inventories consisted of the following (in millions):

	September 25, 2005		June 30, 2005
Raw materials	$	82	$	48
Work in process		183		121
Finished goods		286		262
	$	551	$	431

Deferred Revenues

The following table sets forth an analysis of our deferred revenue activity (in millions):

	Services deferred revenues			Other deferred revenues			Total
Balance at June 30, 2005	$	1,652		$	540		$	2,192
Deferred revenue acquired through acquisitions		117			12			129
Revenue deferred		1,465			398			1,863
Revenue recognized		(1,634	)		(494	)		(2,128	)
Balance at September 25, 2005		1,600			456			2,056
Less short-term portion		(1,113	)		(394	)		(1,507	)
Total long-term deferred revenues	$	487		$	62		$	549

Warranty Reserve

We accrue for our product warranty costs at the time of shipment. These product warranty costs are estimated based upon our historical experience and specific identification of product requirements, which may fluctuate based on product mix.

The following table sets forth an analysis of the warranty reserve activity (in millions):

Balance at June 30, 2005	$	224
Warranty reserve acquired through acquisitions		35
Charged to costs and expenses		75
Utilized		(83	)
Balance at September 25, 2005	$	251

6. RESTRUCTURING CHARGES

In accordance with SFAS 112 No. “Employers’ Accounting for Post Employment Benefits” (SFAS 112) and SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146), we recognized a total of $12 million and $108 million

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in restructuring charges in the three months ended September 25, 2005 and September 26, 2004, respectively. We recorded approximately $52 million of restructuring costs in connection with the StorageTek acquisition, which are based upon plans committed by management. These costs are accounted for under EITF 95-3, “Recognition of Liabilities in Connection with Purchase Business Combinations.” These costs were recognized as a liability assumed in the purchase business combination and included in the allocation of the cost to acquire StorageTek.

We estimated the cost of exiting and terminating our facility leases or acquired leases by referring to the contractual terms of the agreements and by evaluating the current real estate market conditions. In addition, we have estimated sublease income by evaluating the current real estate market conditions or, where applicable, by referring to amounts being negotiated. As of September 25, 2005, our estimated sublease income to be generated from sublease contracts not yet negotiated approximated $90 million. Our ability to generate this amount of sublease income, as well as our ability to terminate lease obligations at the amounts we have estimated, is highly dependent upon the commercial real estate market conditions in certain geographies at the time we perform our evaluations or negotiate the lease termination and sublease arrangements with third parties. The amounts we have accrued represent our best estimate of the obligations we expect to incur and could be subject to adjustment as market conditions change.

Restructuring Plan V

In June 2005, we implemented a workforce reduction and in July 2005, we committed to a facility exit plan (Restructuring Plan V). In a continuing effort to improve our cost structure and improve operating efficiencies, we plan to reduce our workforce by approximately 1,000 employees across all employee levels, business functions, operating units, and geographic regions. In addition, we plan to eliminate excess facility capacity in light of revised facility requirements. In the first quarter of fiscal 2006, we recognized a total of $12 million in charges associated with the Restructuring Plan V, consisting solely of workforce reduction charges.

We anticipate recording additional charges related to our workforce and facilities reductions over the next several quarters, the timing of which will depend upon the timing of notification of the employees leaving Sun as determined by local employment laws and as we exit facilities. In addition, we anticipate incurring additional charges associated with productivity improvement initiatives and expense reduction measures. The total amount and timing of these charges will depend upon the nature, timing, and extent of these future actions.

Restructuring Plan IV

In March 2004, we implemented a plan to reduce our cost structure and improve operating efficiencies by reducing our workforce, exiting facilities, and implementing productivity improvement initiatives and expense reduction measures (Restructuring Plan IV). This plan included reducing our workforce by at least 3,300 employees across all levels, business functions, operating units, and geographic regions. Through the end of fiscal 2005, we reduced our workforce by approximately 4,150 employees under this plan. This plan also included eliminating excess facility capacity in light of revised facility requirements and other actions.

All facilities relating to the amounts accrued under this restructuring plan were exited by June 30, 2005.

As of September 25, 2005, substantially all employees to be terminated as a result of the Restructuring Plan IV had been notified. While most of the severance and related fringe benefits have been paid, in accordance with local employment laws, we expect to pay the remaining restructuring accrual related to severance over the next few quarters.

Restructuring Activity Prior to Plan IV

We committed to restructuring plans in fiscal 2003 and 2002 (Restructuring Plan III and Restructuring Plan II, respectively) and a facility exit plan in fiscal 2001 (Facility Exit Plan I). We recorded initial restructuring charges in fiscal 2003, 2002 and 2001 based on assumptions and related estimates that we deemed appropriate for the economic environment that existed at the time these estimates were made. However, due to the uncertainty of the commercial real estate markets in certain geographies, and the final settlement of certain lease obligations, we have made appropriate adjustments to the initial restructuring charges. These changes to the previous estimates have been reflected as “Provision adjustments” in the period the changes in estimates were made.

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The following table sets forth an analysis of our restructuring accrual activity for the three months ended September 25, 2005 (in millions):

	Restructuring Plan V			Restructuring Plan IV						Restructuring Plan III			Restructuring Plan II			Facility Exit Plan I
	Severance and Benefits			Severance and Benefits			Facilities Related and Other			Facilities Related			Facilities Related			Facilities Related			Total
Balance as of June 30, 2005	$	44		$	37		$	157		$	77		$	129		$	26		$	470
Severance and benefits		7			2			—			—			—			—			9
Accrued lease costs		—			—			2			—			—			—			2
Provision adjustments		5			(1	)		1			(1	)		—			(3	)		1
Total restructuring charges		12			1			3			(1	)		—			(3	)		12
Cash paid		(21	)		(11	)		(12	)		(6	)		(5	)		(5	)		(60	)
Balance as of September 25, 2005	$	35		$	27		$	148		$	70		$	124		$	18		$	422

The remaining cash expenditures relating to workforce reductions are expected to be paid over the next few quarters. Our accrual as of September 25, 2005 for facility-related leases (net of anticipated sublease proceeds) will be paid over their respective lease terms through fiscal 2023. As of September 25, 2005, $149 million of the total $422 million accrual for workforce reductions and facility-related leases was classified as current accrued liabilities and other and the remaining $273 million was classified as other non-current obligations.

Acquisition-related restructuring costs

As a result of the acquisition of StorageTek, we recorded preliminary acquisition-related restructuring expenses associated with the costs of integrating operating locations and activities of StorageTek with those of Sun. U.S. GAAP requires that these acquisition-related restructuring expenses, which are not associated with the generation of future revenues and have no future economic benefit, be reflected as assumed liabilities in the allocation of the purchase price to the net assets acquired. The components of the preliminary acquisition-related restructuring liabilities included in the purchase price allocation for StorageTek are as follows (in millions):

	Severance		Facilities		Total
Acquisition-related restructuring liabilities as of September 25, 2005	$	16	$	36	$	52

The acquisition-related restructuring costs are based on our integration plan which focuses principally on the elimination of duplicative activities. The balance of the StorageTek workforce reduction at September 25, 2005 is expected to be utilized during the remainder of fiscal 2006 and fiscal 2007 and is expected to be funded through cash flows from the combined operations.

Certain aspects of the integration plan are still being finalized, including the evaluation of acquired facilities and workforce. Any changes resulting from the finalization of the integration plan could result in adjustments to our current estimates. As permitted under U.S. GAAP, these adjustments would be reflected in the allocation of the purchase price if made within twelve months from the date of acquisition.

7. COMPREHENSIVE LOSS

The components of comprehensive loss were as follows (in millions):

	Three Months Ended
	September 25, 2005			September 26, 2004
Net loss	$	(123	)	$	(133	)
Change in unrealized value of investments, net		(17	)		8
Change in unrealized fair value of derivative instruments and other, net		(1	)		1
Translation adjustments, net		(19	)		(22	)
	$	(160	)	$	(146	)

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The components of accumulated other comprehensive income were as follows (in millions):

	September 25, 2005			June 30, 2005
Unrealized gains (losses) on investments, net	$	(6	)	$	11
Unrealized gains on derivative instruments and other, net		1			2
Cumulative translation adjustments, net		176			195
	$	171		$	208

8. INCOME TAXES

For the first quarter of fiscal 2006, we recorded an income tax provision of $43 million primarily related to Sun’s operating results, as compared with $39 million for the first quarter of fiscal 2005. These tax provisions were recorded for taxes due on income generated in certain state and foreign tax jurisdictions and, in the first quarter of fiscal 2005, also include adjustments for the difference between estimated amounts recorded and actual liabilities resulting from the filing of prior years’ tax returns.

We currently have provided a full valuation allowance on our U.S. deferred tax assets and a full or partial valuation allowance on certain overseas deferred tax assets. We intend to maintain this valuation allowance until sufficient positive evidence exists to support reversal of the valuation allowance. Likewise, the occurrence of negative evidence with respect to our foreign deferred tax assets could result in an increase to the valuation allowance. Our income tax expense recorded in the future will be reduced or increased to the extent of offsetting decreases or increases to our valuation allowance.

We are currently under examination by the IRS for tax returns filed in fiscal years 2001 and 2002. Although the ultimate outcome is unknown, we have reserved for potential adjustments that may result from the current examination and we believe that the final outcome will not have a material affect on our results of operations.

We have also provided adequate amounts for other anticipated tax audit adjustments in the U.S., state and foreign tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes and interest may be due. In addition, although specific foreign country transfer pricing exposures have not been identified, the risk of potential adjustment exists. If our estimate of the federal, state and foreign income tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result. If events occur which indicate payment of these amounts are unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary.

9. STOCK-BASED COMPENSATION

We have a stock-based compensation program that provides our Board of Directors broad discretion in creating employee equity incentives. This program includes incentive and non-statutory stock options and nonvested stock awards (also known as restricted stock) granted under various plans, the majority of which are stockholder approved. Stock options are generally time-based, vesting 20% on each annual anniversary of the grant date over five years and expire eight years from the grant date. Nonvested stock awards are generally time-based, vesting 50% on the first anniversary of the grant date and 50% six months thereafter. Additionally, we have an Employee Stock Purchase Plan (ESPP) that allows employees to purchase shares of common stock at 85% of the fair market value at the lower of either the date of enrollment or the date of purchase. Shares issued as a result of stock option exercises, nonvested stock and our ESPP are generally first issued out of treasury stock. As of September 25, 2005, we had approximately 387 million shares of common stock reserved for future issuance under our stock option plans and ESPP.

On July 1, 2005, we adopted the provisions of SFAS 123R, requiring us to recognize expense related to the fair value of our stock-based compensation awards. We elected to use the modified prospective transition method as permitted by SFAS 123R and therefore have not restated our financial results for prior periods. Under this transition method, stock-based compensation expense for the three months ended September 25, 2005 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of July 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123 Stock-based compensation expense for all stock-based compensation awards granted subsequent to July 1, 2005 was based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. We recognize compensation expense for stock option awards on a straight-line basis over the requisite service period of the award.

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The following table sets forth the total stock-based compensation expense resulting from stock options, nonvested stock awards, ESPP and options assumed as a result of our acquisitions included in our Condensed Consolidated Statements of Operations (in millions):

	Three Months Ended September 25, 2005
Cost of sales - products	$	2
Cost of sales - services		7
Research and development		17
Selling, general and administrative		24
Stock-based compensation expense before income taxes		50
Income tax benefit		—
Total stock-based compensation expense after income taxes	$	50

Net cash proceeds from the exercise of stock options were $3 million and $15 million for the three months ended September 25, 2005, and September 26, 2004, respectively. No income tax benefit was realized from stock option exercises during the three months ended September 25, 2005, and September 26, 2004. In accordance with SFAS 123R, we present excess tax benefits from the exercise of stock options, if any, as financing cash flows rather than operating cash flows.

Prior to the adoption of SFAS 123R, we applied SFAS No. 123, amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (SFAS 148), which allowed companies to apply the existing accounting rules under APB 25 and related Interpretations. In general, as the exercise price of options granted under these plans was equal to the market price of the underlying common stock on the grant date, no stock-based employee compensation cost was recognized in our net income (loss). As required by SFAS 148 prior to the adoption of SFAS 123R, we provided pro forma net income (loss) and pro forma net income (loss) per common share disclosures for stock-based awards, as if the fair-value-based method defined in SFAS 123 had been applied.

The following table illustrates the effect on net loss after tax and net loss per common share as if we had applied the fair value recognition provisions of SFAS 123 to stock-based compensation during the three-month period ended September 26, 2004 (in millions, except per share amounts):

	September 26, 2004
Pro forma net loss:
Net loss	$	(133	)
Add: stock-based compensation costs included in reported net loss (net of tax effects of none)		5
Deduct: stock-based compensation costs (net of tax effects of none) under SFAS 123		(195	)
Pro forma net loss	$	(323	)
Pro forma basic and diluted net loss per common share:
Pro forma shares used in the calculation of pro forma net loss per common share - basic and diluted		3,343
Pro forma net loss per common share - basic and diluted	$	(0.10	)
Reported net loss per common share - basic and diluted	$	(0.04	)

The fair value of stock-based awards was estimated using the Black-Scholes model with the following weighted-average assumptions for the three months ended September 25, 2005 and September 26, 2004, respectively:

	Options						ESPP
	September 25, 2005			September 26, 2004			September 25, 2005			September 26, 2004
Expected life (in years)		4.8			6.0			0.5			0.5
Interest rate		4.03	%		3.62	%		3.18	%		1.16	%
Volatility		43.10	%		68.38	%		42.49	%		42.84	%
Dividend yield		—			—			—			—
Weighted-average fair value at grant date	$	1.54		$	2.50		$	0.98		$	0.99

Our computation of expected volatility for the quarter ended September 25, 2005 is based on a combination of historical and market-based implied volatility. Our computation of expected life is based on historical exercise patterns. The interest rate for periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of grant.

Prior to the adoption of SFAS 123R, our Board of Directors approved the acceleration of vesting of certain unvested and “out-of-money” stock options with exercise prices equal to or greater than $6.00 per share previously awarded to our employees, including our

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executive officers and directors, under our equity compensation plans. The acceleration of vesting was effective for stock options outstanding as of May 30, 2005. Options to purchase approximately 45 million shares of common stock or 18% of our outstanding unvested options were subject to the acceleration. The weighted average exercise price of the options that were accelerated was $14.85. The purpose of the acceleration was to enable us to avoid recognizing compensation expense associated with these options in our Consolidated Statements of Operations upon the adoption of SFAS 123R in July 2005. We also believe that because the options that were accelerated had exercise prices in excess of the current market value of our common stock, the options had limited economic value and were not fully achieving their original objective of incentive compensation and employee retention.

Stock option activity for the three months ended September 25, 2005, is as follows (in millions, except per share amounts):

	Shares		Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding at June 30, 2005	557		$	11.94
Grants and acquisition-related assumed options	84			3.19
Exercises	(1	)		2.17
Forfeitures or expirations	(19	)		12.52
Outstanding at September 25, 2005	621		$	10.75	4.8	$	135
Exercisable at September 25, 2005	404		$	14.55	3.6	$	64

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (i.e., the difference between Sun’s closing stock price on the last trading day of our first quarter of fiscal 2006 and the exercise price, times the number of shares) that would have been received by the option holders had all option holders exercised their options on September 25, 2005. This amount changes based on the fair market value of Sun’s stock. Total intrinsic value of options exercised is zero for the three months ended September 25, 2005. Total fair value of options vested is $52 million for the three months ended September 25, 2005.

As of September 25, 2005, $422 million of total unrecognized compensation cost related to stock options is expected to be recognized over a weighted-average period of 2.2 years.

On July 28, 2005, our Board of Directors approved a one-time targeted recognition and retention program, which included the issuance of approximately 18 million shares of nonvested stock to certain employees and executive officers with a purchase price of no greater than $0.01 per share. These shares of nonvested stock generally vest 50% on the first anniversary of the grant date and 50% six months thereafter.

The following table summarizes our nonvested stock activity for the three months ended September 25, 2005 (in millions, except per share amounts):

	Number of Shares	Weighted-Average Grant Date Fair Value
Nonvested stock at June 30, 2005	2	$	4.80
Granted	18		3.66
Vested	—		—
Forfeited	—		—
Nonvested stock at September 25, 2005	20	$	3.76

As of September 25, 2005, we retained purchase rights to 17 million shares issued pursuant to stock purchase agreements and other stock plans at a weighted-average price of approximately $0.01.

As of September 25, 2005, $58 million of total unrecognized compensation costs related to nonvested stock is expected to be recognized over a weighted-average period of 1.1 years.

10. OPERATING SEGMENTS

We design, manufacture, market and service network computing infrastructure solutions that consist of Computer Systems (hardware and software), Network Storage systems (hardware and software), Support services, Client solutions and Educational services. Our President and Chief Operating Officer has been identified as the Chief Operating Decision Maker (CODM) as defined by SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information” (SFAS 131). The CODM continues to manage our company based primarily on broad functional categories of sales, services, manufacturing, product development and engineering and

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marketing and strategy. The CODM reviews financial information on revenues and gross margins for products and services. The CODM also reviews operating expenses certain of which have been allocated to our two segments described below.

We operate in two segments: Product Group and Services. Our Product Group segment comprises our end-to-end networking architecture of computing products including our Computer Systems and Network Storage systems product lines. In the Sun Services segment, we provide a full range of services to existing and new customers, including Support services, Client solutions and Educational services.

We are currently reviewing the impact of our acquisitions of StorageTek and SeeBeyond to our operating segment disclosure and anticipate that it may result in a change in our operating segments. Currently, the storage segment and services segment of StorageTek have been included in Product Group and Sun Services segments, respectively.

We have a Global Sales Organization (GSO) that is responsible for selling all of our products and managing the majority of our accounts receivable. Our CODM holds this financial organization accountable for overall products and services revenue and margins at a consolidated level. In addition, we have a Worldwide Marketing Organization (WMO) that is responsible for developing and executing Sun’s overall corporate, strategic and product marketing and advertising strategies. Our CODM looks to this functional organization for advertising, pricing and other marketing strategies for the products and services delivered to market. Operating expenses (primarily sales, marketing and administrative) related to the GSO, the WMO and StorageTek’s comparable functions are not allocated to the reportable segments and, accordingly, are included under the Other segment reported below.

Segment information

The following table presents revenues, interdivision revenues and operating income (loss) for our segments. The Other segment consists of certain functional groups that did not meet the requirements for a reportable segment as defined by SFAS 131, such as GSO and WMO and other miscellaneous functions such as Corporate (in millions):

	Product Group		Sun Services		Other			Total
Three Months Ended:
September 25, 2005
Revenues	$	1,704	$	1,022	$	—		$	2,726
Interdivision revenues		58		92		(150	)		—
Operating income (loss)		307		397		(841	)(1)		(137	)
September 26, 2004
Revenues	$	1,676	$	952	$	—		$	2,628
Interdivision revenues		175		104		(279	)		—
Operating income (loss)		245		364		(730	)(1)		(121	)

⁽¹⁾ Includes restructuring charges and purchased IPRD.

11. LEGAL PROCEEDINGS

On April 20, 2004, we were served with a complaint in a case entitled Gobeli Research (Gobeli) v. Sun Microsystems, Inc. and Apple Computer, Inc. (Apple). The complaint alleges that Sun products, including our Solaris^TM Operating System, infringe on a Gobeli patent related to a system and method for controlling interrupt processing. Gobeli claims that Apple’s OS 9 and OS X operating systems violate that same patent. The case is pending in the United States District Court for the Eastern District of Texas. We have filed a response denying liability and stating various affirmative defenses, and we intend to present a vigorous defense.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders, Sun Microsystems, Inc.

We have reviewed the condensed consolidated balance sheet of Sun Microsystems, Inc. as of September 25, 2005, and the related condensed consolidated statements of operations for the three-month period ended September 25, 2005 and September 26, 2004, and the condensed consolidated statements of cash flows for the three-month period ended September 25, 2005 and September 26, 2004. These financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Sun Microsystems, Inc. as of June 30, 2005, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year then ended not presented herein, and in our report dated September 12, 2005, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of June 30, 2005, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ Ernst & Young LLP

San Jose, California

November 2, 2005

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is intended to be an overview of the areas that management believes are important in understanding the results of the quarter. This overview is not intended as a substitute for the detail provided in the following pages or for the condensed consolidated financial statements and notes that appear elsewhere in this document.

Executive Overview

Sun provides network computing infrastructure solutions that include Computer Systems (hardware and software), Network Storage systems (hardware and software), Support services, and Client solutions and Educational services. Sun’s solutions are based on major Sun technology innovations such as the Java^TM technology platform, the Solaris operating system (Solaris OS), Sun Java products, the N1^TM Grid architecture and the Ultra SPARC^® microprocessor technology, as well as other widely deployed technologies such as the Linux operating system and AMD Opteron^® microprocessor-based systems. Our network computing infrastructure solutions are used in a wide range of technical/scientific, business and engineering applications in industries such as telecommunications, government, financial services, manufacturing, education, retail, life sciences, media and entertainment, transportation, energy/utilities and healthcare. We sell end-to-end networking architecture platform solutions, including products and services, in most major markets worldwide through a combination of direct and indirect channels.

In addition, during the first quarter of fiscal 2006, we leveraged our financial strength to make a strategic acquisition of Storage Technology Corporation (StorageTek). With this acquisition, we have broadened our system strategy by offering our customers a complete range of storage products, services and solutions including StorageTek’s Information Lifecycle Management (ILM) products, where we enable businesses to align the cost of storage with the value of information. StorageTek helps customers gain control of their storage environments by reducing the time, cost and complexity of their storage infrastructures.

We completed our acquisition of StorageTek on August 31, 2005. As a result, the results of operations for the quarter ended September 25, 2005 included the results for StorageTek for the last 25 days of the quarter. StorageTek had historically experienced a disproportionate revenue volume in the last month of each fiscal quarter. Therefore, the results of operations included for the quarter are not indicative of the results for a full fiscal quarter. Storage products revenues for StorageTek is included in Network Storage products and Storage services revenues for StorageTek is included in Support services.

During the first quarter of fiscal 2006, we experienced a year over year increase in total net revenues of approximately 3.7%, which included a favorable foreign currency impact of approximately 1%. Our Products net revenue of $1,704 million was favorably impacted by $127 million of storage revenue related to the operations of StorageTek, offset by competition and a continuing market shift in overall computer system demand away from our data center servers towards the usage of entry level servers. Our Services net revenue of $1,022 million was also favorably impacted by $87 million of revenue related to the operations of StorageTek, offset by competitive pricing pressures, a continued change in the mix towards maintenance contracts sold or renewed with lower services levels and a shift in product sales mix to a greater proportion of low-end products, which are typically sold with reduced levels of services. Services net revenue was also unfavorably impacted by two large solution-based sales that were recognized in the first quarter of fiscal 2005, which did not recur in the current quarter. We also experienced a sequential quarterly decrease in total net revenues of approximately 8.3%, which reflects the normal seasonal decline we experience between the fourth quarter of the previous year and the first quarter of the next fiscal year and included an unfavorable foreign currency impact of approximately 1%. These changes are partially offset by $214 million of revenue related to the operations of StorageTek.

During the first quarter of fiscal 2006, our year over year gross margin increased by approximately 3.3 percentage points. Our Products gross margin increased by 3.2 percentage points primarily due to the impact of our Kodak litigation settlement in the first quarter of fiscal 2005 and manufacturing and component cost reductions, partially offset by the unfavorable impact of discounting and pricing actions. Our Services gross margin increased by 3.3 percentage points primarily due to the favorable impact of delivery efficiencies, cost reductions and productivity measures. Our sequential quarterly Products gross margin increased 1.9 percentage points as planned list price reductions and sales discounting actions and the benefit of inclusion of the operations of StorageTek were partially offset by cost reductions. Sequentially, Services gross margin increased by 3.9 percentage points primarily due to the cost reductions and productivity measures.

During the first quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, our research and development expenses increased $23 million and our sales, general and administrative expenses increased $158 million, primarily due to $94 million of operating expenses related to StorageTek, $50 million of stock-based compensation expense and an increase of $28 million in amortization of other intangible assets. In the first quarter of fiscal 2006, we recorded in-process research and development (IPRD) charges of approximately $60 million in connection with our acquisitions of StorageTek and SeeBeyond Technology Corporation (SeeBeyond).

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Our results of operations for the first quarter of fiscal 2006 were significantly impacted by the adoption of Statement of Financial Accounting Standards (SFAS) No. 123R (revised 2004), “Share-Based Payments” (SFAS 123R), which requires us to recognize a non-cash expense related to the fair value of our stock-based compensation awards. We elected to use the modified prospective transition method of adoption requiring us to include this stock-based compensation charge in our results beginning in the first quarter of 2006 without restating prior periods to include stock-based compensation expense. Of the $50 million in stock-based compensation expense recognized in the first quarter of fiscal 2006, $2 million is included in cost of goods sold-products, $7 million is included in cost of goods sold-services, $17 million is included in research and development expense and $24 million is included in sales, general and administrative expense.

During the first quarter of fiscal 2006, our operating activities provided cash flows of $224 million. Our focus on cash management remains a top priority and we plan to continue to drive improvement in our cash conversion cycle. At September 25, 2005 we had a total cash, cash equivalents and marketable debt securities of approximately $4.5 billion, which decreased from $7.5 billion as of June 30, 2005, primarily due to cash paid for our acquisitions of StorageTek and SeeBeyond during the first quarter of fiscal 2006.

Critical Accounting Policies and Estimates

The accompanying discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States (US GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We base our estimates and judgments on historical experience and on various other assumptions that we believe are reasonable under the circumstances. However, future events are subject to change and the best estimates and judgments routinely require adjustment. We are required to make estimates and judgments in many areas, including those related to fair value of derivative financial instruments, recording of various accruals, bad debt and inventory reserves, the useful lives of long-lived assets such as property and equipment, warranty obligations and potential losses from contingencies and litigation. Except as noted below for equity investments in privately-held companies, we believe the policies disclosed are the most critical to our financial statements because their application places the most significant demands on management’s judgment. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of our Board of Directors.

We believe there have been no significant changes during the three months ended September 25, 2005 to the items that we disclosed as our critical accounting policies and estimates in our discussion and analysis of financial condition and results of operations in our 2005 Form 10-K, except as noted below.

Upon review of the equity investments in privately held companies accounting policy, we determined this policy was no longer critical, as the remaining balance related to investments in privately held companies was not material as of September 25, 2005.

Business Combinations

We are required to allocate the purchase price of acquired companies to the tangible and intangible assets acquired, liabilities assumed, as well as IPRD based on their estimated fair values. We engage independent third-party appraisal firms to assist us in determining the fair values of assets acquired and liabilities assumed. This valuation requires management to make significant estimates and assumptions, especially with respect to long-lived and intangible assets.

Critical estimates in valuing certain of the intangible assets include but are not limited to: future expected cash flows from customer contracts, customer lists, distribution agreements, and acquired developed technologies and patents; expected costs to develop the IPRD into commercially viable products and estimating cash flows from the projects when completed; the acquired company’s brand awareness and market position, as well as assumptions about the period of time the brand will continue to be used in the combined company’s product portfolio; and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur.

Other estimates associated with the accounting for these acquisitions may change as additional information becomes available regarding the assets acquired and liabilities assumed. In particular, liabilities to restructure the pre-acquisition organization, including workforce reductions, are subject to change as management completes its assessment of the pre-merger operations and begins to execute the approved plan.

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Stock-Based Compensation Expense

We account for stock-based compensation in accordance with the provisions of SFAS 123R. Under the fair value recognition provisions of SFAS 123R, stock-based compensation cost is estimated at the grant date based on the value of the award and is recognized as expense ratably over the requisite service period of the award. Determining the appropriate fair value model and calculating the fair value of stock-based awards at the grant date requires judgment, including estimating stock price volatility, forfeiture rates and expected option life.

RESULTS OF OPERATIONS

Net Revenues

(dollars in millions, except revenue per employee dollars in thousands)

	Three Months Ended						Change
	September 25, 2005			September 26, 2004
Computer Systems products	$	1,274		$	1,354		(5.9)	%
Network Storage products		430			322		33.5	%
Products net revenue	$	1,704		$	1,676		1.7	%
Percentage of total net revenues		62.5	%		63.8	%	(1.3)	pts
Support services	$	835		$	745		12.1	%
Client solutions and Educational services		187			207		(9.7)	%
Services net revenue	$	1,022		$	952		7.4	%
Percentage of total net revenues		37.5	%		36.2	%	1.3	pts
Total net revenues	$	2,726		$	2,628		3.7	%
Revenue per employee(1)	$	78		$	78		—	%

(1) Revenue per employee is calculated by dividing the revenue during the period by the average number of employees during the period, including contractors. We use this as a measure of our productivity.

In recent periods, our service business has evolved as we have increased our emphasis on our solutions-based selling model and offered products (e.g. Managed services) that are not easily measured using existing metrics. As a result of these changes, we believe the importance of the services contract penetration rate to understanding of the performance of our services business has diminished. Accordingly, beginning in the first quarter of fiscal 2006, we are no longer including our service contract penetration rate as a key performance indicator. In addition, as a result of our acquisition of StorageTek, we are conducting an evaluation of the key performance indicators used to manage our business and anticipate changes.

Due to the generally weakened U.S. dollar during the first quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, our total net revenues were favorably impacted by foreign currency exchange rates. The net foreign currency impact to our total net revenues is difficult to precisely measure. However, our best estimate of the foreign exchange rate impact during the first quarter of fiscal 2006 as compared with the corresponding period of fiscal 2005, was zero on Products net revenue and approximated a benefit of 1% of Services net revenue.

Products Net Revenue

Products net revenue consists of revenue generated from the sale of Computer Systems and Network Storage products.

During the first quarter of fiscal 2006, as compared with the corresponding period in fiscal 2005, Computer Systems revenue decreased primarily due to reduced sales of our enterprise and data center servers resulting from intense competition and a continuing shift in overall computer system demand towards the usage of our lower-priced entry-level systems. The decrease in Computer Systems revenue was partially offset by increased unit sales of our entry level servers, which included servers running on our SPARC^® and AMD’s Opteron processors. During the first quarter of fiscal 2006, as compared with the corresponding period in fiscal 2005, Network Storage revenue included $127 million related to the operations StorageTek. Excluding the impact of this acquisition, Network Storage revenue decreased by $19 million primarily due to intense competition and reduced sales of our low-end storage components. These decreases were partially offset by increased unit sales of our mid-range and data center storage systems.

Services Net Revenue

Services net revenue consists of revenue generated from Support services, Client solutions and Educational services.

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Support services revenue consists primarily of maintenance contract revenue, which is recognized ratably over the contractual period. During the first quarter of fiscal 2006, as compared with the corresponding period in fiscal 2005, Support services net revenue included $87 million related to the operations of StorageTek. Excluding the impact of this acquisition, Support services revenues remained relatively flat as increases in volume and managed services were offset by competitive pricing pressures, a continued change in the mix towards maintenance contracts sold or renewed with lower service levels and a shift in product sales mix to a greater proportion of low-end products, which are typically sold with reduced levels of services.

Client solutions and Educational services revenue consist primarily of revenue generated from professional services, such as technical consulting that helps our customers plan, implement, and manage distributed network computing environments. The overall decrease in Client solutions and Educational services revenues during the first quarter of fiscal 2006, as compared with the corresponding period in fiscal 2005, was primarily due to revenue from solution-based sales to a health care services provider and an educational institution that was recognized in the first quarter of fiscal 2005.

Net Revenues by Geographic Area

(dollars in millions)

	Three Months Ended						Change
	September 25, 2005			September 26, 2004
United States	$	1,159		$	1,105		4.9	%
Percentage of total net revenues		42.5	%		42.0	%	0.5	pts
Americas-Other (Canada and Latin America)	$	141		$	110		28.2	%
Percentage of total net revenues		5.2	%		4.2	%	1.0	pts
EMEA (Europe, Middle East and Africa)	$	970		$	973		(0.3)	%
Percentage of total net revenues		35.6	%		37.0	%	(1.4)	pts
APAC (Asia, Australia and New Zealand)	$	456		$	440		3.6	%
Percentage of total net revenues		16.7	%		16.8	%	(0.1)	pts
Total International revenues	$	1,567		$	1,523		2.9	%
Percentage of total net revenues		57.5	%		58.0	%	(0.5)	pts
Total net revenues	$	2,726		$	2,628		3.7	%

United States (U.S.)

During the first quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, net revenues in the U.S. included $90 million related to the operations of StorageTek. Excluding the impact of this acquisition, net revenues in the U.S. decreased $36 million primarily related to products net revenue. In the U.S., our sales mix has traditionally included a higher proportion of product sales, which has contributed to the challenge in growing revenue in this geographic market as we continue to experience intense competitive pressures, especially in selling our high-end server products in certain key sectors. In addition, our product transition to a new line of entry level servers released in mid-September may have negatively impacted revenues during the quarter. In the government sector, we continue to experience intense competition and reduced spending in certain areas which have traditionally been sources of relative competitive strength. Additionally, in the first quarter of fiscal 2006, merger and acquisition activity in the telecommunication sector was correlated to reduced customer spending patterns in key accounts.

The following table sets forth net revenues in those geographic markets that contributed significantly to international net revenues during the first quarter of fiscal 2006 (dollars in millions):

	Three Months Ended				Change
	September 25, 2005		September 26, 2004
United Kingdom	$	234	$	292	(19.9	)%
Germany(1)	$	216	$	191	13.1	%
Japan	$	166	$	183	(9.3	)%
Central and Northern Europe	$	156	$	152	2.6	%

(1) Beginning in the second quarter of fiscal 2005, all periods presented have been adjusted to exclude Austria from the Germany geographic market.

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United Kingdom (UK)

During the first quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, net revenues in the UK included $19 million related to the operations of StorageTek. Excluding the impact of this acquisition, net revenues in the UK decreased by $77 million primarily due to revenue related to two large solution-based sales recognized in the first quarter of fiscal 2005 which did not recur in the current quarter. In addition, revenue in the UK decreased due to a continued intense competitive environment and a decrease in the number of major infrastructure solution deals during the first quarter of fiscal 2006.

Germany

During the first quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, net revenues in Germany included $17 million related to the operations of StorageTek. Excluding the impact of this acquisition, net revenue in Germany increased by $8 million due to the benefits arising from certain elements of our strategic alliance with Fujitsu and a moderate increase in Client Solutions net revenue These increases were partially offset by intense competition, the weak demand for our data center servers and a continuing challenging macroeconomic environment.

Japan

During the first quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, net revenues in Japan included $15 million related to the operations of StorageTek. Excluding the impact of this acquisition, net revenue in Japan decreased by $32 million primarily due to a decrease in Products net revenue. The decrease in Products net revenue in Japan is primarily a result of the implementation of certain elements of our broad-based strategic alliance with Fujitsu. As noted above, the revenue impact of this alliance in Japan was offset by other financial benefits received. In addition, we experienced a decrease in the telecommunication sector as a result of intense competition. In addition, our product transition to a new line of entry level servers released in mid-September may have negatively impacted revenues during the quarter.

Central and Northern Europe (CNE)

During the first quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, net revenues in CNE included $18 million related to the operations of StorageTek. Excluding the impact of this acquisition, net revenue in CNE decreased by $14 million primarily due to the weak demand for our data center servers and a challenging macroeconomic environment.

Gross Margin

(dollars in millions)

	Three Months Ended						Change
	September 25, 2005			September 26, 2004
Products gross margin	$	738		$	672		9.8	%
Percentage of products net revenue		43.3	%		40.1	%	3.2	pts
Services gross margin	$	464		$	401		15.7	%
Percentage of services net revenue		45.4	%		42.1	%	3.3	pts
Total gross margin	$	1,202		$	1,073		12.0	%
Percentage of total net revenues		44.1	%		40.8	%	3.3	pts

Products Gross Margin

Products gross margin percentage is influenced by numerous factors including product volume and mix, pricing, geographic mix, foreign currency exchange rates, the mix between sales to resellers and end-users, third-party costs (including both raw material and manufacturing costs), warranty costs and charges related to excess and obsolete inventory. Many of these factors influence, or are interrelated with, other factors. As a result, it is difficult to precisely quantify the impact of each item individually. Accordingly, the following quantification of the reasons for the change in the products gross margin percentage is an estimate only.

During the first quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, our products gross margin percentage increased by 3.2 percentage points due to cost reductions resulting from supply chain restructuring, product cost engineering and continued use of dynamic bidding events which collectively benefited gross margin by approximately 6 percentage points and the impact of our Kodak litigation settlement in the first quarter of fiscal 2005 of approximately 3 percentage points. Offsetting this increase were planned list price reductions and sales discounting actions of approximately 5 percentage points and changes in product mix to a greater proportion of lower-margin products of approximately 2 percentage points.

In the second quarter of fiscal 2006, we expect our products gross margin to be negatively impacted by increased amortization expense associated with acquisition-related intangible assets as well as a full quarter of expense related to the operations of StorageTek.

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Services Gross Margin

Services gross margin percentage is influenced by numerous factors including services mix, pricing, geographic mix, foreign currency exchange rates and third-party costs. Many of these factors influence, or are interrelated with, other factors. As a result, it is difficult to precisely quantify the impact of each item individually. Accordingly, the following quantification of the reasons for the change in the services gross margin percentage is an estimate only.

During the first quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, our services gross margin increased by 3.3 percentage points due to cost savings associated with our workforce reductions of approximately 2 percentage points, cost savings associated with delivery efficiencies of approximately 2 percentage points and the impact of our acquisition of StorageTek during the first quarter of fiscal 2006 of 1 percentage point. Offsetting these increases was increased sales discounting actions of approximately 1 percentage point and stock-based compensation expense related to the adoption of SFAS 123R of approximately 1 percentage point.

Operating Expenses

(dollars in millions)

	Three Months Ended						Change
	September 25, 2005			September 24, 2004
Research and development	$	439		$	416		5.5	%
Percentage of total net revenues		16.1	%		15.8	%	0.3	pts
Selling, general and administrative	$	828		$	670		23.6	%
Percentage of total net revenues		30.4	%		25.5	%	4.9	pts
Restructuring charges	$	12		$	108		(88.9)	%
Percentage of total net revenues		0.4	%		4.1	%	(3.7)	pts
Purchased in-process research and development	$	60		$	—		N/M	*
Percentage of total net revenues		2.2	%		—	%	2.2	pts
Total operating expenses	$	1,339		$	1,194		12.1	%

* Not meaningful

Research and Development (R&D) Expenses

R&D expenses increased by $23 million during the first quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, primarily due to $17 million of stock-based compensation expense, $14 million associated with the operating expenses of StorageTek and a $10 million increase in prototype expenses associated with new product introductions. These increases were partially offset by an $11 million decrease in depreciation and amortization and a $9 million in cost savings associated with workforce reductions.

We believe that to maintain our competitive position in a market characterized by rapid rates of technological advancement, we must continue to invest significant resources in new systems, software, and microprocessor development, as well as continue to enhance existing products.

Selling, General and Administrative (SG&A) Expenses

SG&A expenses increased by $158 million during the first quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, primarily due to $80 million operating expense of StorageTek, a $28 million increase in amortization expense, $17 million in transition cost related to our information technology resourcing, $24 million of stock-based compensation expense and a $21 million increase in compensation costs associated with salaries and bonuses and a $12 million increase in outside services costs. These increases were partially offset by $10 million in cost savings associated with workforce reductions and $10 million in reductions in legal costs.

We are continuing to focus our efforts on achieving additional operating efficiencies by reviewing and improving upon our existing business processes and cost structure. In the second quarter of fiscal 2006, we expect our SG&A expenses to be negatively impacted by increased amortization expense associated with acquisition related intangible assets as well as a full quarter of expense related to the operations of StorageTek and SeeBeyond.

Restructuring Charges

In accordance with SFAS 112 No. “Employers’ Accounting for Post Employment Benefits” (SFAS 112) and SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146), we recognized a total of $12 million and $108 million in restructuring charges in the three months ended September 25, 2005 and September 26, 2004, respectively. We recorded approximately $52 million of restructuring costs in connection with the StorageTek acquisition, which are based upon plans committed by management. These costs are accounted for under EITF 95-3, “Recognition of Liabilities in Connection with Purchase Business Combinations.” These costs were recognized as a liability assumed in the purchase business combination and included in the allocation of the cost to acquire StorageTek.

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We estimated the cost of exiting and terminating our facility leases or acquired leases by referring to the contractual terms of the agreements and by evaluating the current real estate market conditions. In addition, we have estimated sublease income by evaluating the current real estate market conditions or, where applicable, by referring to amounts being negotiated. As of September 25, 2005, our estimated sublease income to be generated from sublease contracts not yet negotiated approximated $90 million. Our ability to generate this amount of sublease income, as well as our ability to terminate lease obligations at the amounts we have estimated, is highly dependent upon the commercial real estate market conditions in certain geographies at the time we perform our evaluations or negotiate the lease termination and sublease arrangements with third parties. The amounts we have accrued represent our best estimate of the obligations we expect to incur and could be subject to adjustment as market conditions change.

Restructuring Plan V

In June 2005, we implemented a workforce reduction and in July 2005, we committed to a facility exit plan (Restructuring Plan V). In a continuing effort to improve our cost structure and improve operating efficiencies, we plan to reduce our workforce by approximately 1,000 employees across all employee levels, business functions, operating units, and geographic regions. In addition, we plan to eliminate excess facility capacity in light of revised facility requirements. In the first quarter of fiscal 2006, we recognized a total of $12 million in charges associated with the Restructuring Plan V, consisting solely of workforce reduction charges.

We anticipate recording additional charges related to our workforce and facilities reductions over the next several quarters, the timing of which will depend upon the timing of notification of the employees leaving Sun as determined by local employment laws and as we exit facilities. In addition, we anticipate incurring additional charges associated with productivity improvement initiatives and expense reduction measures. The total amount and timing of these charges will depend upon the nature, timing, and extent of these future actions.

Restructuring Plan IV

In March 2004, we implemented a plan to reduce our cost structure and improve operating efficiencies by reducing our workforce, exiting facilities, and implementing productivity improvement initiatives and expense reduction measures (Restructuring Plan IV). This plan included reducing our workforce by at least 3,300 employees across all levels, business functions, operating units, and geographic regions. Through the end of fiscal 2005, we reduced our workforce by approximately 4,150 employees under this plan. This plan also included eliminating excess facility capacity in light of revised facility requirements and other actions.

All facilities relating to the amounts accrued under this restructuring plan were exited by June 30, 2005.

As of September 25, 2005, substantially all employees to be terminated as a result of Restructuring Plan IV had been notified. While most of the severance and related fringe benefits have been paid, in accordance with local employment laws, we expect to pay the remaining restructuring accrual related to severance over the next few quarters.

Restructuring Activity Prior to Plan IV

We committed to restructuring plans in fiscal 2003 and 2002 (Restructuring Plan III and Restructuring Plan II, respectively) and a facility exit plan in fiscal 2001 (Facility Exit Plan I). We recorded initial restructuring charges in fiscal 2003, 2002 and 2001 based on assumptions and related estimates that we deemed appropriate for the economic environment that existed at the time these estimates were made. However, due to the uncertainty of the commercial real estate markets in certain geographies, and the final settlement of certain lease obligations, we have made appropriate adjustments to the initial restructuring charges. These changes to the previous estimates have been reflected as “Provision adjustments” in the period the changes in estimates were made.

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The following table sets forth an analysis of our restructuring accrual activity for the three months ended September 25, 2005 (in millions):

	Restructuring Plan V			Restructuring Plan IV						Restructuring Plan III			Restructuring Plan II			Facility Exit Plan I			Total
	Severance and Benefits			Severance and Benefits			Facilities Related and Other			Facilities Related			Facilities Related			Facilities Related
Balance as of June 30, 2005	$	44		$	37		$	157		$	77		$	129		$	26		$	470
Severance and benefits		7			2			—			—			—			—			9
Accrued lease costs		—			—			2			—			—			—			2
Provision adjustments		5			(1	)		1			(1	)		—			(3	)		1
Total restructuring charges		12			1			3			(1	)		—			(3	)		12
Cash paid		(21	)		(11	)		(12	)		(6	)		(5	)		(5	)		(60	)
Balance as of September 25, 2005	$	35		$	27		$	148		$	70		$	124		$	18		$	422

The remaining cash expenditures relating to workforce reductions are expected to be paid over the next few quarters. Our accrual as of September 25, 2005 for facility-related leases (net of anticipated sublease proceeds) will be paid over their respective lease terms through fiscal 2023. As of September 25, 2005, $149 million of the total $422 million accrual for workforce reductions and facility-related leases was classified as current accrued liabilities and other and the remaining $273 million was classified as other non-current obligations.

Acquisition-related restructuring costs

As a result of the acquisition of StorageTek, we recorded preliminary acquisition-related restructuring expenses associated with the costs of integrating operating locations and activities of StorageTek with those of Sun. U.S. GAAP requires that these acquisition-related restructuring expenses, which are not associated with the generation of future revenues and have no future economic benefit, be reflected as assumed liabilities in the allocation of the purchase price to the net assets acquired. The components of the preliminary acquisition-related restructuring liabilities included in the purchase price allocation for StorageTek are as follows (in millions):

	Severance		Facilities		Total
Acquisition-related restructuring liabilities as of September 25, 2005	$	16	$	36	$	52

The acquisition-related restructuring costs are based on our integration plan which focuses principally on the elimination duplicative activities.

The balance of workforce reduction of StorageTek at September 25, 2005 is expected to be utilized during the remainder of fiscal 2006 and fiscal 2007 and is expected to be funded through cash flows from the combined operations.

Certain aspects of the integration plan are still being finalized, including the evaluation of acquired facilities and workforce. Any changes resulting from the finalization of the integration plan could result in adjustments to our current estimates. As permitted under U.S. GAAP, these adjustments would be reflected in the allocation of the purchase price if made within twelve months from the date of acquisition.

Purchased In-Process Research and Development (IPRD)

Overview

In the first quarter of fiscal 2006 we recorded total IPRD expense of $60 million related to our acquisitions of StorageTek and SeeBeyond. At the date of each acquisition, the projects associated with the IPRD efforts had not yet reached technological feasibility and the IPRD had no alternative future uses. Accordingly, these amounts were expensed on the respective acquisition dates of each of the Acquired Companies.

Also see Note 3 to the Condensed Consolidated Financial Statements for further discussion.

Preliminary valuation

Through the engagement of an independent third party, we have estimated the fair value of IPRD using the income approach. These calculations gave consideration to relevant market sizes and growth factors, expected industry trends, the anticipated nature and timing of new product introductions by us and our competitors, individual product sales cycles, and the estimated lives of each of the product’s underlying technology. The value of the IPRD reflects the relative value and contribution of the acquired research and development. In determining the value assigned to IPRD, we considered the R&D’s stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred, and the projected cost to complete the project.

The values assigned to developed technologies related to each acquisition were based upon discounted cash flows related to the existing products’ projected income stream. Elements of the projected income stream included revenues, cost of sales (COS), R&D expenses and SG&A expenses. The discount rates used in the present value calculations were generally derived from a weighted average cost of capital, adjusted upward to reflect the additional risks inherent in the development life cycle, including the useful life of the technology, profitability levels of the technology, and the uncertainty of technology advances that are known at the date of each acquisition. Because each acquired entity’s IPRD is unique, the discount rate, revenue, COS, R&D and SG&A assumptions used varied on a case-by-case basis.

Preliminary valuation assumptions

The following bullets summarize the significant assumptions underlying the preliminary valuation related to IPRD as of the relevant acquisition dates:

• Acquisition of StorageTek – We acquired $49 million in IPRD related to nine projects within StorageTek’s tape, disk and network product lines. At the date of acquisition, we estimated that development efforts were generally 50% - 60% complete and that approximately $56 million in additional cost were required to complete development. Release dates range from the third quarter in fiscal 2006 to the second quarter in fiscal 2007.

• Acquisition of SeeBeyond – We acquired $11 million in IPRD related to the development of ICAN version 5.1. At the date of acquisition, we estimated that development efforts were 75% complete and that approximately $3 million in additional costs were required to complete development. The estimated completion date for ICAN 5.1 is the third quarter of fiscal 2006.

Given the uncertainties of the commercialization process, no assurances can be given that deviations from our estimates will not occur. At the time of the acquisitions, we believed there was a reasonable chance of realizing the economic return expected from the acquired in-process technology. However, as there is risk associated with the realization of benefits related to commercialization of an in-process project due to rapidly changing customer needs, the complexity of technology , and growing competitive pressures, there can be no assurance that any project will meet commercial success. Failure to successfully commercialize an in-process project would result in the loss of the expected economic return inherent in the fair value allocation. Additionally, the value of our intangible assets may become impaired.

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Gain (Loss) on Equity Investments

(dollars in millions)

	Three Months Ended					Change
	September 25, 2005		September 26, 2004
Gain (loss) on equity investments, net	$	13	$	(4	)	N/M	*

* Not meaningful

In the first quarter of fiscal 2006, our gain (loss) on equity investments, net was favorably impacted by gains on the sale of certain marketable equity investments in publicly traded companies of $6 million, gains of the sale of certain equity investments in privately held companies of $3 million and gains on warrants of $3 million. Our portfolio primarily consists of investments in privately held and publicly traded technology companies. The loss on equity investments of $4 million in the first quarter of fiscal 2005 was primarily related to decline in valuation of warrants and a decline in the value of our equity investments that was considered other than temporary.

As of September 25, 2005, our equity investment portfolio of $70 million consisted of $26 million in marketable equity securities, $27 million in equity investments in privately held companies and $17 million in investments in venture capital funds and joint ventures. The ongoing valuation of our investment portfolio remains uncertain and may be subject to fluctuations based on whether we participate in additional investment activity or as a result of the occurrence of events outside of our control.

Interest and Other Income, net

(dollars in millions)

	Three Months Ended						Change
	September 25, 2005			September 26, 2004
Interest and other income, net	$	44		$	31		41.9	%
Percentage of total net revenues		1.6	%		1.2	%

In the first quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, interest and other income, net, increased $13 million. This increase was due to higher yields than the first quarter of fiscal 2005. This was partially offset by higher realized losses on the sale of certain marketable debt securities and interest expense on debt.

As of September 25, 2005, the average duration of our portfolio of marketable debt securities increased to 0.85 years from 0.66 years at September 26, 2004. The increase of 0.19 years is primarily related to the liquidation of certain short duration securities due to cash paid for our acquisition of StorageTek in the first quarter of fiscal 2006. In general, we would expect the volatility of this portfolio to increase as its duration increases.

Our interest income and expense are sensitive primarily to changes in the general level of U.S. interest rates. In this regard, changes in U.S. interest rates affect the interest earned on our cash equivalents and marketable debt securities, which are predominantly short-term fixed income instruments. To better match the interest rate characteristics of our investment portfolio and our issued fixed-rate unsecured senior debt securities, we have entered into interest rate swap transactions so that the interest associated with these debt securities effectively becomes variable.

Income Taxes

(dollars in millions)

	Three Months Ended
	September 25, 2005		September 26, 2004		Change
Provision for income taxes	$	43	$	39	10.3	%

For the first quarter of fiscal 2006, we recorded an income tax provision of $43 million, primarily related to Sun’s operating results, as compared with $39 million for the first quarter of fiscal 2005. These tax provisions were recorded for taxes due on income generated in certain state and foreign tax jurisdictions and, in the first quarter of fiscal 2005, also include adjustments for the difference between estimated amounts recorded and actual liabilities resulting from the filing of prior years’ tax returns.

We currently have provided a full valuation allowance on our U.S. deferred tax assets and a full or partial valuation allowance on certain overseas deferred tax assets. We intend to maintain this valuation allowance until sufficient positive evidence exists to support reversal of the valuation allowance. Likewise, the occurrence of negative evidence with respect to our foreign deferred tax assets could result in an increase to the valuation allowance. Our income tax expense recorded in the future will be reduced or increased to the extent of offsetting decreases or increases to our valuation allowance.

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We are currently under examination by the IRS for tax returns filed in fiscal years 2001 and 2002. Although the ultimate outcome is unknown, we have reserved for potential adjustments that may result from the current examination and we believe that the final outcome will not have a material affect on our results of operations.

We have also provided adequate amounts for other anticipated tax audit adjustments in the U.S., state and foreign tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes and interest may be due. In addition, although specific foreign country transfer pricing exposures have not been identified, the risk of potential adjustment exists. If our estimate of the federal, state and foreign income tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result. If events occur which indicate payment of these amounts are unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary.

Stock Options and Incentive Plans

Our stock option program is a broad-based, long-term retention program that is intended to attract and retain talented employees and align stockholder and employee interests. We primarily rely on three stock option plans that provide broad discretion to our Board of Directors to create appropriate equity incentives for members of our Board of Directors and our employees. Substantially all of our employees participate in our stock option program. On July 1, 2005, we adopted the provisions of SFAS 123R, requiring us to recognize expense related to the fair value of our stock-based compensation awards. We elected the modified prospective transition method as permitted by SFAS 123R. Under this transition method, stock-based compensation expense for the three months ended September 25, 2005 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of July 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123 and compensation expense for all stock-based compensation awards granted subsequent to July 1, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. See Note 9 to our Consolidated Financial Statements for further detail, including the impact of the adoption to our Consolidated Statements of Operations.

Equity Compensation Plan Information

A summary of our stockholder approved and non-approved equity compensation plans as of September 25, 2005 is as follows (in millions, except exercise price amounts):

Plan Category	Number of Securities to be Issued upon Exercise of Outstanding Options, Warrants and Rights	Weighted Average Exercise Price of Outstanding Options, Warrants and Rights (in dollars)		Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans
Equity compensation plans approved by security holders (excluding ESPP)	545	$	11.62	358
Equity compensation plans not approved by security holders (excluding ESPP)(1)	94	$	3.68	29
Total (excluding ESPP)	639	$	10.45	387
Equity compensation plans approved by security holders (ESPP only)	N/A		N/A	N/A
Equity compensation plans not approved by security holders (ESPP only)	N/A		N/A	N/A
Total (ESPP only)	N/A		N/A	N/A
All Plans	639	$	10.45	387

(1) Includes assumed plans from acquisitions as well as our Equity Compensation Acquisition Plan for initial options granted to employees acquired through acquisitions.

Options and Nonvested Stock (Restricted Stock) Granted During the Three Months Ended September 25, 2005 to the Most Highly Compensated Executive Officers Named in Our Most Recent Proxy Statement

Name	Number of Options Granted	Weighted Average Exercise Price		Number of Nonvested Stock Awards Granted	Weighted Average Purchase Price
Scott G. McNealy	900,000	$	3.85	1,354,000	$	0.01
Jonathan I. Schwartz	900,000	$	3.85	432,000	$	0.01
Crawford W. Beveridge	150,000	$	3.85	208,500	$	0.01
Stephen T. McGowan	150,000	$	3.85	227,500	$	0.01
Gregory M. Papadopoulos	300,000	$	3.85	232,000	$	0.01

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LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION

(dollars in millions)

	September 25, 2005			June 30, 2005			Change
Cash and cash equivalents	$	1,508		$	2,051		$	(543	)
Marketable debt securities		3,025			5,473			(2,448	)
Total cash, cash equivalents and marketable debt securities	$	4,533		$	7,524		$	(2,991	)
Percentage of total assets		31.3	%		53.0	%		(21.7	) pts
	Three Months Ended						Change
	September 25, 2005			September 26, 2004
Cash provided by operating activities	$	224		$	124		$	100
Cash provided by (used in) investing activities		(770	)		157			(927	)
Cash provided by (used in) financing activities		3			(235	)		238
Net increase (decrease) in cash and cash equivalents	$	(543	)	$	46		$	(589	)

Changes in Cash Flow

During the first quarter of fiscal 2006, our operating activities generated cash flows of $224 million. The following items significantly impacted our cash provided by operating activities:

• Net loss of $123 million included non-cash charges of approximately $226 million, which included depreciation and amortization of $143 million, stock-based compensation of $50 million and amortization of acquisition-related other intangible assets of $46 million;

• Receipt of $137 million associated with an international income tax refund;

• Payments associated with severance and facilities restructuring liabilities totaling $60 million; and

• Purchased IPRD of $60 million.

The reasons for certain changes in our working capital are discussed further in the cash conversion cycle section below.

During fiscal 2005, our cash used in investing activities of $770 million was primarily attributable to cash used for acquisitions, net of $3,150 million, offset by purchases, net of proceeds from sales and maturities of marketable debt securities of $2,439 million.

Cash Conversion Cycle

	September 25, 2005		June 30, 2005		Change
Days sales outstanding (DSO)(1)	69		68		(1	)
Days of supply in inventory (DOS)(2)	33		22		(11	)
Days payable outstanding (DPO)(3)	(64	)	(60	)	4
Cash conversion cycle	38		30		(8	)
Inventory turns - products only	8.6		9.3		(0.7	)

(1) DSO measures the number of days it takes, based on a 90 day average, to turn our receivables into cash.

(2) DOS measures the number of days it takes, based on a 90 day average, to sell our inventory.

(3) DPO measures the number of days it takes, based on a 90 day average, to pay the balances of our accounts payable.

We ended the first quarter of fiscal 2006 with a cash conversion cycle of 38 days, a decline of 8 days from June 30, 2005. The cash conversion cycle is the duration between the purchase of inventories and services and the collection of the cash for the sale of our products and services and is a metric on which we have focused as we continue to try to efficiently manage our assets. The cash conversion cycle results from the calculation of days sales outstanding (DSO) added to days of supply in inventories (DOS), reduced by days payable outstanding (DPO). Our cash conversion cycle was impacted by our acquisition of StorageTek on August 31, 2005 due to 25 days of their contribution included in our results of operations. DSO remained relatively flat from June 30, 2005. Excluding the impact of our acquisition of StorageTek, DSO improved 9 days due to improved billings and collections throughout the quarter. DOS negatively impacted our cash conversion cycle by 11 days to 33 days. Excluding the impact of our acquisition of StorageTek, DOS declined 3 days due to an increase in inventories from June 30, 2005 and our products inventory turn rate remained relatively flat at 8.6 turns at September 25, 2005 from

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9.3 turns at June 30, 2005. Inventory turns is annualized and represents the number of times product inventory is replenished during the year. Inventory management will continue to be an area of focus as we balance the need to maintain sufficient inventory levels to help ensure competitive lead times with the risk of inventory obsolescence due to rapidly changing technology and customer requirements. DPO improved 4 days and accounts payable decreased $76 million from June 30, 2005 due to negotiation of more favorable terms with our vendors. Excluding the impact of our acquisition of StorageTek, DPO remained relatively flat.

Acquisitions

We completed three acquisitions during the first three months of fiscal 2006. On July 13, 2005, we acquired Tarantella to enhance our thin-client product offerings and strengthen our utility computing strategy. On August 25, 2005, we acquired SeeBeyond to strengthen our software portfolio and create a complete offering for the development, deployment and management of enterprise applications and Service Oriented Architectures. On August 31, 2005, we acquired StorageTek in order to offer customers the most complete range of products, services and solutions available for securely managing mission-critical data assets. See Note 3 of our Condensed Consolidated Financial Statements for a detailed discussion of these acquisitions.

Stock Repurchases

From time to time, our Board of Directors approves common stock repurchase programs allowing management to repurchase shares of our common stock in the open market pursuant to price-based formulas. In February 2001, we announced our intention to acquire up to $1.5 billion of our outstanding common stock under a stock repurchase program authorized by our Board of Directors. Under the repurchase program, the timing and actual number of shares subject to repurchase are at the discretion of management and are contingent on a number of factors, including our projected cash flow requirements, our return to sustained profitability and our share price. During the first three months of fiscal 2006 and the fiscal year ended June 30, 2005, we did not repurchase common stock under our repurchase program. All prior repurchases were made in compliance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended. As of September 25, 2005, approximately $230 million of the $1.5 billion authorized, remained unused and available for repurchase.

Borrowings

Our $1.05 billion of unsecured senior debt securities (Senior Notes) outstanding are due at various times through August 2009. The Senior Notes are subject to compliance with certain covenants that do not contain financial ratios. We are currently in compliance with these covenants. If we failed to be in compliance with these covenants, the trustee of the Senior Notes or holders of not less than 25% in principal amount of the Senior Notes would have the ability to demand immediate payment of all amounts outstanding.

In January 2005, our Board of Directors authorized our management to repurchase debt from time to time in partial or full tranches based on available cash and market conditions.

In addition, we have uncommitted lines of credit aggregating approximately $513 million and no amounts were drawn from these lines of credit as of September 25, 2005. Interest rates and other terms of borrowing under these lines of credit vary from country to country depending on local market conditions at the time of borrowing. There is no guarantee that the banks would approve our request for funds under these uncommitted lines of credit.

Contractual Obligations

Through the normal course of our business, we purchase or place orders for the necessary components of our products from various suppliers and we commit to purchase service where we would incur a penalty if the agreement was canceled. We estimate that such contractual obligations at September 25, 2005 were $739 million due within the following twelve months. This range does not include contractual obligations recorded on the balance sheet as current liabilities. As part of our acquisitions of StorageTek and SeeBeyond, we have also assumed operating lease obligations of $156 million as of September 25, 2005. In addition, we have a contractual obligation under the terms of our strategic alliance with Fujitsu, whereby, under certain circumstances, we have committed to buy Fujitsu products with a list price of up to $230 million within the first twelve months following full implementation of Sun’s distribution of Fujitsu products and, under certain circumstances, up to approximately $265 million during the second twelve months following full implementation of Sun’s distribution of Fujitsu products, at a predetermined discount from list price, depending upon the type of product purchased. Contractual obligations for the purchase of goods or services are comprised of agreements that are enforceable and legally binding on Sun and that specify all significant terms, including fixed or minimum quantities to be purchased, fixed, minimum or variable price provisions, and the appropriate timing of the transactions. Our purchase orders are based on our current manufacturing needs and are fulfilled by our vendors within a short time.

Sun is insured by nationally recognized insurers for certain potential liabilities, including worker’s compensation, general liability, automotive liability, employer’s liability, errors and omissions liability, employment practices liability, property, cargo and crime and directors and officers liability. We have self-insured between $2 and $25 million per occurrence on these lines of coverage.

Sun performs an annual actuarial analysis to develop an estimate of amounts to be paid for both claims reported and potential losses on activities that have occurred but have not yet been reported. Loss accruals were $32 million and $33 million as of September 25, 2005 and June 30, 2005, respectively.

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Capital Resources and Financial Condition

Our long-term strategy is to maintain a minimum amount of cash and cash equivalents in subsidiaries for operational purposes and to invest the remaining amount of our cash in interest bearing and highly liquid cash equivalents and marketable debt securities. Accordingly, in addition to the approximately $1,508 million in cash and cash equivalents, at September 25, 2005 we had approximately $3,025 million in marketable debt securities that were available for shorter-term requirements, such as future operating, financing and investing activities, for a total cash and marketable debt securities position of approximately $4,533 million. However, at June 30, 2005, approximately $1,095 million of this balance represented earnings generated from operations domiciled in foreign tax jurisdictions that were designated as permanently invested in the respective tax jurisdictions. In addition, as a result of our acquisition of StorageTek in the first quarter of fiscal 2006, we acquired an additional $120 million of unremitted earnings. Should we decide to repatriate these earnings, we would be required to accrue and pay additional taxes to repatriate these funds. We are reviewing the provisions of the American Jobs Creation Act of 2004, and have not completed our evaluation of its impact to Sun. In addition, deposits in foreign countries of approximately $520 million as of June 30, 2005, are subject to local banking laws and may bear higher or lower risk than cash deposited in the United States.

We believe that the liquidity provided by existing cash, cash equivalents, marketable debt securities and cash generated from operations will provide sufficient capital to meet our requirements for at least the next 12 months. We believe our level of financial resources is a significant competitive factor in our industry and we may choose at any time to raise additional capital to strengthen our financial position, facilitate growth, and provide us with additional flexibility to take advantage of business opportunities that arise.

NON-AUDIT SERVICES OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Our auditors, Ernst & Young LLP, perform the following non-audit services that have been pre-approved by our Audit Committee of the Board of Directors: expatriate tax and relocation services, international and U.S. tax planning services. Starting in fiscal 2005, we have selected another firm to perform expatriate tax and relocation services and are in the process of transitioning these services from Ernst & Young LLP. In addition, our Audit Committee has pre-approved tax compliance services being transitioned as a result of our acquisition of StorageTek and SeeBeyond. Sun and Ernst & Young LLP continue to evaluate and review processes relevant to the maintenance of Ernst & Young LLP’s independence.

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RISK FACTORS

Because of the following factors, as well as other factors affecting our operating results and financial condition, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.

If we are unable to compete effectively with existing or new competitors, the loss of our competitive position could result in price reductions, fewer customer orders, reduced revenues, reduced margins, reduced levels of profitability and loss of market share.

We compete in the computer systems (hardware and software) and network storage (hardware and software) products and services markets. These markets are intensely competitive. If we fail to compete successfully in these markets, the demand for our products and services would decrease. Any reduction in demand could lead to fewer customer orders, reduced revenues, pricing pressures, reduced margins, reduced levels of profitability and loss of market share. These competitive pressures could materially and adversely affect our business and operating results.

Our competitors are some of the largest, most successful companies in the world. They include International Business Machines Corporation (IBM), Hewlett-Packard Company (HP), EMC Corporation (EMC), Fujitsu Limited (Fujitsu) and the Fujitsu-Siemens joint venture. We also compete with systems manufacturers and resellers of systems based on microprocessors from Intel Corporation (Intel) and the Windows family of operating systems software from Microsoft Corporation (Microsoft). These competitors include Dell Inc. (Dell) and HP, in addition to Intel and Microsoft. Certain of these competitors compete aggressively on price and seek to maintain very low cost structures. Some of these competitors are seeking to increase their market share in the enterprise server market, which creates increased pressure, including pricing pressure, on our workstation and lower-end server product lines. In particular, we are seeing increased competition and pricing pressures from competitors offering systems running Linux software and other open source software. In addition, certain of our competitors, including IBM and HP, have financial and human resources that are substantially greater than ours, which increases the competitive pressures we face.

Customers make buying decisions based on many factors, including among other things, new product and service offerings and features; product performance and quality; availability and quality of support and other services; price; platform; interoperability with hardware and software of other vendors; quality; reliability, security features and availability of products; breadth of product line; ease of doing business; a vendor’s ability to adapt to customers’ changing requirements; responsiveness to shifts in the marketplace; business model (e.g., utility computing, subscription-based software usage, consolidation versus outsourcing); contractual terms and conditions; vendor reputation and vendor viability. As competition increases, each factor on which we compete becomes more important and the lack of competitive advantage with respect to one or more of these factors could lead to a loss of competitive position, resulting in fewer customer orders, reduced revenues, reduced margins, reduced levels of profitability and loss of market share. We expect competitive pressure to remain intense.

Fujitsu and its subsidiaries have, for many years, been key strategic channel partners for Sun, distributing substantial quantities of our products throughout the world. In addition, on May 31, 2004, we entered into a number of agreements with Fujitsu intended to substantially increase the scope of our relationship with them, including through collaborative selling efforts and joint development and marketing of a future generation of server products. However, Fujitsu is also a competitor of Sun and, as a licensee of various technologies from Sun and others, it has developed products that currently compete directly with our products.

Over the last several years, we have invested significantly in our network storage products business with a view to increasing the sales of these products both on a stand-alone basis to customers using the systems of our competitors, and as part of the systems that we sell. The intelligent storage products business is intensely competitive. EMC is currently a leader in the network storage products market and our primary competitor.

We are continuing the implementation of a solution-based selling approach. While our strategy is that this will enable us to increase our revenues and margins, there can be no assurance that we will be successful in this approach. In fact, our implementation of this selling model may result in reductions in our revenues and/or margins, particularly in the short term, as we compete to attract business. In addition, if our emphasis on solution-based sales increases, we face strong competition from systems integrators such as IBM, Fujitsu-Siemens and HP. Our inability to successfully implement this model in the long term would have a material adverse impact on our revenues and margins.

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We maintain higher research and development costs, as a percentage of total net revenues, than many of our competitors and our earnings are dependent upon maintaining revenues and gross margins at a sufficient level to offset these costs.

One of our business strategies is to derive a competitive advantage and a resulting enhancement of our gross margins from our investment in innovative new technologies which customers value. As a result, as a percentage of total net revenues, we incur higher fixed R&D costs than many of our competitors. To the extent that we are unable to develop and sell products with attractive gross margins in sufficient volumes, our earnings may be materially and adversely affected by our cost structure. We continue to add new products to our entry-level server product line that are offered at a lower price point and, accordingly, provide us with a lower gross margin percentage than our products as a whole. Although our strategy is to sell these products as part of overall systems which include other products with higher gross margin percentages, to the extent that the mix of our overall revenues represented by sales of lower gross margin products increases, as it did during much of fiscal 2005, our gross margins and earnings may be materially and adversely affected.

In addition, one of our business strategies is to grow incremental revenue through recurring service models, such as subscriptions, leasing and pay-per-use. Under these recurring service models, we would recognize revenue for the contract incrementally over time or based upon usage rather than all at once upon the initial sale of a hardware or software product. However, if we increase our recurring service model base either while (1) not maintaining or increasing our point product sales; or (2) not growing them sufficiently to cover the decline in point product sales, we will incur a near-term reduction in our revenues, as revenues that ordinarily would have been recognized upon the initial sale of products will be deferred until future periods, which would have a material adverse effect on our revenues, gross margins and earnings.

The products we make are very complex. If we are unable to rapidly and successfully develop and introduce new products and manage our inventory, we will not be able to satisfy customer demand.

We operate in a highly competitive, quickly changing environment, and our future success depends on our ability to develop and introduce new products that our customers choose to buy. If we are unable to develop new products, our business and operating results could be adversely affected. We must quickly develop, introduce, and deliver in quantity new, complex systems, software, and hardware products and components. These include products that incorporate our UltraSPARC IV architecture and the Solaris Operating System (Solaris OS), the Java platform, Sun Java System portfolio and N1 Grid architecture, among others. The development process for these complicated products is very uncertain. It requires high levels of innovation from both our product designers and the suppliers of the components used in our products. The development process is also lengthy and costly. If we fail to accurately anticipate our customers’ needs and technological trends, or are otherwise unable to complete the development of a product on a timely basis, we will be unable to introduce new products into the market on a timely basis, if at all, and our business and operating results would be materially and adversely affected.

The manufacture and introduction of our new products is also a complicated process. Once we have developed a new product, we face several challenges in the manufacturing process. We must be able to manufacture new products in sufficient volumes so that we can have an adequate supply of new products to meet customer demand. We must also be able to manufacture the new products at acceptable costs. This requires us to be able to accurately forecast customer demand so that we can procure the appropriate components at optimal costs. Forecasting demand requires us to predict order volumes, the correct mix of our hardware and software products, and the correct configurations of these products. We must manage new product introductions and transitions to minimize the impact of customer-delayed purchases of existing products in anticipation of new product releases. We must also try to reduce the levels of older product and component inventories to minimize inventory write-offs. If we have excess inventory, it may be necessary to reduce our prices and write down inventory, which could result in lower gross margins. Additionally, our customers may delay orders for existing products in anticipation of new product introductions. As a result, we may decide to adjust prices of our existing products during this process to try to increase customer demand for these products. Our future operating results would be materially and adversely affected if such pricing adjustments were to occur and we were unable to mitigate the resulting margin pressure by maintaining a favorable mix of systems, software, service and other products, or if we were unsuccessful in achieving component cost reductions, operating efficiencies and increasing sales volumes.

If we are unable to timely develop, manufacture, and introduce new products in sufficient quantity to meet customer demand at acceptable costs, or if we are unable to correctly anticipate customer demand for our new and existing products, our business and operating results could be materially adversely affected.

We face numerous risks associated with our strategic alliance with Fujitsu.

On May 31, 2004, we entered into a number of agreements with Fujitsu intended to substantially increase the scope of our relationship with them. These agreements contemplate collaborative sales and marketing efforts and the joint development and manufacturing of a future generation of server products known as the Advanced Product Line (APL). We anticipate that the APL will ultimately replace a proportion of our server product line and have agreed not to sell certain products which may compete with the APL at certain times as well as to purchase certain components solely from Fujitsu at certain times. In addition, the agreements contemplate that we dedicate substantial financial and human resources to this new relationship. As such, our future performance and financial condition will be impacted by the success or failure of this relationship.

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Joint development and marketing of a complex new product line is an inherently difficult undertaking and is subject to numerous risks. If we do not satisfy certain development or supply obligations under the agreements, or if we otherwise violate the terms of the agreements, we may be subject to significant contractual or legal penalties. Further, if Fujitsu encounters any of a number of potential problems in its business, such as intellectual property infringement claims, supply difficulties, difficulties in meeting development milestones or financial challenges, these could impact our strategic relationship with them and could result in a material adverse effect on our business or results of operations.

The contractual arrangements contain objectives and deliverables that are to be concluded in the near term, known in the agreements as the “Interim Period.” As the Interim Period commitments are foundational to the overall alliance, failure to achieve those commitments will place the overall alliance at risk.

There can be no assurance that our strategic relationship with Fujitsu will be successful or that the economic terms of the agreements establishing the relationship will ultimately prove to be favorable to us. If any of the risks described above come to pass, they may result in a material adverse effect on our business, results of operations or financial condition.

The competitive advantage we derive from controlling the development of our Solaris operating system may be reduced now that it has been released as open source software.

We have released our Solaris OS to the open source development community as open source software under an open source license. Although open source licensing models vary, generally open source software licenses permit the liberal copying, modification and distribution of a software program allowing a diverse programming community to contribute to the software. As a result of such release, there could be an impact on revenue related to our Solaris OS and we may no longer be able to exercise control over some aspects of the future development of the Solaris OS. In addition, the feature set and functionality of the Solaris OS may diverge from those that best serve our strategic objectives, move in directions in which we do not have competitive expertise or fork into multiple, potentially incompatible variations. We currently derive a significant competitive advantage from our development and licensing of Solaris and any of these events could reduce our competitive advantage or impact market demand for our products, software and services.

Our reliance on single source suppliers could delay product shipments and increase our costs.

We depend on many suppliers for the necessary parts and components to manufacture our products. There are a number of vendors producing the parts and components that we need. However, there are some components that can only be purchased from a single vendor due to price, quality or technology reasons. For example, we currently depend on Texas Instruments for the manufacture of our UltraSPARC microprocessors, AMD for the Opteron processors used in our Sun Fire x64 servers and several other companies for custom integrated circuits. If we were unable to purchase on acceptable terms or experienced significant delays or quality issues in the delivery of necessary parts and/or components from a particular vendor and we had to find a new supplier for these parts and components, our new and existing product shipments could be delayed which could have a material adverse effect on our business, results of operations and financial conditions.

Our future operating results depend on our ability to purchase a sufficient amount of components to meet the demands of our customers.

We depend heavily on our suppliers to design, manufacture, and deliver on a timely basis the necessary components for our products. While many of the components we purchase are standard, we do purchase some components, including color monitors, custom power supplies, application specific integrated circuits (ASICs) and custom memory and graphics devices, that require long lead times to manufacture and deliver. Long lead times make it difficult for us to plan component inventory levels in order to meet the customer demand for our products. In addition, in the past, we have experienced shortages in certain of our components (specifically, ASICs, dynamic random access memories (DRAMs) and static random access memories (SRAMs)). If a component delivery from a supplier is delayed, if we experience a shortage in one or more components, or if we are unable to provide for adequate levels of component inventory, our new and existing product shipments could be delayed and our business and operating results could be materially and adversely affected.

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Because we may order components from suppliers in advance of receipt of customer orders for our products which include these components, we could face a material inventory risk.

As part of our component planning, we place orders with or pay certain suppliers for components in advance of receipt of customer orders. We occasionally enter into negotiated orders with vendors early in the manufacturing process of our microprocessors to make sure we have enough of these components for our new products to meet anticipated customer demand. Because the design and manufacturing process for these components is very complicated it is possible that we could experience a design or manufacturing flaw that could delay or even prevent the production of the components for which we have previously committed to pay. We also face the risk of ordering too many components, or conversely, not enough components, since supply orders are generally based on forecasts of customer orders rather than actual customer orders. In addition, in some cases, we make noncancelable order commitments to our suppliers for work-in-progress, supplier’s finished goods, custom sub-assemblies and Sun unique raw materials that are necessary to meet our lead times for finished goods. If we cannot change or be released from supply orders, we could incur costs from the purchase of unusable components, either due to a delay in the production of the components or other supplies or as a result of inaccurately predicting supply orders in advance of customer orders. Our business and operating results could be materially and adversely affected as a result of these increased costs.

Delays in product development or customer acceptance and implementation of new products and technologies could seriously harm our business.

Generally, the computer systems we sell to customers incorporate various hardware and software products that we sell, such as UltraSPARC microprocessors, various software elements, from the Solaris OS to the Java platform, Sun Java System portfolio, N1 Grid, the SL8500 modular library system and Sun StorEdge array products. Any delay in the development, delivery or acceptance of key elements of the hardware or software included in our systems could delay our shipment of these systems. Delays in the development and introduction of our products may occur for various reasons.

In addition, if customers decided to delay the adoption and implementation of new releases of our Solaris OS this could also delay customer acceptance of new hardware products tied to that release. Implementing a new release of an operating environment requires a great deal of time and money for a customer to convert its systems to the new release. The customer must also work with software vendors who port their software applications to the new operating system and make sure these applications will run on the new operating system. As a result, customers may decide to delay their adoption of a new release of an operating system because of the cost of a new system and the effort involved to implement it. Such delays in product development and customer acceptance and implementation of new products could materially and adversely affect our business.

Our products may have quality issues that could adversely affect our sales and reputation.

In the course of conducting our business, we experience and address quality issues. Some of our hardware and software products contain defects, including defects in our engineering, design and manufacturing processes, as well as defects in third-party components included in our products, which may be beyond our control. Often defects are identified during our design, development and manufacturing processes and we are able to correct many of these. Sometimes defects are identified after introduction and shipment of new products or enhancements to existing products.

When a quality issue is identified, we work extensively with our customers to remedy such issues. We may test the affected product to determine the root cause of the problem and to determine appropriate solutions. We may find an appropriate solution (often called a “patch”) or offer a temporary fix while a permanent solution is being determined. If we are unable to determine the root cause, find an appropriate solution or offer a temporary fix, we may delay shipment to customers. We may, however, ship products while we continue to explore a suitable solution if we believe the defect is not significant to the product’s functionality.

Our international customers and operations subject us to a number of risks.

Currently, more than half of our revenues come from international sales. In addition, a portion of our operations consists of manufacturing and sales activities outside of the U.S. Our ability to sell our products and conduct our operations internationally is subject to a number of risks. Local economic, political and labor conditions in each country could adversely affect demand for our products and services or disrupt our operations in these markets. We may also experience reduced intellectual property protection or longer and more challenging collection cycles as a result of different customary business practices in certain countries where we do business which could have a material adverse effect on our business operations and financial results. Currency fluctuations could also materially and adversely affect our business in a number of ways. Although we take steps to reduce or eliminate certain foreign currency exposures that can be identified or quantified, we may incur currency translation losses as a result of our international operations. Further, in the event that currency fluctuations cause our products to become more expensive in overseas markets in local currencies, there could be a reduction in demand for our products or we could lower our pricing in some or all of these markets resulting in reduced revenue and margins. Alternatively, a weakening dollar could result in greater costs to us for our overseas

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operations. Changes to and compliance with a variety of foreign laws and regulations may increase our cost of doing business in these jurisdictions. Trade protection measures and import and export licensing requirements subject us to additional regulation and may prevent us from shipping products to a particular market, and increase our operating costs. In addition, we could be subject to regulations, fines and penalties for violations of import and export regulations. Although we implement policies and procedures designed to ensure compliance with these laws, there can be no assurance that all of our employees, contractors and agents, as well as those companies to which we outsource certain of our business operations, including those based in or from countries where practices which violate such United States laws may be customary, will not take actions in violations of our policies. These violations could result in penalties, including prohibiting us from exporting our products to one or more countries, and could materially and adversely affect our business.

Moreover, local laws and customs in many countries differ significantly from those in the U.S. We incur additional legal compliance costs associated with our international operations and could become subject to legal penalties in foreign countries if we do not comply with local laws and regulations, which may be substantially different from those in the United States. In many foreign countries, particularly in those with developing economies, it is common for local businesses to engage in business practices that are prohibited by United States regulations applicable to us such as the Foreign Corrupt Practices Act. Although we implement policies and procedures designed to ensure compliance with these laws, there can be no assurance that all of our employees, contractors and agents, as well as our resellers and those companies to which we outsource certain of our business operations, including those based in or from countries where practices which violate such United States laws may be customary, will not take actions in violations of our policies. Any such violation, even if prohibited by our policies, could have a material adverse effect on our business.

Failure to successfully implement our global resourcing activities could adversely affect our results of operations.

We continuously seek to make our cost structure more efficient and focus on our core strengths. We continue to develop and implement our global resourcing strategy and operating model which includes activities that are focused on increasing workforce flexibility and scalability, and improving overall competitiveness by leveraging external talent and skills worldwide. To the extent we rely on partners or third party service providers for the provision of key business process functions, we may incur increased business continuity risks. We may no longer be able to exercise control over some aspects of the future development, support or maintenance of outsourced operations and processes, including the internal controls associated with those outsourced business operations and processes, which could adversely affect our business. If we are unable to effectively develop and implement our resourcing strategy due to, among other things, data protection, contract and regulatory compliance issues, we may not realize cost structure efficiencies and our operating and financial results could be materially and adversely affected. In addition, if we are unable to effectively utilize or integrate and interoperate with external resources or if our partners or third party service providers experience business difficulties or are unable to provide business process services as anticipated, we may need to seek alternative service providers or resume providing these business processes internally, which could be costly and time consuming and have a material adverse material effect on our operating and financial results.

We expect our quarterly revenues, cash flows and operating results to fluctuate for a number of reasons.

Future operating results and cash flows will continue to be subject to quarterly fluctuations based on a wide variety of factors, including:

Seasonality. Although our sales and other operating results can be influenced by a number of factors and historical results are not necessarily indicative of future results, our sequential quarterly operating results generally fluctuate downward in the first and third quarters of each fiscal year when compared with the immediately preceding quarter.

Linearity. Our quarterly sales have historically reflected a pattern in which a disproportionate percentage of such quarter’s total revenues occur in the last month of the quarter. This pattern can make prediction of revenues, earnings and working capital for each financial period difficult and uncertain and increase the risk of unanticipated variations in quarterly results and financial condition.

Foreign Currency Fluctuations. As a large portion of our business takes place outside of the U.S., we enter into transactions in other currencies. Although we employ various hedging strategies, we are exposed to changes in exchange rates, which causes fluctuations in our quarterly operating results. See Part II, Item 7A. “Quantitative and Qualitative Disclosures About Market Risk — Foreign Currency Exchange Risk.”

Deferred Tax Assets. Estimates and judgments are required in the calculation of certain tax liabilities and in the determination of the recoverability of certain of the deferred tax assets, which arise from net operating losses, tax carryforwards and temporary differences between the tax and financial statement recognition of revenue and expense. SFAS No. 109, “Accounting for Income Taxes,” also requires that the deferred tax assets be reduced by a valuation allowance, if based on the weight of available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods.

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In evaluating our ability to recover our deferred tax assets, in full or in part, we consider all available positive and negative evidence including our past operating results, the existence of cumulative losses in the most recent fiscal years and our forecast of future taxable income on a jurisdiction by jurisdiction basis. In determining future taxable income, we are responsible for the assumptions utilized including the amount of state, federal and international pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses. Cumulative losses incurred in the U.S. and certain foreign jurisdictions in recent years and insufficient forecasted future taxable income in certain other foreign jurisdictions represented sufficient negative evidence to require full and partial valuation allowances in these jurisdictions. We have established a valuation allowance against the deferred tax assets in these jurisdictions, which will remain until sufficient positive evidence exists to support reversal. Future reversals or increases to our valuation allowance could have a significant impact on our future earnings.

Goodwill and Other Intangible Assets. We perform an analysis on our goodwill balances to test for impairment on an annual basis or whenever events occur that may indicate impairment possibly exists. Goodwill is deemed to be impaired if the net book value of the reporting unit exceeds the estimated fair value. The impairment of a long-lived intangible asset is only deemed to have occurred if the sum of the forecasted undiscounted future cash flows related to the asset are less than the carrying value of the intangible asset we are testing for impairment. If the forecasted cash flows are less than the carrying value, then we must write down the carrying value to its estimated fair value. We recognized an impairment charge of $49 million related to our goodwill during the fourth quarter of fiscal 2004 and an impairment charge of $2.1 billion related to our goodwill and other intangible assets during the second quarter of fiscal 2003. As of September 25, 2005, we had a goodwill balance of $2,466 million. Going forward we will continue to review our goodwill and other intangible assets for possible impairment. Any additional impairment charges could adversely affect our future earnings.

Income tax laws and regulations subject us to a number of risks and could result in significant liabilities and costs.

As a multinational corporation, we are subject to income taxes in both the U.S. and various foreign jurisdictions. Our domestic and foreign tax liabilities are subject to the allocation of revenues and expenses in different jurisdictions. Additionally, the amount of income taxes paid is subject to our interpretation of applicable tax laws in the jurisdictions in which we operate. We are regularly subject to audits by tax authorities. While we believe we have complied with all applicable income tax laws, there can be no assurance that a governing tax authority will not have a different interpretation of the law and reallocate revenues and expenses resulting in additional taxes. We regularly review the likelihood of adverse outcomes resulting from these audits to determine if additional income taxes, penalties and interest would be assessed. There can be no assurance that the outcomes from these audits will not have an adverse effect on the Company’s results of operations in the period for which the review is made.

We are dependent on significant customers and specific industries.

Sales to General Electric Company (GE) and its subsidiaries in the aggregate accounted for approximately 16%, 14% and 11% of our fiscal 2005, 2004 and 2003 net revenues, respectively. More than 80% of the revenue attributed to GE was generated through GE subsidiaries acting as either a reseller or financier of our products. The vast majority of this revenue is from a single GE subsidiary, comprising 13%, 11% and 9% of net revenues in fiscal 2005, 2004 and 2003, respectively. This GE subsidiary acts as a distributor of our products to resellers who in turn sell those products to end users. No other customer accounted for more than 10% of net revenues. The revenues from GE are generated in the Product Group and Sun Services segments.

We also depend on the telecommunications, financial services and government sectors for a significant portion of our revenues. Our revenues are dependent on the level of technology capital spending in the U.S. and international economies. If the current uncertain economic conditions continue in some or all of these sectors and geographies, we would expect that the significant reduction and deferrals of capital spending could continue. If capital spending declines in these industries over an extended period of time, our business will continue to be materially and adversely affected. We continue to execute on our strategy to reduce our dependence on these industries by expanding our product reach into new industries, but no assurance can be given that this strategy will be successful.

We are dependent upon our channel partners for a significant portion of our revenues.

Our channel partners include distributors, original equipment manufacturers (OEMs), independent software vendors (ISVs), system integrators, service providers and resellers. We continue to see an increase in revenues via our reseller channel. We face ongoing business risks due to our reliance on our channel partners to maintain customer relationships and create customer demand with customers where we have no direct relationships. Should the effectiveness of our channel partners decline, we face risk of declining demand which could affect our results of operations.

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Our business may suffer if it is alleged or found that we have infringed the intellectual property rights of others.

From time to time we have been notified that we may be infringing certain patents or other intellectual property rights of others. Responding to such claims, regardless of their merit, can be time consuming, result in costly litigation, divert management’s attention and resources and cause us to incur significant expenses. Several pending claims are in various stages of evaluation. From time to time, we consider the desirability of entering into licensing agreements in certain of these claims. No assurance can be given that licenses can be obtained on acceptable terms or that litigation will not occur. In the event there is a temporary or permanent injunction entered prohibiting us from marketing or selling certain of our products, or a successful claim of infringement against us requiring us to pay royalties to a third party, and we fail to license such technology on acceptable terms and conditions or to develop or license a substitute technology, our business, results of operations or financial condition could be materially adversely affected. See Part II, Item 1, “Legal Proceedings” for further discussion.

We face costs and risks associated with remediating a material weakness in our internal control over financial reporting and compliance with Section 404 of the Sarbanes-Oxley Act.

In our Annual Report on Form 10-K for the fiscal year ended June 30, 2005, we identified a material weakness in our internal control over financial reporting that resulted from deficiencies in the design and operation of our controls related to the review of accounting for income tax reserves. Because of this material weakness, our management determined as of June 30, 2005, that we did not maintain effective internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Further, we have not yet fully remediated this material weakness and, therefore, our Chief Executive Officer and our Chief Financial Officer have concluded in connection with this Quarterly Report on Form 10-Q that our disclosure controls and procedures were not effective as of September 25, 2005.

In response to this material weakness in our internal control over financial reporting, we are implementing additional controls and procedures and are incurring additional related expenses. We cannot be certain that the measures we have taken and are planning to take will sufficiently and satisfactorily remediate the identified material weakness in full. Furthermore, we intend to continue improving our internal control over financial reporting and the implementation and testing of these efforts to implement improvements could result in increased cost and could divert management attention away from operating our business. In addition, we acquired three publicly-traded companies in the first quarter of fiscal 2006. There can be no assurance that we will be able to properly integrate the internal control processes of these acquired companies into our internal controls over financial reporting.

If we are unable to remediate the identified material weakness discussed above, or if additional material weaknesses are identified in our internal control over financial reporting, whether as a result of acquisitions or otherwise, our management will be unable to report favorably as to the effectiveness of our internal control over financial reporting and/or our disclosure controls and procedures and we could be required to further implement expensive and distracting remedial measures and potentially lose investor confidence in the accuracy and completeness of our financial reports which could have an adverse effect on our stock price and potentially subject us to litigation.

Our acquisition and alliance activities could disrupt our ongoing business and diminish the anticipated value of these acquisitions and alliances. In addition, the full operational integration of certain non-US subsidiaries of SeeBeyond and StorageTek into Sun has been delayed due to compliance with local laws in certain jurisdictions, primarily in Europe. As a result, Sun may incur additional expenses or miss revenue opportunities until the operations are integrated.

We expect to continue to make investments in companies, products, and technologies, either through acquisitions or investments or alliances. For example, we have purchased several companies in the past and have also formed alliances, such as our strategic relationship with Fujitsu for the development, manufacturing and marketing of server products and our OEM relationship with Hitachi Data Systems for the collaboration on, and delivery of, a broad range of storage products and services. We also rely on IT services partners and independent software developers to enhance the value to our customers of our products and services. Acquisitions and alliance activities often involve risks, including: (1) difficulty in assimilating the acquired operations and employees; (2) difficulty in managing product co-development activities with our alliance partners; (3) retaining the key employees of the acquired operation; (4) disruption of our or the acquired company’s ongoing business; (5) inability to successfully integrate the acquired technology and operations into our business and maintain uniform standards, controls, policies, and procedures; and (6) lacking the experience to enter into new product or technology markets. In addition, from time to time, our competitors acquire or enter into exclusive arrangements with companies with whom we do business or may do business in the future. Reductions in the number of partners with whom we may do business in a particular context may reduce our ability to enter into critical alliances on attractive terms or at all, and the termination of an existing alliance by a business partner may disrupt our operations.

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In August 2005, we acquired StorageTek and SeeBeyond, both U.S. publicly traded companies. In addition to the risks we generally face in connection with acquisitions, there are several unique risks we face in connection with the StorageTek and SeeBeyond acquisitions. Our due diligence investigations of these two companies have been limited, and there may be liabilities, accounting issues or internal control issues of which we were not aware. We have little experience integrating and managing significant acquisitions of public companies with substantial employee bases. Integration issues are complex, time-consuming and expensive and without proper planning and implementation, they could significantly disrupt our business. In addition, although the acquisitions of StorageTek and SeeBeyond were completed in August 2005, local laws in certain jurisdictions, primarily in Europe, require that, in those jurisdictions, we operate the Sun subsidiaries separately from the StorageTek and SeeBeyond subsidiaries until certain legal requirements are satisfied. The simultaneous integration of both StorageTek and SeeBeyond, as well as our acquisition of Tarantella, could divert management’s attention from managing our existing on-going business. Additionally, we could fail to coordinate and integrate the substantial international operations, relationships and facilities, of these companies which may be subject to additional constraints imposed by local laws and regulations. Moreover, we may have higher than anticipated costs in continuing support and development of the products from these acquisitions. Our failure to effectively consolidate our facilities, IT operations and other administrative operations with those of these companies could affect anticipated synergies. In addition, coordinating our sales and marketing efforts to effectively and efficiently sell the products of our combined company may prove unsuccessful. Our failure to properly motivate the sales forces of these companies could cause retention issues that could materially affect the success of the acquisitions. Finally, our failure to persuade employees that our business cultures are compatible, or our inability to maintain good employee morale and retain key employees, could materially affect our business operations. If we fail to successfully address these integration challenges in a timely manner, or at all, we may not realize the anticipated benefits or synergies of the transactions to the extent, or in the time frame, anticipated. Even if these acquisitions are successfully integrated, we may not receive the expected benefits of the transactions, which are based on forecasts which are subject to numerous assumptions which may prove to be inaccurate. Any one of these integration challenges or any combination thereof could materially affect our results of operations.

We may be materially affected by a decrease in demand for our tape products or by an inability to maintain key competitive advantages in tape

As a result of the acquisition of StorageTek, a significant portion of Network Storage products revenue will be generated by sales of our tape products If overall demand for tape storage products declines, or if we lose significant market share in tape, our financial condition and results of operations could be materially affected.

One of the key competitive advantages that our tape products have over competing disk products is that tape products store data at a fraction of the price of disk storage. The price of disk storage continues to decrease rapidly due to competition and decreasing manufacturing costs associated with new disk drive technologies such as ATA disk. We must continue to develop and introduce new tape products that reduce the cost of tape storage at a rate that is similar to or greater than the decline in disk storage costs in order to maintain this competitive advantage. For a discussion of risk associated with new products, see “The products we make are very complex. If we are unable to rapidly and successfully develop and introduce new products and manage our inventory, we will not be able to satisfy customer demand,” above. We cannot provide any assurance that we will be able to reduce the price of our tape products at a rate similar to the decline in disk storage costs.

Our credit rating is subject to downgrade.

Three credit rating agencies follow Sun. Fitch Ratings has rated us BBB-, which is an investment grade rating. Moody’s Investor Services has assigned us a non-investment grade rating of Ba1. Standard & Poor’s has assigned us a long-term non-investment grade rating of BB+ and a short-term investment-grade rating of A-3. All three credit rating agencies have placed us on stable outlook. These ratings reflect those credit agencies’ expectations that the intense competitive environment facing Sun in its core markets will continue to challenge Sun’s revenue and profitability, at least over the near term. If we were to be downgraded by these ratings agencies, such downgrades could increase our costs of obtaining, or make it more difficult to obtain or issue, new debt financing. In addition, downgrades could affect our interest rate swap agreements that we use to modify the interest characteristics of any new debt. Any of these events could materially and adversely affect our business and financial condition.

We depend on key employees and face competition in hiring and retaining qualified employees.

Our employees are vital to our success, and our key management, engineering, and other employees are difficult to replace. We generally do not have employment contracts with our key employees. Further, we do not maintain key person life insurance on any of our employees. Because our compensation packages include equity-based incentives, pressure on our stock price could affect our ability to offer competitive compensation packages to current employees. In addition, we must continue to motivate employees and

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keep them focused on our strategies and goals, which may be difficult due to morale challenges posed by our workforce reductions, global resourcing strategies and related uncertainties. Should these conditions continue, we may not be able to retain highly qualified employees in the future which could adversely affect our business.

Our use of a self-insurance program to cover certain claims for losses suffered and costs or expenses incurred could negatively impact our business upon the occurrence of an uninsured event.

Sun has adopted a program of self-insurance with regard to certain risks such as California earthquakes and as supplemental coverage for certain potential liabilities including, but not limited to general liability, directors and officers liability, workers compensation, errors and omissions liability and property. We self-insure when we believe the lack of availability and high cost of commercially available insurance products do not make the transfer of this risk a reasonable approach. In the event that the frequency of losses experienced by Sun increased unexpectedly, the aggregate of such losses could materially increase our liability and adversely affect our financial condition, liquidity, cash flows and results of operations. In addition, while the insurance market continues to limit the availability of certain insurance products while increasing the costs of such products, we will continue to evaluate the levels of claims we include in our self-insurance program. Any increases to this program increase our risk exposure and therefore increase the risk of a possible material adverse effect on our financial condition, liquidity, cash flows and results of operations. In addition, we have made certain judgments as to the limits on our existing insurance coverage that we believe are in line with industry standards, as well as in light of economic and availability considerations. Unforeseen catastrophic loss scenarios could prove our limits to be inadequate, and losses incurred in connection with the known claims we self-insure could be substantial. Either of these circumstances could materially adversely affect our financial and business condition.

Business interruptions could adversely affect our business.

Our operations and those of our suppliers are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure, terrorist attacks and other events beyond our control. A substantial portion of our facilities, including our corporate headquarters and other critical business operations, are located near major earthquake faults. In addition, some of our facilities are located on filled land and, therefore, may be more susceptible to damage if an earthquake occurs. We do not carry earthquake insurance for direct earthquake-related losses. In addition, we do not carry business interruption insurance for, nor do we carry financial reserves against, business interruptions arising from earthquakes or certain other events. If a business interruption occurs, our business could be materially and adversely affected.

Recently issued regulations related to equity compensation could adversely affect our ability to attract, retain and motivate key personnel.

Since our inception, we have used stock options and other long-term equity incentives as a fundamental component of our employee compensation packages. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder value and, through the use of vesting, encourage employees to remain with Sun. The FASB issued changes to U.S. GAAP that requires us to record a charge to earnings for new and unvested employee stock option grants beginning on July 1, 2005. This regulation has made it more expensive to grant stock options to employees and has negatively impact our reported earnings by $50 million for the first quarter of fiscal year 2006. In addition, regulations of the Nasdaq National Market that require shareholder approval for all stock option plans, and regulations implemented by the New York Stock Exchange that prohibit NYSE member organizations from giving a proxy to vote on equity-compensation plans unless the beneficial owner of the shares has given voting instructions, could make it more difficult for us to grant options to employees in the future. To the extent that new regulations make it more difficult or expensive to grant stock options to employees, we may change our equity compensation strategy, which may make it difficult to attract, retain and motivate key employees, which in turn could materially and adversely affect our business.

Our failure to comply with contractual obligations may result in significant penalties.

We offer terms to some of our distributors and other customers that, in some cases, include complex provisions for pricing, data protection and other terms. In connection with these contracts, we are in some cases required to allow the customer to audit certain of our records to verify compliance with these terms. In particular, government agency customers audit and investigate government contractors, including us. These agencies review our performance under the applicable contracts as well as compliance with applicable laws, regulations and standards. It is the general practice of government agencies to subject commercial companies, such as ours, to renegotiation of existing contracts. To the extent that significant adjustments to our government contractual terms result from such renegotiations, our business and results of operations could be materially impacted. The government also may review the adequacy of, and our compliance with, contractual obligations, our internal control systems and policies, including our purchasing, property, estimating, compensation, management information systems and data protection requirements. If an audit uncovers improper or illegal activities, we may be subject to penalties and other sanctions. In addition, we could suffer serious harm to our reputation if allegations of impropriety were made against us. The General Services Administration is currently auditing the schedule contract it has with us.

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Some of our Restructuring Plans may not result in the anticipated cost saving and benefits.

Since March 2004, our Board of Directors and our management approved Restructuring Plans IV and V. Our ability to achieve the cost savings and operating efficiencies anticipated by these restructuring plans is dependent on our ability to effectively implement the workforce and excess capacity reductions contemplated. If we are unable to implement these initiatives effectively, we may not achieve the level of cost savings and efficiency benefits expected for fiscal 2006 and beyond.

Uncertain economic conditions could affect our ability to sublease properties in our portfolio.

In response to the global economic slowdown, we implemented facility exit plans in each of the last five fiscal years as part of our ongoing efforts to consolidate excess facilities. The uncertain economic conditions in the United States and in many of the countries in which we have significant leased properties have resulted in a surplus of business facilities making it difficult to sublease properties. We may be unable to sublease our excess properties, or we may not meet our expected estimated levels of subleasing income, and accordingly our results of operations could be materially and adversely affected.

Environmental laws and regulations subject us to a number of risks and could result in significant liabilities and costs.

Some of our operations are subject to state, federal, and international laws governing protection of the environment, human health and safety, and regulating the use of certain chemical substances. We endeavor to comply with these environmental laws, yet compliance with such laws could increase our operations and product costs; increase the complexities of product design, procurement, and manufacture; limit our sales activities; and impact our future financial results. Any violation of these laws can subject us to significant liability, including fines, penalties, and prohibiting sales of our products into one or more states or countries, and result in a material adverse effect on our financial condition.

Currently, a significant portion of our revenues come from international sales. Recent environmental legislation within the European Union (EU) may increase our cost of doing business internationally and impact our revenues from EU countries as we comply with and implement these new requirements. The EU has published Directives on the restriction of certain hazardous substances in electronic and electrical equipment (the RoHS Directive), and on electronic and electrical waste management (the WEEE Directive).

Under the RoHS Directive, specified electronic products which we place on the market in the EU must meet the restrictions on lead and certain other chemical substances as of July 1, 2006. We must adjust our product composition and design to respond to the RoHS Directive, which may increase our research and development, manufacturing, procurement, and quality control costs, may affect product performance, and could result in product delays. If we are unable to introduce new products to conform to the RoHS Directive substance restrictions, sales of our products within the EU could decline. In addition, certain electronic products that we maintain in inventory may be rendered obsolete if not in compliance with the substance restriction, which could negatively impact our ability to generate revenue from those products.

The WEEE Directive makes producers of certain electrical and electronic equipment financially responsible for collection, reuse, recycling, treatment, and disposal of equipment placed on the EU market after August 13, 2005. The WEEE Directive also makes commercial end users of electronic equipment financially responsible for the collection and management of equipment placed on the market before the August 2005 date. In our capacity as a producer of electronic equipment, we must bear the costs of taking back products we sell into the EU and managing the treatment and ultimate disposal of these products. As an end user of electronic equipment in our EU business operations, we must also bear the cost of managing this waste equipment at the end of its useful life. The WEEE Directive also requires labeling products placed on the EU market after the August 2005 date. As a result of these obligations, our product distribution, logistics and waste management costs may increase and may adversely impact our financial condition. Certain member states within the EU have begun to promulgate national enabling legislation under the WEEE Directive, but others have yet to enact such legislation. In the absence of this legislation, it is difficult to determine the amount of expenses necessary to comply with the WEEE Directive. However, in our capacity as an end user, we will account for our historic waste equipment in accordance with the Financial Accounting Standards Board FSP 143-1 pronouncement published on June 8, 2005, which requires such waste be treated as an asset retirement obligation. Our liability as a producer of waste electronic and electrical equipment is not covered by the FASB pronouncement and is assumed to be treated as a a non-current accrued liability starting on August 13, 2005.

Similar environmental legislation has been or may be enacted in other jurisdictions, including the U.S. (under federal and state laws), and China, the cumulative impact of which could be significant. We are committed to offering products that are environmentally responsible and to complying with any current or future laws protecting the environment, human health and safety.

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Our stock price can be volatile.

Our stock price, like that of other technology companies, continues to be volatile. For example, our stock price can be affected by many factors such as quarterly increases or decreases in our earnings, speculation in the investment community about our financial condition or results of operations and changes in revenue or earnings estimates, downgrades in our credit ratings, announcement of new products, technological developments, alliances, acquisitions or divestitures by us or one of our competitors or the loss of key management personnel. In addition, general macroeconomic and market conditions unrelated to our financial performance may also affect our stock price.

FORWARD-LOOKING STATEMENTS

This quarterly report, including the foregoing sections, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, particularly statements: that Sun’s business is singularly focused on providing network and computing products and services; that, with the recent acquisition of StorageTek, we have broadened our system strategy by offering our customers a complete range of storage products, services and solutions; that we acquired Tarantella to enhance our thin-client product offerings and strengthen our utility computing strategy; that we acquired SeeBeyond to strengthen our software portfolio and create a complete offering for the development, deployment and management of enterprise applications and service oriented architectures; that we acquired StorageTek in order to offer customers a complete range of products, services and solutions for securely managing mission-critical data assets; that we plan to eliminate excess facility capacity in light of revised facility requirements; that we anticipate recording additional charges related to our workforce and facilities reductions over the next several quarters, the timing of which will depend upon the timing of notification of the employees leaving Sun as determined by local employment laws and as we exit facilities; that we anticipate incurring additional charges associated with productivity improvement initiatives and expense reduction measures; that we are currently reviewing the impact of our acquisition of StorageTek to our operating segment disclosure and anticipate that it may result in a change in our operating segments; that we intend to present a vigorous defense in the Gobelli patent infringement case; that there is a continuing market shift in overall computer system demand away from our data center servers towards the usage of entry level servers; that there is a continued change in the mix towards maintenance contracts sold or renewed with lower service levels and a shift in product sales mix to a greater proportion of low-end products, which are typically sold with reduced levels of service; that as a result of our acquisition of StorageTek, we are conducting an evaluation of the key performance indicators used to mange our business and anticipate change; that in the second quarter of fiscal 2006, we expect our products gross margin to be negatively impacted by increased amortization expense associated with acquisition-related intangible assets as well as a full quarter of expense related to the operations of StorageTek; that we believe that to maintain our competitive position in a market characterized by rapid rates of technological advancement, we must continue to invest significant resources in new systems, software, and microprocessor development, as well as continue to enhance existing products; that in the second quarter of fiscal 2006, we expect our SG&A expenses to be negatively impacted by increased amortization expense associated with acquisition-related intangible assets as well as a full quarter of expense related to the operations of StorageTek and SeeBeyond; that we are continuing to focus our efforts on achieving additional operating efficiencies by reviewing and improving upon our existing business processes and cost structure; that the volatility of our portfolio of marketable debt securities will increase as its duration increases; that inventory management will continue to be an area of focus as we balance the meet to maintain sufficient inventory levels to help ensure competitive lead times with the risk of inventory obsolescence due to rapidly changing technology and customer requirements; that we believe that the liquidity provided by existing cash, cash equivalents, marketable debt securities and cash generated from operations will provide sufficient capital to meet our requirements for at least the next 12 months; that we believe our level of financial resources is a significant competitive factor in our industry and we may choose at any time to raise additional capital to strengthen our financial position, facilitate growth and provide us with additional flexibility to take advance of business opportunities that arise; and that our current plan anticipates that we will remediate our material weakness in our internal controls over financial reporting prior to the end of fiscal year 2006.

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These forward-looking statements involve risks and uncertainties, and the cautionary statements set forth above and those contained in “RISK FACTORS,” identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. Such factors include, but are not limited to, increased competition, increased pricing pressures, failure to maintain sufficient revenues and gross margin to offset our higher research and development costs, the complexity of our products and the importance of rapidly and successfully developing and introducing new products, failure associated with the Fujitsu strategic alliance, risks associated with releasing our Solaris operating system to the open source development community as open source software, reliance on single source suppliers, lack of acceptance of new products and services, unexpected changes in the demand for our products and services, delays in product introductions and projects, lack of success implementing new selling models, failure to further reduce costs or improve operating efficiencies, adverse business conditions, quality issues associated with our hardware or software products, our dependence on currency fluctuations, fluctuation in our quarterly revenues, cash flows and operating results, our dependence on significant customers and specific industries, our dependence upon our channel partners for a significant portion of our revenue, our failure to comply with export control laws, costs and risks associated with remediating a material weakness in our internal controls over financial reporting and compliance with Section 404 of the Sarbanes-Oxley Act, our acquisitions and alliance activities could disrupt our ongoing business, our reliance on tape storage products and our ability to retain our price advantage over disk storage products, our dependence upon key employees, a change in our use of long-term equity incentives as a fundamental component of employee compensation as a result of regulatory changes might cause us to use such incentives less, making it difficult for us to attract, retain and motivate key personnel, that the uncertain economic conditions could affect our ability to sublease properties in our portfolio, and the risks and costs of complying with environmental laws and regulations.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk related to changes in interest rates, foreign currency exchange rates, and equity security prices. To mitigate some of these risks, we utilize derivative financial instruments to hedge these exposures. We do not use derivative financial instruments for speculative or trading purposes. All of the potential changes noted below are based on sensitivity analyses performed on our financial position at September 25, 2005. Actual results may differ materially.

Interest Rate Sensitivity

Our investment portfolio consists primarily of fixed income instruments with an average duration of 0.85 years as of September 25, 2005 as compared with 0.66 years as of September 26, 2004. The primary objective of our investments in debt securities is to preserve principal while maximizing yields, without significantly increasing risk. These available-for-sale securities are subject to interest rate risk. The fair market value of these securities may fluctuate with changes in interest rates. A sensitivity analysis was performed on this investment portfolio based on a modeling technique that measures the hypothetical fair market value changes (using a three-month horizon) that would result from a parallel shift in the yield curve of plus 150 basis points (BPS). Based on this analysis, for example, a hypothetical 150 BPS increase in interest rates would result in an approximate $44 million decrease in the fair value of our investments in debt securities as of September 25, 2005.

We have also entered into various interest-rate swap agreements to modify the interest characteristics of the Senior Notes so that the interest payable on the Senior Notes effectively becomes variable and thus matches the variable interest rate received from our cash and marketable debt securities. Accordingly, interest rate fluctuations impact the fair value of our Senior Notes outstanding, which will be offset by corresponding changes in the fair value of the swap agreements. However, by entering into these swap agreements, we have a cash flow exposure related to the risk that interest rates may increase. For example, at September 25, 2005, a hypothetical 150 BPS increase in interest rates would result in an approximate $16 million decrease in cash related to interest expense over a year.

Foreign Currency Exchange Risk

As a large portion of our business takes place outside of the U.S., we enter into transactions in other currencies. We are primarily exposed to changes in exchange rates for the Euro, Japanese yen, and British pound. We are a net receiver of currencies other than the U.S. dollar and, as such, can benefit from a weaker dollar, and can be adversely affected by a stronger dollar relative to major currencies worldwide. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, may adversely affect our consolidated revenue and operating margins as expressed in U.S. dollars. To minimize currency exposure gains and losses, we may borrow funds in local currencies, and we often enter into forward exchange contracts, purchase foreign currency options and promote natural hedges by purchasing components and incurring expenses in local currencies. Currently, we have no plans to discontinue our hedging programs; however, we may evaluate the benefits of our hedging strategies and may choose to discontinue them in the future.

Based on our foreign currency exchange instruments outstanding at September 25, 2005, we estimate a maximum potential one-day loss in fair value of approximately $1 million, as compared with $2 million as of June 30, 2005, using a Value-at-Risk (VAR) model. The VAR model estimates were made assuming normal market conditions and a 95% confidence level. We used a Monte Carlo simulation type model that valued foreign currency instruments against three thousand randomly generated market price paths. Anticipated transactions, firm commitments, receivables, and accounts payable denominated in foreign currencies were excluded from the model. The VAR model is a risk estimation tool, and as such is not intended to represent actual losses in fair value that will be incurred by us. Additionally, as we utilize foreign currency instruments for hedging anticipated and firmly committed transactions, a loss in fair value for those instruments is generally offset by increases in the value of the underlying exposure.

Equity Security Price Risk

We are exposed to price fluctuations on the marketable portion of equity securities included in our portfolio of equity investments. These investments are generally in companies in the high-technology industry sector, many of which are small capitalization stocks. We typically do not attempt to reduce or eliminate the market exposure on these securities. A 20% adverse change in equity prices would result in an approximate $5 million decrease in the fair value of our available-for-sale equity investments as of September 25, 2005, as compared with $8 million as of September 26, 2004. At September 25, 2005, two equity securities represented substantially of the $26 million total fair value of the marketable equity securities.

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ITEM 4. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures. Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q.

During the first quarter of 2006, we took steps toward remediating the identified material weakness related to the review of accounting for income tax reserves discussed in detail in our 2005 Form 10-K for the year ended June 30, 2005. However, as of September 25, 2005 we had not yet completed the remediation of this material weakness. Therefore, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures were not effective. Our current plan anticipates the remediation of this material weakness prior to the end of our fiscal year.

Changes in internal control over financial reporting. There was no change in our internal control over financial reporting that occurred during the fiscal quarter covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On April 20, 2004, we were served with a complaint in a case entitled Gobeli Research (Gobeli) v. Sun Microsystems, Inc. and Apple Computer, Inc. (Apple). The complaint alleges that Sun products, including our Solaris^TM Operating System, infringe on a Gobeli patent related to a system and method for controlling interrupt processing. Gobeli claims that Apple’s OS 9 and OS X operating systems violate that same patent. The case is pending in the United States District Court for the Eastern District of Texas. We have filed a response denying liability and stating various affirmative defenses, and we intend to present a vigorous defense.

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ITEM 6. EXHIBITS

See Index to Exhibits on Pages 49 hereof.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

SUN MICROSYSTEMS, INC.
BY	/s/ Stephen T. McGowan
	Stephen T. McGowan
	Chief Financial Officer and Executive Vice President, Corporate Resources (Principal Financial Officer)
	/s/ Robyn M. Denholm
	Robyn M. Denholm
	Senior Vice President, Finance (Principal Accounting Officer)

Dated: November 3, 2005

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INDEX TO EXHIBITS

Exhibit Number		Description
3.4		Bylaws of the Registrant, as amended September 22, 2005.
10.1	*	Representative form of restricted stock grant agreement under the 1990 Plan.
10.2	*	Chief Executive Officer Bonus Terms for FY06 under the Section 162(m) Executive Officer Performance-Based Bonus Plan.
10.3	*	Chief Operating Officer Bonus Terms for FY06 under the Section 162(m) Executive Officer Performance-Based Bonus Plan.
10.4	*	SMX Staff Executive Officer Bonus Terms for FY06 under the Section 162(m) Executive Officer Performance-Based Bonus Plan.
10.5	*	EMG Staff Executive Officer Bonus Terms for FY06 under the Section 162(m) Executive Officer Performance-Based Bonus Plan.
10.6	*	FY06 Quarterly SMI Bonus Plan
10.7	*	FY06 Base Salaries and Target Annual Incentive Awards for Named Executive Officers
10.8	*	FY05 Discretionary Bonus Payments for Named Executive Officers
15.1		Letter re Unaudited Interim Financial Information
31.1		Rule 13a-14(a) Certification of Chief Executive Officer
31.2		Rule 13a-14(a) Certification of Chief Financial Officer
32.1		Section 1350 Certificate of Chief Executive Officer
32.2		Section 1350 Certificate of Chief Financial Officer

* Indicates a management contract or compensatory plan or arrangement.

49

EX-3.4

Exhibit 3.4

BYLAWS

OF

SUN MICROSYSTEMS, INC.

(As adopted on December 14, 1990

and last amended as of September 22, 2005)

SMI Bylaws 1/30 September 22, 2005

TABLE OF CONTENTS

		Page
	ARTICLE I – CORPORATE OFFICES	5
1.1	REGISTERED OFFICE	5
1.2	OTHER OFFICES	5
	ARTICLE II – STOCKHOLDERS	5
2.1	PLACE OF MEETINGS	5
2.2	ANNUAL MEETING	5
2.3	SPECIAL MEETING	7
2.4	NOTICE OF STOCKHOLDERS’ MEETINGS	8
2.5	MANNER OF GIVING NOTICE; AFFIDAVIT OF NOTICE	8
2.6	QUORUM	8
2.7	ADJOURNED MEETING; NOTICE	9
2.8	CONDUCT OF BUSINESS	9
2.9	WAIVER OF NOTICE	9
2.10	STOCKHOLDER ACTION BY WRITTEN CONSENT WITHOUT A MEETING	9
2.11	RECORD DATE FOR STOCKHOLDER NOTICE; VOTING; GIVING CONSENTS	10
2.12	VOTING	11
2.13	PROXIES	12
2.14	LIST OF STOCKHOLDERS ENTITLED TO VOTE	12
2.15	INSPECTORS OF ELECTION	13
	ARTICLE III – DIRECTORS	13
3.1	POWERS	13
3.2	NUMBER OF DIRECTORS	13
3.3	ELECTION, QUALIFICATION AND TERM OF OFFICE OF DIRECTORS	14
3.4	RESIGNATION AND VACANCIES	14
3.5	PLACE OF MEETINGS; MEETINGS BY TELEPHONE	15

SMI Bylaws 2/30 September 22, 2005

		Page
3.6	REGULAR MEETINGS	16
3.7	SPECIAL MEETINGS; NOTICE	16
3.8	QUORUM	16
3.9	WAIVER OF NOTICE	16
3.10	CONDUCT OF BUSINESS	17
3.11	BOARD ACTION BY WRITTEN CONSENT WITHOUT A MEETING	17
3.12	FEES AND COMPENSATION OF DIRECTORS	17
3.13	APPROVAL OF LOANS TO OFFICERS	17
3.14	REMOVAL OF DIRECTORS	17
	ARTICLE IV – COMMITTEES	18
4.1	COMMITTEES OF DIRECTORS	18
4.2	COMMITTEE MINUTES	19
4.3	MEETINGS AND ACTION OF COMMITTEES	19
	ARTICLE V – OFFICERS	19
5.1	GENERAL MATTERS	19
5.2	APPOINTMENT OF OFFICERS	19
5.3	SUBORDINATE OFFICERS	20
5.4	REMOVAL AND RESIGNATION OF OFFICERS	20
5.5	VACANCIES IN OFFICES	20
5.6	CHAIRMAN OF THE BOARD	20
5.7	CHIEF EXECUTIVE OFFICER	20
5.8	PRESIDENT	21
5.9	VICE PRESIDENTS	21
5.10	SECRETARY	21
5.11	CHIEF FINANCIAL OFFICER	22
5.12	REPRESENTATION OF SHARES OF OTHER CORPORATIONS	22
5.13	AUTHORITY AND DUTIES OF OFFICERS	22
	ARTICLE VI – INDEMNITY	22
6.1	THIRD PARTY ACTIONS	22
6.2	ACTIONS BY OR IN THE RIGHT OF THE CORPORATION	23
6.3	SUCCESSFUL DEFENSE	23

SMI Bylaws 3/30 September 22, 2005

		Page
6.4	DETERMINATION OF CONDUCT	23
6.5	PAYMENT OF EXPENSES IN ADVANCE	24
6.6	INDEMNITY NOT EXCLUSIVE	24
6.7	INSURANCE INDEMNIFICATION	24
6.8	THE CORPORATION	24
6.9	EMPLOYEE BENEFIT PLANS	25
6.10	INDEMNITY FUND	25
6.11	INDEMNIFICATION OF OTHER PERSONS	25
6.12	SAVINGS CLAUSE	25
6.13	CONTINUATION OF INDEMNIFICATION AND ADVANCEMENT OF EXPENSES	25
	ARTICLE VII - RECORDS AND REPORTS	26
7.1	MAINTENANCE AND INSPECTION OF RECORDS	26
7.2	INSPECTION BY DIRECTORS	26
7.3	ANNUAL STATEMENT TO STOCKHOLDERS	26
	ARTICLE VIII - GENERAL MATTERS	27
8.1	CHECKS	27
8.2	EXECUTION OF CORPORATE CONTRACTS AND INSTRUMENTS	27
8.3	STOCK CERTIFICATES; PARTLY PAID SHARES	27
8.4	SPECIAL DESIGNATION ON CERTIFICATES	28
8.5	LOST CERTIFICATES	28
8.6	CONSTRUCTION; DEFINITIONS	28
8.7	DIVIDENDS	28
8.8	FISCAL YEAR	29
8.9	SEAL	29
8.10	TRANSFER OF STOCK	29
8.11	STOCK TRANSFER AGREEMENTS	29
8.12	REGISTERED STOCKHOLDERS	29
8.13	NOTICES	29
	ARTICLE IX – AMENDMENTS	30

SMI Bylaws 4/30 September 22, 2005

BYLAWS

OF

SUN MICROSYSTEMS, INC.

ARTICLE I

CORPORATE OFFICES

1.1 REGISTERED OFFICE

The registered office of the corporation shall be in the City of Wilmington, County of New Castle, State of Delaware. The name of the registered agent of the corporation at such location is The Corporation Trust Company.

1.2 OTHER OFFICES

The board of directors may at any time establish other offices at any place or places where the corporation is qualified to do business.

ARTICLE II

STOCKHOLDERS

2.1 PLACE OF MEETINGS

Meetings of stockholders shall be held at any place, within or outside the State of Delaware, designated by the board of directors. The Board may, in its sole discretion, determine that a meeting of stockholders shall not be held at any place, but may instead be held solely by means of remote communication as authorized by Section 211(a)(2) of the Delaware General Corporation Law (the “DGCL”). In the absence of any such designation or determination, stockholders’ meetings shall be held at the registered office of the corporation.

2.2 ANNUAL MEETING

The annual meeting of the stockholders of this corporation shall be held each year on a date and at a time designated by the board of directors. At the meeting, directors shall be elected and any other proper business may be transacted. Nominations of persons for election to the board of directors of the corporation and the proposal of business to be considered by the stockholders may be made at an annual meeting of stockholders only (a) pursuant to the corporation’s notice of meeting, (b) by or at the direction of the board of

SMI Bylaws 5/30 September 22, 2005

directors or (c) by any stockholder of the corporation who was a stockholder of record at the time of giving of notice provided for in these Bylaws, who is entitled to vote at the meeting and who complies with the notice procedures set forth in this Bylaw.

For nominations or other business to be properly brought before an annual meeting by a stockholder pursuant to clause (c) of the preceding sentence, the stockholder must have given timely notice thereof in writing to the secretary of the corporation and such other business must otherwise be a proper matter for stockholder action. To be timely, a stockholder proposal to be presented at an annual meeting must be delivered to the secretary of the corporation at the corporation’s principal executive offices not less than 60 or more than 90 calendar days prior to the first anniversary of the date that the corporation first mailed its proxy statement to stockholders in connection with the previous year’s annual meeting of stockholders, except that if no annual meeting was held in the previous year or the date of the annual meeting has been changed by more than 30 calendar days from the first anniversary date of the previous year’s annual meeting, notice by the stockholder to be timely must be received no later than the close of business on the tenth day following the day on which public announcement of the date of such annual meeting is first made. In no event shall the public announcement of an adjournment of an annual meeting commence a new period for the giving of a stockholder’s notice as described above. Such stockholder’s notice shall set forth (a) as to each person whom the stockholder proposes to nominate for election or reelection as a director all information relating to such person that is required to be disclosed in solicitations of proxies for election of director in an election contest, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (or any successor thereto) (the “Exchange Act”) and Rule 14a-11 thereunder (or any successor thereto) (including such person’s written consent to being named in the proxy statement as a nominee and to serving as a director if elected); (b) as to any other business that the stockholder proposes to bring before the meeting, a brief description of the business desired to be brought before the meeting, the reasons for conducting such business at the meeting and any material interest in such business of such stockholder and the beneficial owner, if any, on whose behalf the proposal is made; and (c) as to the stockholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made (i) the name and address of such stockholder, as they appear on the corporation’s books, and such beneficial owner, and (ii) the class and number of shares for the corporation which are owned beneficially and of record by such stockholder and such beneficial owner. Notwithstanding any provision herein to the contrary, no business shall be conducted at an annual meeting except in accordance with the procedures set forth in this Section 2.2. For purposes of Section 2.2 and 3.3 of these Bylaws “public announcement” shall mean disclosure in a press release reported by the Dow Jones News Service, Associated Press or a comparable national news service or in a document publicly filed by the corporation with the Securities and Exchange Commission pursuant to Section 13, 14 or 15(d) of the Exchange Act.

SMI Bylaws 6/30 September 22, 2005

2.3 SPECIAL MEETING

A special meeting of the stockholders may be called at any time by the board of directors, or by the chairman of the board, or by any executive officer of the corporation, or by one or more stockholders holding shares in the aggregate entitled to cast not less than ten percent of the votes at that meeting.

If a special meeting is called by any person or persons other than the board of directors, the request shall be in writing to the secretary of the corporation, and shall set forth (a) as to each person whom such person or persons propose to nominate for election or reelection as a director at such meeting all information relating to such proposed nominee that is required to be disclosed in solicitations of proxies for election of directors in an election contest, or is otherwise required, in each case pursuant to Regulation 14A under the Exchange Act (or any successor thereto) and Rule 14a-11 thereunder (or any successor thereto)(including such proposed nominee’s written consent to being named in the proxy statement as a nominee and to serving as a director if elected); (b) as to any other business to be taken the meeting, a brief description of such business, the reasons for conducting such business and any material interest in such business of the person or persons calling such meeting and the beneficial owners, if any, on whose behalf such meeting is called; and (c) as to the person or persons calling such meeting and the beneficial owners, if any, on whose behalf the meeting is called (i) the name and address of such persons, as they appear on the corporation’s books, and of such beneficial owners, and (ii) the class and number of shares of the corporation which are owned beneficially and of record by such persons and such beneficial owners. No business may be transacted at such special meeting otherwise than specified in such notice or by or at the direction of the corporation’s board of directors. Within twenty days after such request is received, the corporation’s secretary shall determine whether or not such request is valid and conforms to the requirements of this Section 2.3. If the secretary so determines, the board of directors shall have the sole authority to fix the place, date and hour of such meeting, which date shall be not less than sixty nor more than ninety days after the secretary’s determination, and the corporation’s secretary shall cause notice to be given to the stockholders entitled to vote, in accordance with the provisions of Sections 2.4 and 2.5. Nothing contained in this paragraph 2.3 shall be construed as limiting, fixing or affecting the time when a meeting of stockholders called by action of the board of directors may be held.

Only such business shall be conducted at a special meeting of stockholders called by action of the board of directors as shall have been brought before the meeting pursuant to the corporation’s notice of meeting.

This Section 2.3 may not be amended to eliminate the right of one or more stockholders holding shares in the aggregate entitled to cast not less than ten percent of the votes at a special meeting of stockholders to call such a special meeting of stockholders, unless holders of at least seventy-five percent of the shares entitled to vote thereon approve such an amendment.

SMI Bylaws 7/30 September 22, 2005

2.4 NOTICE OF STOCKHOLDERS’ MEETINGS

All notices of meetings with stockholders shall be in writing and shall be sent or otherwise given in accordance with Section 2.5 of these Bylaws not less than ten (10) nor more than sixty (60) days before the date of the meeting to each stockholder entitled to vote at such meeting, except as otherwise provided herein or required by law (meaning, here and hereinafter, as required from time to time by the General Corporation Law of Delaware or the certificate of incorporation of the corporation). The notice shall specify the place, date, and hour of the meeting, and, in the case of a special meeting, the purpose or purposes for which the meeting is called.

2.5 MANNER OF GIVING NOTICE; AFFIDAVIT OF NOTICE

Notice of any meeting of stockholders shall be given:

(i) if mailed, when deposited in the United States mail, postage prepaid, directed to the stockholder at his or her address as it appears on the corporation’s records; or

(ii) if electronically transmitted as provided in Section 232 of the General Corporation Law of Delaware of these bylaws.

An affidavit of the secretary or an assistant secretary of the corporation or of the transfer agent or any other agent of the corporation that the notice has been given by mail or by a form of electronic transmission, as applicable, shall, in the absence of fraud, be prima facie evidence of the facts stated therein.

Notice shall be deemed to have been given to all stockholders of record who share an address if notice is given in accordance with the “householding” rules set forth in Rule 14a-3(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”).

2.6 QUORUM

At any meeting of the stockholders, the holders of a majority of all of the shares of the stock entitled to vote at the meeting, present in person or by proxy, shall constitute a quorum for all purposes, unless or except to the extent that the presence of a larger number may be required by law. Where a separate vote by a class or classes is required, a majority of the shares of such class or classes entitled to take action with respect to that vote on that matter, present in person or by proxy, shall constitute a quorum. If a quorum shall fail to attend any meeting, the chairman of the meeting may adjourn the meeting to another place, date or time, without notice other than announcement at the meeting, until a quorum is present or represented. At such adjourned meeting at which a quorum is present or represented, any business may be transacted that might have been transacted at the meeting as originally noticed. The stockholders present at a duly called or convened meeting, at which a quorum is present, may continue to transact business until adjournment, notwithstanding the withdrawal of enough stockholders to leave less than a quorum.

SMI Bylaws 8/30 September 22, 2005

2.7 ADJOURNED MEETING; NOTICE

When a meeting is adjourned to another time or place, unless these bylaws otherwise require, notice need not be given of the adjourned meeting if the time, place, if any, thereof, and the means of remote communications, if any, by which stockholders and proxy holders may be deemed to be present in person and vote at such adjourned meeting are announced at the meeting at which the adjournment is taken. At the adjourned meeting, the corporation may transact any business which might have been transacted at the original meeting. If the adjournment is for more than 30 days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting.

2.8 CONDUCT OF BUSINESS

Such person as the board of directors may have designated or, in the absence of such a person, any executive officer of the corporation, shall call to order any meeting of the stockholders and act as chairman of the meeting. In the absence of the secretary of the corporation, the secretary of the meeting shall be such person as the chairman appoints. The chairman of any meeting of stockholders shall determine the order of business and the procedure at the meeting, including such regulation of the manner of voting and the conduct of discussion as seem to him in order. The date and time of the opening and closing of the polls for each matter upon which the stockholders will vote at the meeting shall be announced at the meeting.

2.9 WAIVER OF NOTICE

Whenever notice is required to be given under any provision of the General Corporation Law of Delaware or of the certificate of incorporation or these Bylaws, a written waiver thereof, signed by the person entitled to notice, whether before or after the time stated therein, shall be deemed equivalent to notice. Attendance of a person at a meeting shall constitute a waiver of notice of such meeting, except when the person attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the stockholders need be specified in any written waiver of notice unless so required by the certificate of incorporation or these Bylaws.

2.10 STOCKHOLDER ACTION BY WRITTEN CONSENT WITHOUT A MEETING

Any action required or able to be taken at any annual or special meeting of stockholders may be taken without a meeting, without prior notice, and without a vote if a consent or consents in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would

SMI Bylaws 9/30 September 22, 2005

be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted and shall be delivered to the corporation at its registered office in Delaware, its principal place of business, or to an officer or agent of the corporation having custody of the book in which proceedings of meetings of stockholders are recorded. Delivery to the corporation’s registered office shall be made by hand or by certified or registered mail, return receipt requested.

Every written consent shall bear the date of signature of each stockholder who signs the consent and no written consent shall be effective to take the corporate action referred to therein unless, within sixty (60) days of the date the earliest dated consent is delivered to the corporation, a written consent or consents signed by a sufficient number of holders to take action are delivered to the corporation in the manner prescribed in the first paragraph of this section.

Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented in writing. If the action which is consented to is such as would have required the filing of a certificate under any section of the General Corporation Law of Delaware if such action had been voted on by stockholders at a meeting thereof, then the certificate filed under such section shall state, in lieu of any statement required by such section concerning any vote of stockholders, that written notice and written consent have been given as provided in Section 228 of the General Corporation Law of Delaware.

2.11 RECORD DATE FOR STOCKHOLDER NOTICE; VOTING; GIVING CONSENTS

In order that the corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the board of directors may fix a record date, which shall not be more than sixty (60) nor less than ten (10) days before the date of such meeting, nor more than sixty (60) days prior to any other action.

If the board of directors does not so fix a record date:

(i) The record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day next preceding the day on which notice is given, or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held.

(ii) The record date for determining stockholders entitled to receive payment of any dividend or other distribution or allotment of rights or to exercise any rights of change, conversion or exchange of stock or for any other purpose shall be at the close of business on the day on which he board of directors adopts the resolution relating thereto.

SMI Bylaws 10/30 September 22, 2005

In order that the corporation may determine the stockholders entitled to consent to corporate action in writing without a meeting, the board of directors may fix a record date, which record date shall neither precede nor be more than ten (10) days after the date upon which such resolution is adopted by the board of directors. Any stockholder of record seeking to have the stockholders authorize or take action by written consent shall, by written notice to the secretary, request the board of directors to fix a record date. The board of directors shall promptly, but in all events within ten (10) days after the date on which such noticed is received, adopt a resolution fixing the record date.

If the board of directors has not fixed a record date within such time, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting, when no prior action by the board of directors is required by law, shall be the first date on which a signed written consent setting forth the action taken or proposed to be taken is delivered to the corporation in the manner prescribed in the first paragraph of Section 2.10 of these Bylaws. If the board of directors has not fixed a record date within such time and prior action by the board of directors is required by law, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting shall be at the close of business on the date on which the board of directors adopts the resolution taking such prior action.

A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the board of directors may fix a new record date for the adjourned meeting.

2.12 VOTING

The stockholders entitled to vote at any meeting of stockholders shall be determined in accordance with the provisions of Section 2.11 of these Bylaws, subject to the provisions of Sections 217 and 218 of the General Corporation Law of Delaware (relating to voting rights of fiduciaries, pledgors and joint owners of stock and to voting trusts and other voting agreements).

Each stockholder shall have one (1) vote for every share of stock entitled to vote that is registered in his or her name on the record date for the meeting (as determined in accordance with Section 2.11 of these Bylaws), except as otherwise provided herein or required by law.

At a stockholders’ meeting at which directors are to be elected, each stockholder shall be entitled to cumulate votes (i.e., cast for any candidate a number of votes greater than the number of votes which such stockholder normally is entitled to cast) if the candidates’ names have been properly placed in nomination (in accordance with these Bylaws) prior to commencement of the voting and the stockholder requesting cumulative voting has given

SMI Bylaws 11/30 September 22, 2005

notice prior to commencement of the voting of the stockholder’s intention to cumulate votes. If cumulative voting is properly requested, each holder of stock, or of any class or classes or of a series or series thereof, who elects to cumulate votes shall be entitled to as many votes as equals the number of votes which (absent this provision as to cumulative voting) he would be entitled to cast for the election of directors with respect to his shares of stock multiplied by the number of directors to be elected by him, and he may cast all of such votes for a single director or may distribute them among the number to be voted for, or for any two or more of them, as he may see fit.

Every stock vote shall be taken by ballots, each of which shall state the name of the stockholder or proxy voting and such other information as may be required under the procedure established for the meeting. All elections shall be determined by a plurality of the votes cast, and except as otherwise required by law or provided herein, all other matters shall be determined by a majority of the votes cast affirmatively or negatively.

2.13 PROXIES

Each stockholder entitled to vote at a meeting of stockholders or to express consent or dissent to corporate action in writing without a meeting may authorize another person or persons to act for him by a written or electronic proxy, filed in accordance with the procedure established for the meeting or taking of action in writing, but no such proxy shall be voted or acted upon after three (3) years from its date, unless the proxy provides for a longer period. Any copy, facsimile telecommunication or other reliable reproduction of the writing or transmission created pursuant to this Section 2.13 may be substituted or used in lieu of the original writing or transmission for any and all purposes for which the original writing or transmission could be used, provided that such copy, facsimile telecommunication or other reproduction shall be a complete reproduction of the entire original writing or transmission. An electronic proxy (which may be transmitted via telephone, e-mail, the Internet or such other electronic means as the Board of Directors may determine from time to time) shall be deemed executed if the Company receives an appropriate electronic transmission from the stockholder or the stockholder’s attorney-in-fact along with a pass code or other identifier which reasonably establishes the stockholder or the stockholder’s attorney-in-fact as the sender of such transmission. The revocability of a proxy that states on its face that it is irrevocable shall be governed by the provisions of Section 212(c) of the General Corporation Law of Delaware.

2.14 LIST OF STOCKHOLDERS ENTITLED TO VOTE

The officer who has charge of the stock ledger of a corporation shall prepare and make, at least ten (10) days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten (10) days prior to the meeting, either at a place within the city where the meeting is to be held, which

SMI Bylaws 12/30 September 22, 2005

place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present. Such list shall presumptively determine the identity of the stockholders entitled to vote at the meeting and the number of shares held by each of them.

2.15 INSPECTORS OF ELECTION

The corporation may, and to the extent required by law, shall, in advance of any meeting of stockholders, appoint one or more inspectors to act at the meeting and make a written report thereof. The corporation may designate one or more persons as alternate inspectors to replace any inspector who fails to act. If no inspector or alternate is able to act at a meeting of stockholders, the person presiding at the meeting may, and to the extent required by law, shall, appoint one or more inspectors to act at the meeting. Each inspector, before entering upon the discharge of his duties, shall take and sign an oath faithfully to execute the duties of inspector with strict impartiality and according to the best of his ability. Every vote taken by ballots shall be counted by an inspector or inspectors appointed by the chairman of the meeting

ARTICLE III

DIRECTORS

3.1 POWERS

Subject to the provisions of the General Corporation Law of Delaware and any limitations in the Certificate of Incorporation or these Bylaws relating to action required to be approved by the stockholders or by the outstanding shares, the business and affairs of the corporation shall be managed and all corporate powers shall be exercised by or under the direction of the board of directors.

3.2 NUMBER OF DIRECTORS

The number of directors of the corporation shall be no less than six (6) or more than eleven (11). The exact number of directors shall be nine (9), until changed, within the limits specified above, by a resolution duly adopted by the board of directors. The indefinite number of directors may be changed, or a definite number fixed without provision for an indefinite number, by an adopted amendment to this Bylaw duly adopted by the vote or written consent of holders of a majority of the outstanding shares entitled to vote; provided, however, that an amendment reducing the number or the minimum number of directors to a number less than five (5) cannot be adopted if the votes cast against its adoption at a meeting of the stockholders, or the shares not consenting in the case of action by written consent, are equal to more than sixteen and two-thirds percent (16- ²/3%) of the outstanding shares entitled to vote thereon. No amendment may change the stated maximum number of authorized directors to a number greater than two (2) times the stated number of directors minus one (1).

SMI Bylaws 13/30 September 22, 2005

No reduction of the authorized number of directors shall have the effect of removing any director before that director’s term of office expires.

3.3 ELECTION, QUALIFICATION AND TERM OF OFFICE OF DIRECTORS

Except as provided in Section 3.4 of these Bylaws, directors shall be elected at each annual meeting of stockholders to hold office until the next annual meeting. Directors need not be stockholders unless so required by the certificate of incorporation or these Bylaws, wherein other qualifications for directors may be prescribed. Each director, including a director elected to fill a vacancy, shall hold office until his successor is elected and qualified or until his earlier resignation or removal.

Nominations for election to the board of directors of the corporation at an annual meeting of stockholders may be made by the board or on behalf of the board by a nominating committee appointed by the board, or by any stockholder of the corporation entitled to vote for the election of directors at such meeting. Such nominations, other than those made by or on behalf of the board, shall be made by notice in writing received by the secretary of the corporation at the corporation’s principal executive offices not less than 60 or more than 90 calendar days prior to the first anniversary of the date that the corporation first mailed its proxy statement to stockholders in connection with the previous year’s annual meeting of stockholders, except that if no annual meeting was held in the previous year or the date of the annual meeting has been changed by more than 30 calendar days from the first anniversary date of the previous year’s annual meeting, notice by the stockholder to be timely must be received no later than the close of business on the tenth day following the day on which public announcement (as defined in Section 2.2) of the date of such annual meeting is first made. Such notice shall set forth as to each proposed nominee who is not an incumbent director (i) the name, age, business address and, if known, residence address of each nominee proposed in such notice, (ii) the principal occupation or employment of such nominee, (iii) the number of shares of stock of the corporation beneficially owned by each such nominee and by the nominating stockholder, and (iv) any other information concerning the nominee that must be disclosed of nominees in proxy solicitations pursuant to Regulation 14A under the Securities Exchange Act of 1934.

The chairman of the annual meeting may, if the facts warrant, determine and declare to the meeting that a nomination was not made in accordance with the foregoing procedure. If such determination and declaration is made, the defective nomination shall be disregarded.

3.4 RESIGNATION AND VACANCIES

Any director may resign at any time upon written notice to the attention of the Secretary of the corporation. When one or more directors so resigns and the resignation is effective at a future date, only a majority of the directors then in office, including those who

SMI Bylaws 14/30 September 22, 2005

have so resigned, shall have power to fill such vacancy or vacancies, the vote thereon to take effect when such resignation or resignations shall become effective, and each director so chosen shall hold office as provided in this section in the filling of other vacancies.

Unless otherwise provided in the certificate of incorporation or these Bylaws:

(i) Vacancies and newly created directorships resulting from any increase in the authorized number of directors elected by all of the stockholders having the right to vote as a single class may be filled only by a majority of the directors then in office, although less than a quorum, or by a sole remaining director.

(ii) Whenever the holders of any class or classes of stock or series thereof are entitled to elect one or more directors by the provisions of the certificate of incorporation, vacancies and newly created directorships of such class or classes or series may be filled only by a majority of the directors elected by such class or classes or series thereof then in office, or by a sole remaining director so elected.

If at any time, by reason of death or resignation or other cause, the corporation should have no directors in office, then any officer or any stockholder or an executor, administrator, trustee or guardian of a stockholder, or other fiduciary entrusted with like responsibility for the person or estate of a stockholder, may call a special meeting of stockholders in accordance with the provisions of the certificate of incorporation or these Bylaws, or may apply to the Court of Chancery for a decree summarily ordering an election as provided in Section 211 of the General Corporation Law of Delaware.

If, at the time of filling any vacancy or any newly created directorship, the directors then in office constitute less than a majority of the whole board (as constituted immediately prior to any such increase), then the Court of Chancery may, upon application of any stockholder or stockholders holding at least ten (10) percent of the total number of the shares at the time outstanding having the right to vote for such directors, summarily order an election to be held to fill any such vacancies or newly created directorships, or to replace the directors chosen by the directors then in office as aforesaid, which election shall be governed by the provisions of Section 211 of the General Corporation Law of Delaware as far as applicable.

3.5 PLACE OF MEETINGS; MEETINGS BY TELEPHONE

The board of directors of the corporation may hold meetings, both regular and special, either within or outside the State of Delaware.

Unless otherwise restricted by the certificate of incorporation or these Bylaws, members of the board of directors, or any committee designated by the board of directors, may participate in a meeting of the board of directors, or any committee, by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and such participation in a meeting shall constitute presence in person at the meeting.

SMI Bylaws 15/30 September 22, 2005

3.6 REGULAR MEETINGS

Regular meetings of the board of directors shall be held at such place or places, on such date or dates, and at such time or times as shall have been established by the board of directors and publicized among all directors. A notice of each regular meeting shall not be required.

3.7 SPECIAL MEETINGS; NOTICE

Special meetings of the board of directors for any purpose or purposes may be called at any time by any executive officer of the corporation, or by one-third of the directors then in office (rounded up to the nearest whole number) and shall be held at a place, on a date and at a time as such officer or such directors shall fix. Notice of the place, date and time of special meetings, unless waived, shall be given to each director by mailing written notice not less than two (2) days before the meeting or by sending a facsimile transmission of the same not less than two (2) hours before the time of the holding of the meeting. If the circumstances warrant, notice may also be given personally or by telephone not less than two (2) hours before the time of the holding of the meeting. Oral notice given personally or by telephone may be communicated either to the director or to a person at the office of the director who the person giving the notice has reason to believe will promptly communicate it to the director. Unless otherwise indicated in the notice thereof, any and all business may be transacted at a special meeting.

3.8 QUORUM

At all meetings of the board of directors, a majority of the authorized number of directors shall constitute a quorum for the transaction of business and the act of a majority of the directors present at any meeting at which there is a quorum shall be the act of the board of directors, except as may be otherwise specifically provided by statute or by the certificate of incorporation. If a quorum is not present at any meeting of the board of directors, then the directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum is present.

A meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of directors, if any action taken is approved by at least a majority of the required quorum for that meeting.

3.9 WAIVER OF NOTICE

Whenever notice is required to be given under any provision of the General Corporation Law of Delaware or of the certificate of incorporation or these Bylaws, a written

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waiver thereof, signed by the person entitled to notice, whether before or after the time stated therein, shall be deemed equivalent to notice. Attendance of a person at a meeting shall constitute a waiver of notice of such meeting, except when the person attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the directors, or members of a committee of directors, need be specified in any written waiver of notice unless so required by the certificate of incorporation or these Bylaws.

3.10 CONDUCT OF BUSINESS

At any meeting of the board of directors, business shall be transacted in such order and manner as the board may from time to time determine, and all matters shall be determined by the vote of a majority of the directors present, except as otherwise provided herein or required by law.

3.11 BOARD ACTION BY WRITTEN CONSENT WITHOUT A MEETING

Unless otherwise restricted by the certificate of incorporation or these Bylaws, any action required or permitted to be taken at any meeting of the board of directors, or of any committee thereof, may be taken without a meeting if all members of the board or committee, as the case may be, consent thereto in writing and the writing or writings are filed with the minutes of proceedings of the board or committee.

3.12 FEES AND COMPENSATION OF DIRECTORS

Unless otherwise restricted by the certificate of incorporation or these Bylaws, the board of directors shall have the authority to fix the compensation of directors.

3.13 APPROVAL OF LOANS TO OFFICERS

The corporation may lend money to, or guarantee any obligation of, or otherwise assist any officer or other employee of the corporation or of its subsidiary, including any officer or employee who is a director of the corporation or its subsidiary, whenever, in the judgment of the directors, such loan, guaranty or assistance may reasonably be expected to benefit the corporation. The loan, guaranty or other assistance may be with or without interest and may be unsecured, or secured in such manner as the board of directors shall approve, including, without limitation, a pledge of shares of stock of the corporation. Nothing in this section contained shall be deemed to deny, limit or restrict the powers of guaranty or warranty of the corporation at common law or under any statute.

3.14 REMOVAL OF DIRECTORS

Unless otherwise restricted by statute, by the certificate of incorporation or by these Bylaws, any director or the entire board of directors may be removed, with or without cause,

SMI Bylaws 17/30 September 22, 2005

by the holders of a majority of the shares then entitled to vote at an election of directors; provided, however, that, so long as stockholders of the corporation are entitled to cumulative voting, if less than the entire board is to be removed, no director may be removed without cause if the votes cast against his removal would be sufficient to elect him if then cumulatively voted at an election of the entire board of directors.

No reduction of the authorized number of directors shall have the effect of removing any director prior to the expiration of such director’s term of office.

ARTICLE IV

COMMITTEES

4.1 COMMITTEES OF DIRECTORS

The board of directors may, by resolution passed by a majority of the whole board, designate one or more committees, with each committee to consist of one or more of the directors of the corporation. The board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. In the absence or disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the board of directors to act at the meeting in the place of any such absent or disqualified member. Any such committee, to the extent provided in the resolution of the board of directors or in the Bylaws of the corporation, shall have and may exercise all the powers and authority of the board of directors in the management of the business and affairs of the corporation, and may authorize the seal of the corporation to be affixed to all papers that may require it; but no such committee shall have the power or authority to (i) amend the certificate of incorporation (except that a committee may, to the extent authorized in the resolution or resolutions providing for the issuance of shares of stock adopted by the board of directors as provided in Section 151(a) of the General Corporation Law of Delaware, fix the designations and any of the preferences or rights of such shares relating to dividends, redemption, dissolution, any distribution of assets of the corporation or the conversion into, or the exchange of such shares for, shares of any other class or classes or any other series of the same or any other class or classes of stock of the corporation or fix the number of shares of any series of stock or authorize the increase or decrease of the shares of any series), (ii) adopt an agreement of merger or consolidation under Sections 251 or 252 of the General Corporation Law of Delaware, (iii) recommend to the stockholders the sale, lease or exchange of all or substantially all of the corporation’s property and assets, (iv) recommend to the stockholders a dissolution of the corporation or a revocation of a dissolution, or (v) amend the Bylaws of the corporation; and, unless the board resolution establishing the committee, a supplemental resolution of the board of directors, the Bylaws or the certificate of incorporation expressly so provide, no such committee shall have the power or authority to declare a dividend, to authorize the issuance of stock, or to adopt a certificate of ownership and merger pursuant to Section 253 of the General Corporation Law of Delaware.

SMI Bylaws 18/30 September 22, 2005

4.2 COMMITTEE MINUTES

Each committee shall keep regular minutes of its meetings and report the same to the board of directors when required.

4.3 MEETINGS AND ACTION OF COMMITTEES

Meetings and actions of committees shall be governed by, and held and taken in accordance with, the provisions of Article III of these Bylaws, Section 3.5 (place of meetings and meetings by telephone), Section 3.6 (regular meetings), Section 3.7 (special meetings and notice), Section 3.8 (quorum), Section 3.9 (waiver of notice), and Section 3.11 (action without a meeting), with such changes in the context of those Bylaws as are necessary to substitute the committee and its members for the board of directors and its members; provided, however, that the time of regular meetings of committees may be determined either by resolution of the board of directors or by resolution of the committee, that special meetings of committees may also be called by resolution of the board of directors and that notice of special meetings of committees shall also be given to all alternate members, who shall have the right to attend all meetings of the committee. The board of directors may adopt rules for the government of any committee not inconsistent with the provisions of these Bylaws.

ARTICLE V

OFFICERS

5.1 GENERAL MATTERS

The officers of the corporation shall be a president, a secretary, and a chief financial officer. The corporation may also have, at the discretion of the board of directors, a chairman of the board, a chief executive officer, one or more vice presidents, one or more assistant secretaries, one or more assistant treasurers, and any such other officers as may be appointed in accordance with the provisions of Section 5.3 of these Bylaws. Any number of offices may be held by the same person.

5.2 APPOINTMENT OF OFFICERS

The officers of the corporation, except such officers as may be appointed in accordance with the provisions of Sections 5.3 or 5.5 of these Bylaws, shall be appointed by the board of directors, subject to the rights, if any, of an officer under any contract of employment.

SMI Bylaws 19/30 September 22, 2005

5.3 SUBORDINATE OFFICERS

The board of directors may appoint, or empower the chief executive officer or the president to appoint, such other officers and agents as the business of the corporation may require, each of whom shall hold office for such period, have such authority, and perform such duties as are provided in these Bylaws or as the board of directors may from time to time determine. Officers appointed by the board of directors shall constitute executive officers of the corporation. Officers appointed by the president or chief executive officer shall be subordinate officers, unless otherwise specified by the board of directors.

5.4 REMOVAL AND RESIGNATION OF OFFICERS

Subject to the rights, if any, of an officer under any contract of employment, any officer may be removed, either with or without cause, by an affirmative vote of the majority of the board of directors at any regular or special meeting of the board or, except in the case of an officer chosen by the board of directors, by any officer upon whom such power of removal may be conferred by the board of directors.

Any officer may resign at any time by giving written notice to the corporation. Any resignation shall take effect at the date of the receipt of that notice or at any later time specified in that notice; and, unless otherwise specified in that notice, the acceptance of the resignation shall not be necessary to make it effective. Any resignation is without prejudice to the rights, if any, of the corporation under any contract to which the officer is a party.

5.5 VACANCIES IN OFFICES

Any vacancy occurring in any office of the corporation shall be filled by the board of directors if such officer was appointed by the board of directors, or by such other person as appointed by the board of directors to fill such vacancy.

5.6 CHAIRMAN OF THE BOARD

The chairman of the board, if such an officer be elected, shall, if present, preside at meetings of the board of directors and exercise and perform such other powers and duties as may from time to time be assigned to him by the board of directors or as may be prescribed by these Bylaws. If there is no chief executive officer or president, then the chairman of the board shall also be the chief executive officer of the corporation and shall have the powers and duties prescribed in Section 5.7 of these Bylaws.

5.7 CHIEF EXECUTIVE OFFICER

Subject to such supervisory powers, if any, as may be given by the board of directors to the chairman of the board, if there be such an officer, the chief executive officer of the corporation shall, subject to the control of the board of directors, have general supervision, direction, and control of the business and the officers of the corporation. He shall preside at all meetings of the stockholders and, in the absence or nonexistence of a chairman of the

SMI Bylaws 20/30 September 22, 2005

board, at all meetings of the board of directors. He shall have the general powers and duties of management usually vested in the chief executive officer of a corporation and shall have such other powers and duties as may be prescribed by the board of directors or these Bylaws.

5.8 PRESIDENT

Subject to such supervisory powers, if any, as may be given by the board of directors to the chairman of the board or the chief executive officer, if there be such officers, the president shall have general supervision, direction, and control of the business and other officers of the corporation. He shall have the general powers and duties of management usually vested in the office of president of a corporation and shall have such other powers and duties as may be prescribed by the board of directors or these Bylaws.

5.9 VICE PRESIDENTS

In the absence or disability of the chief executive officer and president, the vice presidents, if any, in order of their rank as fixed by the board of directors or, if not ranked, a vice president designated by the board of directors, shall perform all the duties of the president and when so acting shall have all the powers of, and be subject to all the restrictions upon, the president and chief executive officer. The vice presidents shall have such other powers and perform such other duties as from time to time may be prescribed for them respectively by the board of directors, these Bylaws, the president, chief executive officer or the chairman of the board.

5.10 SECRETARY

The secretary shall keep or cause to be kept, at the principal executive office of the corporation or such other place as the board of directors may direct, a book of minutes of all meetings and actions of directors, committees of directors, and stockholders. The minutes shall show the time and place of each meeting, whether regular or special (and, if special, how authorized and the notice given), the names of those present at directors’ meetings or committee meetings, the number of shares present or represented at stockholders’ meetings, and the proceedings thereof.

The secretary shall keep, or cause to be kept, at the principal executive office of the corporation or at the office of the corporation’s transfer agent or registrar, as determined by resolution of the board of directors, a share register, or a duplicate share register, showing the names of all stockholders and their addresses, the number and classes of shares held by each, the number and date of certificates evidencing such shares, and the number and date of cancellation of every certificate surrendered for cancellation.

The secretary shall give, or cause to be given, notice of all meetings of the stockholders and of the board of directors required to be given by law or by these Bylaws. He shall keep the seal of the corporation, if one be adopted, in safe custody and shall have such other powers and perform such other duties as may be prescribed by the board of directors or by these Bylaws.

SMI Bylaws 21/30 September 22, 2005

5.11 CHIEF FINANCIAL OFFICER

The chief financial officer shall keep and maintain, or cause to be kept and maintained, adequate and correct books and records of accounts of the properties and business transactions of the corporation, including accounts of its assets, liabilities, receipts, disbursements, gains, losses, capital retained earnings, and shares. The books of account shall at all reasonable times be open to inspection by any director.

The chief financial officer shall deposit all moneys and other valuables in the name and to the credit of the corporation with such depositories as may be designated by the board of directors. He shall disburse the funds of the corporation as may be ordered by the board of directors, shall render to the chief executive officer, president and directors, whenever they request it, an account of all his transactions as chief financial officer and of the financial condition of the corporation, and shall have other powers and perform such other duties as may be prescribed by the board of directors or the Bylaws.

5.12 REPRESENTATION OF SHARES OF OTHER CORPORATIONS

The chairman of the board, any executive officer of this corporation, or any other person designated by the board of directors, shall be authorized to vote, represent, and exercise on behalf of this corporation all rights incident to any and all shares of any other corporation or corporations standing in the name of this corporation. The authority granted herein may be exercised either by such person directly or by any other person authorized to do so by proxy or power of attorney duly executed by such person having the authority.

5.13 AUTHORITY AND DUTIES OF OFFICERS

In addition to the foregoing authority and duties, all officers of the corporation shall respectively have such authority and perform such duties in the management of the business of the corporation as may be designated from time to time by the board of directors or the stockholders.

ARTICLE VI

INDEMNITY

6.1 THIRD PARTY ACTIONS

The corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending, or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that he is or was a director or officer of the corporation, or that such director or officer is or was serving at the request of the corporation as a director,

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officer, employee or agent of another corporation, partnership, joint venture trust or other enterprise (collectively “Agent”), against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement (if such settlement is approved in advance by the Company, which approval shall not be unreasonably withheld) actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interest of the corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful.

6.2 ACTIONS BY OR IN THE RIGHT OF THE CORPORATION

The corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that he is or was an Agent (as defined in Section 6.1) against expenses (including attorneys’ fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in manner he reasonably believed to be in or not opposed to the best interests of the corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Delaware Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Delaware Court of Chancery or such other court shall deem proper.

6.3 SUCCESSFUL DEFENSE

To the extent that an Agent of the corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in Sections 6.1 and 6.2, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys’ fees) actually and reasonably incurred by him in connection therewith.

6.4 DETERMINATION OF CONDUCT

Any indemnification under Sections 6.1 and 6.2 (unless ordered by a court) shall be made by the corporation only as authorized in the specific case upon a determination that the indemnification of the Agent is proper in the circumstances because he has met the applicable standard of conduct set forth in Sections 6.l and 6.2. Such determination shall be made (1) by the board of directors or the executive committee by a majority vote of a quorum consisting of directors who were not parties to such action, suit or proceeding or (2) or if such quorum is not obtainable or, even if obtainable, a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (3) by the stockholders.

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6.5 PAYMENT OF EXPENSES IN ADVANCE

Expenses incurred in defending a civil or criminal action, suit or proceeding shall be paid by the corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of the director, officer, employee or agent to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the corporation as authorized in this Article VI.

6.6 INDEMNITY NOT EXCLUSIVE

The indemnification and advancement of expenses provided or granted pursuant to the other sections of this Article VI shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any Bylaw, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office.

6.7 INSURANCE INDEMNIFICATION

The corporation shall have the power to purchase and maintain on behalf any person who is or was an Agent of the corporation, or is or was serving at the request of the corporation, as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the corporation would have the power to indemnify him against such liability under the provisions of this Article VI.

6.8 THE CORPORATION

For purposes of this Article VI, references to “the corporation” shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors and officers, so that any person who is or was a director or Agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under and subject to the provisions of this Article VI (including, without limitation the provisions of Section 6.4) with respect to the resulting or surviving corporation as he would have with respect to such constituent corporation if its separate existence had continued.

SMI Bylaws 24/30 September 22, 2005

6.9 EMPLOYEE BENEFIT PLANS

For purposes of this Article VI, references to “other enterprises” shall include employee benefit plans; references to “fines” shall include any excise taxes assessed on a person with respect to an employee benefit plan; and references to “serving at the request of the corporation” shall include any service as a director, officer, employee or agent of the corporation which imposes duties on, or involves services by, such director, officer, employee, or agent with respect to an employee benefit plan, its participants, or beneficiaries; and a person who acted in good faith and in a manner he reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner “not opposed to the best interests of the corporation” as referred to in this Article VI.

6.10 INDEMNITY FUND

Upon resolution passed by the board, the corporation may establish a trust or other designated account, grant a security interest or use other means (including, without limitation, a letter of credit), to ensure the payment of certain of its obligations arising under this Article VI and/or agreements which may be entered into between the company and its officers and directors from time to time.

6.11 INDEMNIFICATION OF OTHER PERSONS

The provisions of this Article VI shall not be deemed to preclude the indemnification of any person who is not an agent (as defined in Section 6.1), but whom the corporation has the power or obligation to indemnify under the provisions of the General Corporation Law of the State of Delaware or other-wise. The corporation may, in its sole discretion, indemnify an employee, trustee or other agent as permitted by the General Corporation Law of the State of Delaware. The corporation shall indemnify an employee, trustee or other agent where required by law.

6.12 SAVINGS CLAUSE

If this article or any portion thereof shall be invalidated on any ground by any court of competent jurisdiction, then the corporation shall nevertheless indemnify each agent against expenses (including attorney’s fees), judgments, fines and amounts paid in settlement with respect to any action, suit, proceeding or investigation, whether civil, criminal or administrative, and whether internal or external, including a grand jury proceeding and an action or suit brought by or in the right of the corporation, to the full extent permitted by any applicable portion of this Article that shall not have been invalidated, or by any other applicable law.

6.13 CONTINUATION OF INDEMNIFICATION AND ADVANCEMENT OF EXPENSES

The indemnification and advancement of expenses provided by, or granted pursuant to, this Article VI shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person.

SMI Bylaws 25/30 September 22, 2005

ARTICLE VII

RECORDS AND REPORTS

7.1 MAINTENANCE AND INSPECTION OF RECORDS

The corporation shall, either at its principal executive office or at such place or places as designated by the board of directors, keep a record of its stockholders listing their names and addresses and the number of class of shares held by each stockholder, a copy of these Bylaws as amended to date, accounting books, and other records.

Any stockholder of record, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose the corporation’s stock ledger, a list of its stockholders, and its other books and records and to make copies or extracts therefrom. A proper purpose shall mean a purpose reasonably related to such person’s interest as a stockholder. In every instance where an attorney or other agent is the person who seeks the right to inspection, the demand under oath shall be accompanied by a power of attorney or such other writing that authorizes the attorney or other agent to so act on behalf of the stockholder. The demand under oath shall be directed to the corporation at its registered office in Delaware or at its principal place of business.

7.2 INSPECTION BY DIRECTORS

Any director shall have the right to examine the corporation’s stock ledger, a list of its stockholders, and its other books and records for a purpose reasonably related to his position as a director. The Court of Chancery is hereby vested with the exclusive jurisdiction to determine whether a director is entitled to the inspection sought. The court may summarily order the corporation to permit the director to inspect any and all books and records, the stock ledger, and the stock list and to make copies or extracts therefrom. The Court may, in its discretion, prescribe any limitations or conditions with reference to the inspection, or award such other and further relief as the Court may deem just and proper.

7.3 ANNUAL STATEMENT TO STOCKHOLDERS

The board of directors shall present at each annual meeting, and at any special meeting of the stockholders when called for by vote of the stockholders, a full and clear statement of the business and condition of the corporation.

SMI Bylaws 26/30 September 22, 2005

ARTICLE VIII

GENERAL MATTERS

8.1 CHECKS

From time to time, the board of directors shall determine by resolution which person or persons may sign or endorse all checks, drafts, other orders for payment of money, notes or other evidences of indebtedness that are issued in the name of or payable to the corporation, and only the persons so authorized shall sign or endorse those instruments.

8.2 EXECUTION OF CORPORATE CONTRACTS AND INSTRUMENTS

The board of directors, except as otherwise provided in these Bylaws, may authorize any officer or officers, or agent or agents, to enter into any contract or execute any instrument in the name of and on behalf of the corporation; such authority may be general or confined to specific instances. Unless so authorized or ratified by the board of directors or within the agency power of an officer, no officer, agent or employee shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or for any amount.

8.3 STOCK CERTIFICATES; PARTLY PAID SHARES

The shares of a corporation shall be represented by certificates, provided that the board of directors of the corporation may provide by resolution or resolutions that some or all of any or all classes or series of its stock shall be uncertified shares. Any such resolution shall not apply to shares represented by a certificate until such certificate is surrendered to the corporation. Notwithstanding the adoption of such a resolution by the board of directors, every holder of stock represented by certificates and upon request every holder of uncertificated shares shall be entitled to have a certificate signed by, or in the name of the corporation by the chairman of or vice-chairman of the board of directors, or the secretary or an assistant secretary of such corporation representing the number of shares registered in certificate form. Any or all of the signatures on the certificate may be a facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate has ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if he were such officer, transfer agent or registrar at the date of issue.

The corporation may issue the whole or any part of its shares as partly paid and subject to call for the remainder of the consideration to be paid therefor. Upon the face or back of each stock certificate issued to represent any such partly paid shares, upon the books and records of the corporation in the case or uncertificated partly paid shares, the total amount of the consideration to be paid therefor and the amount paid thereon shall be stated. Upon the declaration of any dividend on fully paid shares, the corporation shall declare a dividend upon partly paid shares of the same class, but only upon the basis of the percentage of the consideration actually paid thereon.

SMI Bylaws 27/30 September 22, 2005

8.4 SPECIAL DESIGNATION ON CERTIFICATES

If the corporation is authorized to issue more than one class of stock or more than one series of any class, then the powers, the designations, the preferences, and the relative, participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights shall be set forth in full or summarized on the face or back of the certificate that the corporation shall issue to represent such class or series of stock; provided, however, that, except as otherwise provided in Section 202 of the General Corporation Law or Delaware, in lieu of the foregoing requirements there may be set forth on the face or back of the certificate that the corporation shall issue to represent such class or series of stock a statement that the corporation will furnish without charge to each stockholder who so requests the powers, the designations, the preferences, and the relative, participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights.

8.5 LOST CERTIFICATES

Except as provided in this Section 8.5, no new certificates for shares shall be issued to replace a previously issued certificate unless the latter is surrendered to the corporation and canceled at the same time. The corporation may issue a new certificate of stock or uncertificated shares in the place of any certificate theretofore issued by it, alleged to have been lost, stolen or destroyed, and the corporation may require the owner of the lost, stolen or destroyed certificate, or his legal representative, to give the corporation a bond sufficient to indemnify it against any claim that may be made against it on account of the alleged loss, theft or destruction of any such certificate or the issuance of such new certificate or uncertificated shares.

8.6 CONSTRUCTION; DEFINITIONS

Unless the context requires otherwise, the general provisions, rules of construction, and definitions in the General Corporation Law of Delaware shall govern the construction of these Bylaws. Without limiting the generality of this provision, the singular number includes the plural, the plural number includes the singular, and the term “person” includes both a corporation and a natural person.

8.7 DIVIDENDS

The directors of the corporation, subject to any restrictions contained in (i) the General Corporation Law of Delaware or (ii) the certificate of incorporation, may declare and pay dividends upon the shares of its capital stock. Dividends may be paid in cash, in property, or in shares of the corporation’s capital stock.

The directors of the corporation may set apart out of any of the funds of the corporation available for dividends a reserve or reserves for any proper purpose and may abolish any such reserve. Such purposes shall include but not be limited to equalizing dividends, repairing or maintaining any property of the corporation, and meeting contingencies.

SMI Bylaws 28/30 September 22, 2005

8.8 FISCAL YEAR

The fiscal year of the corporation shall be fixed by resolution of the board of directors and may be changed by the board of directors.

8.9 SEAL

The corporation may adopt a corporate seal, which may be altered at pleasure, and may use the same by causing it or a facsimile thereof, to be impressed or affixed or in any other manner reproduced.

8.10 TRANSFER OF STOCK

Upon surrender to the corporation or the transfer agent of the corporation of a certificate for shares duly endorsed or accompanied by proper evidence of succession, assignation or authority to transfer, it shall be the duty of the corporation to issue a new certificate to the person entitled thereto, cancel the old certificate, and record the transaction in its books.

8.11 STOCK TRANSFER AGREEMENTS

The corporation shall have power to enter into and perform any agreement with any number of stockholders of any one or more classes of stock of the corporation to restrict the transfer of shares of stock of the corporation of any one or more classes owned by such stockholders in any manner not prohibited by the General Corporation Law of Delaware.

8.12 REGISTERED STOCKHOLDERS

The corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends and to vote as such owner, shall be entitled to hold liable for calls and assessments the person registered on its hooks as the owner of shares, and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of another person, whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of Delaware.

8.13 NOTICES

Except as otherwise specifically provided herein or required by law, all notices required to be given to any stockholder, director, officer, employee or agent shall be in writing and may in every instance be effectively given by hand delivery, by mail, postage paid, or by facsimile transmission. Any such notice shall be addressed to such stockholder,

SMI Bylaws 29/30 September 22, 2005

director, officer, employee or agent at his last known address as it appears on the books of the corporation. The time when such notice shall be deemed received, if hand delivered, or dispatched, if sent by mail or facsimile, transmission, shall be the time of the giving of the notice.

ARTICLE IX

AMENDMENTS

Any of these Bylaws may be altered, amended or repealed by the affirmative vote of a majority of the board of directors or, with respect to Bylaw amendments placed before the stockholders for approval and except as otherwise provided herein or required by law, by the affirmative vote of the holders of seventy-five percent of the shares of the corporation’s stock entitled to vote in the election of directors, voting as one class.

SMI Bylaws 30/30 September 22, 2005

EX-10.1

Exhibit 10.1

SUN MICROSYSTEMS, INC.

RESTRICTED STOCK PURCHASE AGREEMENT

This Restricted Stock Purchase Agreement, including all Exhibits hereto, (the “Agreement”) is made as of the 28^th day of July, 2005 by and between SUN MICROSYSTEMS, INC., a Delaware corporation (the “Company”), and PURCHASER’S NAME (the “Purchaser”).

The parties agree as follows:

1. SALE OF COMMON STOCK.

Subject to the terms and conditions of this Agreement and the Company’s 1990 Long-Term Equity Incentive Plan (the “Plan”), the Company hereby sells to the Purchaser and the Purchaser hereby purchases from the Company, on the closing date (as defined herein) XXXXX shares of the Company’s Common Stock (the “Shares”) at a price of $0.01 per share for an aggregate purchase price of $XXX. The term “Shares” refers to the Shares purchased herein and all securities received in replacement thereof, pursuant to or in consequence of other similar change in the Company’s capitalization.

2. CLOSING; SECURITY INTEREST.

2.1 Closing. The purchase and sale of the shares shall occur at a closing (the “Closing”) to be held no later than September 26, 2005 (the “Closing Date”).

2.2 Payment and Delivery of Certificate. At the Closing, the Company shall deliver to the Purchaser a certificate or certificates representing the Shares to be purchased by the Purchaser (which shall be issued in the name of the Purchaser or jointly in the name of the Purchaser and the Purchaser’s spouse) upon receiving the purchase price from Purchaser. The purchase price for the Shares shall be paid no later than 5:00 p.m., Pacific Time on the Closing Date by delivery of a check payable in U.S. dollars to the Company.

3. LIMITATIONS ON TRANSFER.

In addition to any other limitation on transfer created by applicable U.S. or foreign securities laws, the Purchaser shall not assign, encumber or dispose of any interest in the Shares except in compliance with the restrictions set forth in this paragraph.

3.1 Repurchase Option. In the event of the voluntary or involuntary termination or cessation of active employment or association of the Purchaser with the Company or any subsidiary in which the Company has a majority ownership interest (“Subsidiary”) for any reason whatsoever, with or without cause (including death or disability), the Company shall, upon the date of such termination, have an irrevocable, exclusive option to repurchase (the “Repurchase Option”) all or any portions of the Shares held by the Purchaser which are subject to the Repurchase Option as of such date at the original purchase price per share specified in Section 1. If the Repurchase Option is exercised, the original purchase price will be paid to Purchaser in U.S. dollars and will not be adjusted for inflation, fluctuations in the exchange rates, etc. since Purchaser initially purchased the Shares. Termination of the Purchaser’s active employment with the Company or a Subsidiary shall not be deemed to have occurred during any period that the Purchaser is on a duly authorized leave of absence from the Company or a Subsidiary of less than twelve (12) months, or such longer period as the Committee of the Board of Directors administering the Plan approved in writing. If Purchaser does not return to work with the Company or a Subsidiary on or prior to the last day of an authorized leave of absence, Purchaser’s active employment with the Company or a Subsidiary shall be deemed to terminate on the last day of the authorized leave of absence and the Company’s Repurchase Option specified herein shall become exercisable on such date. For the purposes of this Agreement, an authorized leave of absence shall mean a leave of absence approved by an officer of the Company and by the Human Resources Department.

Initially, all of the Shares purchased by the Purchaser shall be subject to the Company’s Repurchase Option as set forth above. The Shares held by the Purchaser shall be released from the Company’s Repurchase Option under this Section 3.1 as follows:

(a) 25% of the shares (i.e., XXX Shares) shall be released July 28, 2006 provided that the Purchaser is still actively employed with the Company or a Subsidiary on such date; and

(b) 25% of the shares (i.e., XXX Shares) shall be released July 28, 2007 provided that the Purchaser is still actively employed with the Company or a Subsidiary on such date; and

(c) 25% of the shares (i.e., XXX Shares) shall be released July 28, 2008 provided that the Purchaser is still actively employed with the Company or a Subsidiary on such date; and

(d) The remaining 25% of the Shares (i.e., XXX Shares) shall be released July 28, 2009 provided that the Purchaser is still actively employed with the Company or a Subsidiary on such date.

The continuation of the Purchaser’s active employment with the Company or a Subsidiary is a material inducement to the Company in selling the Shares to Purchaser and failure to provide services to the Company or a Subsidiary, for any reason whatsoever shall trigger the Company’s Repurchase Option.

Notwithstanding the foregoing, the lapse of the Repurchase Option will be delayed if Purchaser takes an authorized unpaid leave of absence (including a leave of absence for military, educational, disability or personal purposes) of more than thirty (30) days or an authorized paid leave of absence of more than ninety (90) days. The lapse of the Repurchase Option will be delayed for the number of days that the authorized unpaid leave of absence or authorized paid leave of absence extends beyond the periods set forth above. The delay in the lapse of Repurchase Option shall commence on the thirty-first (31^st) day of an authorized unpaid leave of absence of more than thirty (30) days or, in the case of an authorized paid leave of absence of more than ninety (90) days, on the ninety-first (91^st) day of such leave and the delay shall terminate on the earlier of (1) the last business day preceding the date on which such individual’s leave of absence terminates or (2) a date twelve (12) months after the commencement of the leave of absence, unless the Compensation Committee of the Board of Directors extends such period. Lapse of the Repurchase Option will not be delayed in the event of a leave of absence if such delay is contrary to applicable local law. Vesting will not be suspended in the event of a leave of absence if such suspension is contrary to applicable local law. Sun policies on leave of absence may vary outside the US, in accordance with local law.

Within sixty (60) days following the Purchaser’s termination, the Company shall notify the Purchaser as to whether it wishes to purchase the Shares pursuant to the exercise of the Repurchase Option. If the Company elects to purchase said Shares hereunder, it shall set a date for the closing of the transaction at a place specified by the Company not later than thirty (30) days from the date of such notice. At such closing, the Company shall tender payment for the Shares and the certificate or certificates representing the Shares so purchased shall be canceled. The Purchaser hereby authorizes and directs the Secretary or Transfer Agent of the Company to transfer the Shares as to which the Repurchase Option has been exercised from the Purchaser to the Company. Except as provided under Section 3.5, the Purchaser shall not transfer by sale, assignment, hypothecation, donation or otherwise any of the Shares or any interest therein prior to the release of such Shares from the Repurchase Option. The Purchaser further authorizes the Company to refuse or to cause its Transfer Agent to refuse to transfer or record any Shares to be transferred in violation of this Agreement.

3.2 Assignment by Company. The Company’s Repurchase Option may be assigned in whole or in part to any shareholder or shareholders of the Company or other persons or organizations.

3.3 Obligations Binding Upon Transferees. All transferees of Shares or any interest therein will receive and hold such Shares or interests subject to the provisions of this Agreement including, insofar as applicable, the Company’s Repurchase Option under Section 3 and the Company’s rights under Section 2. Any sale, transfer or other disposition of the Shares or any interest therein in violation of this Agreement shall be void and without effect.

3.4 Replacement Certificate. In the event the restrictions imposed by this Agreement shall be terminated as provided in this Section 3, a new certificate or certificates representing the Shares shall be issued, on request, without the legend referred to in Section 5 herein.

3.5 Excluded Transfers. The restrictions on transfer of this Section 3 shall not apply to an inter-vivos transfer to the Purchaser’s ancestors or descendants or spouse or to a trustee for their benefit, provided that such transferee shall agree in writing to take such Shares subject to all the terms of this Agreement, including restrictions on further transfer.

4. ESCROW.

4.1 Delivery of Certificate to Escrow Agent. As security for the Purchaser’s performance of the terms and provisions of this Agreement and to ensure the availability for delivery of the Shares upon the Company’s exercise of its Repurchase Option, the Purchaser agrees to deliver to the Secretary of the Company (sometimes referred to as the “Escrow Agent” as the context requires) the certificate or certificates representing the Shares and his duly executed blank stock assignment in the form attached as Exhibit A hereto for use in transferring all or a portion of said Shares if, as and when required pursuant to Section 3 above.

4.2 Certificate Held in Escrow. The certificate or certificates representing the Shares and the duly executed blank stock assignment delivered at the Closing by the Purchaser shall be held by the Escrow Agent pursuant to the joint escrow instructions attached hereto as Exhibit B and made a part hereof, which joint escrow instructions shall be signed by the Purchaser, the Company and the Escrow Agent at the Closing.

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5. LEGENDS.

The certificate or certificates representing the Shares shall bear the following legend:

THE SHARES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO REPURCHASE PROVISIONS IN ACCORDANCE WITH THE TERMS OF AN AGREEMENT BETWEEN THE COMPANY AND THE SHAREHOLDER, A COPY OF WHICH IS ON FILE WITH THE SECRETARY OF THE COMPANY.

6. TAX WITHHOLDING AND RESPONSIBILTY FOR PAYMENT OF TAXES.

Regardless of any action Company or Purchaser’s employer (the “Employer”) takes with respect to any or all income tax, social insurance, payroll tax, payment on account or other tax-related withholding (“Tax-Related Items”), Purchaser acknowledges that the ultimate liability for all Tax-Related Items legally due by him or her is and remains Purchaser’s responsibility and that Company and/or the Employer (1) make no representations or undertakings regarding the treatment of any Tax-Related Items in connection with any aspect of the grant of restricted stock purchase rights, including the grant, purchase of Shares, lapse of Repurchase Option, the subsequent sale of Shares and/or the receipt of any dividends; and (2) do not commit to structure the terms of the grant or any aspect of the grant of restricted stock purchase rights to reduce or eliminate Purchaser’s liability for Tax-Related Items.

Prior to the lapse of the Repurchase Option, Purchaser will pay or make adequate arrangements satisfactory to Company and/or the Employer to satisfy all withholding and payment on account obligations of Company and/or the Employer. Company retains the right to determine, when the shares are released from Repurchase Option, how payment for taxes will be made (whether paid directly by Grantee, withheld from cash compensation, or through the sale of shares), in accordance with local law. In this regard, Purchaser authorizes Company and/or the Employer to withhold all applicable Tax-Related Items legally payable by Purchaser from his or her wages or other cash compensation paid to Purchaser by Company and/or the Employer or from proceeds of the sale of Shares. Alternatively, or in addition, if permissible under local law, Company may (1) sell or arrange for the sale of Shares to meet the withholding obligation for Tax-Related Items, and/or (2) withhold in Shares, provided that Company only withholds the amount of Shares necessary to satisfy the minimum withholding amount. Finally, Purchaser will pay to Company or the Employer any amount of Tax-Related Items that Company or the Employer may be required to withhold as a result of Purchaser’s participation in the Plan or the lapse of the Repurchase Option that cannot be satisfied by the means previously described. Company may refuse to allow the Repurchase Option to lapse or refuse to remove the transfer restrictions on the Shares if Purchaser fails to comply with his or her obligations in connection with the Tax-Related Items as described in this section.

7. NATURE OF GRANT.

In accepting the offer to acquire Shares, Purchaser acknowledges that: (a) the Plan is established voluntarily by the Company, it is discretionary in nature and it may be modified, amended, suspended or terminated by the Company at any time, unless otherwise provided in the Plan and this Agreement; (b) the grant of restricted stock purchase rights is voluntary and occasional and does not create any contractual or other right to receive future grants of restricted stock purchase rights, or benefits in lieu of such purchase rights even if purchase rights have been granted repeatedly in the past; (c) all decisions with respect to future restricted stock purchase rights grants, if any, will be at the sole discretion of the Company; (d) Purchaser is voluntarily participating in the Plan; (e) the grant of restricted stock purchase rights is an extraordinary item that does not constitute compensation of any kind for services of any kind rendered to the Company or the Employer, and which is outside the scope of Purchaser’s employment contract, if any; (f) the restricted stock purchase rights are not part of normal or expected compensation or salary for any purposes, including, but not limited to, calculating any severance, resignation, termination, redundancy, end of service payments, bonuses, long-service awards, pension or retirement benefits or similar payments; (g) the future value of the Shares is unknown and cannot be predicted with certainty; (h) in consideration of the grant of restricted stock purchase rights, no claim or entitlement to compensation or damages shall arise from the Company’s exercise of the Repurchase Option or diminution in value of the Shares resulting from termination of Purchaser’s active employment by the Company or the Employer (for any reason whatsoever and whether or not in breach of contract or local labor laws) and Purchaser irrevocably releases the Company and the Employer from any such claim that may arise; if, notwithstanding the foregoing, any such claim is found by a court of competent jurisdiction to have arisen, then, by signing this Agreement, Purchaser shall be deemed irrevocably to have waived his/her entitlement to pursue such claim; and (i) notwithstanding any terms or conditions of the Plan to the contrary, in the event of involuntary termination of Purchaser’s active employment (whether or not in breach of contract or local labor laws), Purchaser’s right to have the Company’s Repurchase Option lapse, if any, will terminate effective as of the date that Purchaser is no longer actively employed and will not be extended by any notice period mandated under local law (e.g., active employment would not include a period of “garden leave” or similar period pursuant to local law), except as expressly provided herein, and that the Company shall have the exclusive discretion to determine when Purchaser is no longer actively employed for purposes of administering his or her restricted stock purchase rights.

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8. DATA PRIVACY.

Purchaser hereby explicitly and unambiguously consents to the collection, use and transfer, in electronic or other form, of his/her personal data as described in this document by and among, as applicable, the Employer, and the Company and its Subsidiaries and affiliates for the exclusive purpose of implementing, administering and managing Purchaser’s participation in the Plan. Purchaser understands that the Company and the Employer hold certain personal information about him/her, including, but not limited to, his/her name, home address and telephone number, date of birth, social insurance number or other identification number, salary, nationality, job title, any Shares or directorships held in the Company, details of all Shares or any other entitlement to Shares awarded, canceled, exercised, vested, unvested or outstanding in Purchaser’s favor, for the purpose of implementing, administering and managing the Plan (“Data”). Purchaser understands that Data may be transferred to any third parties assisting in the implementation, administration and management of the Plan, that these recipients may be located in his/her country or elsewhere including outside the European Union, and that the recipient’s country may have different data privacy laws and protections than Purchaser’s country. Purchaser understands that Purchaser may request a list with the names and addresses of any potential recipients of the Data by contacting his/her local human resources representative. Purchaser authorizes the recipients to receive, possess, use, retain and transfer the Data, in electronic or other form, for the purposes of implementing, administering and managing his/her participation in the Plan, including any requisite transfer of such Data as may be required to a broker or other third party with whom Purchaser deposits any Shares. Purchaser understands that Data will be held only as long as is necessary to implement, administer and manage Purchaser’s participation in the Plan. Purchaser understands that Purchaser may, at any time, view Data, request additional information about the storage and processing of Data, require any necessary amendments to Data or refuse or withdraw the consents herein, in any case without cost, by contacting in writing Purchaser’s local human resources representative. Purchaser understands, however, that refusing or withdrawing Purchaser’s consent may affect his or her ability to participate in the Plan. For more information on the consequences of Purchaser’s refusal to consent or withdrawal of consent, Purchaser understands that he/she may contact his/her local human resources representative.

9. COUNTRY-SPECIFIC TERMS.

Exhibit C of this Agreement contains additional terms and conditions which are specific to employees in certain countries. Purchaser should review Exhibit C to determine what additional terms and conditions will apply to his or her grant of restricted stock purchase rights.

10. MISCELLANEOUS.

10.1Amendment. This Agreement may be amended by written agreement between Company and the Purchaser.

10.2 Notices. Any notice, demand or request required or permitted to be given under this Agreement shall be in writing and shall be deemed sufficient when delivered personally or sent by telegram or upon the lapse of forty-eight (48) hours after being deposited in the post, as certified or registered mail, postage prepaid and addressed, if to the Company, at its principal place of business, Attention: the President, and if to the Purchaser, at his address as shown on the stock records of the Company.

10.3 Assignment. The rights and benefits of this Agreement shall inure to the benefit of and be enforceable by the Company’s successors and assigns. The rights and obligations of the Purchaser under this Agreement may only be assigned with the prior written consent of the Company.

10.4 Further Assurances. Both parties agree to execute any additional documents necessary to carry out the purposes of this Agreement.

10.5 Shareholder Rights. Subject to the foregoing, the Purchaser shall, during the term of this Agreement, exercise all rights and privileges of a shareholder of the Company with respect to the Shares.

10.6 Specific Performance. The Purchaser agrees that the Company and/or other shareholders shall be entitled to a decree of specific performance of the terms hereof or an injunction restraining violations of this Agreement, said right to be in addition to any of the remedies of the Company.

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10.7 Delaware Law/Choice of Venue. This Agreement shall be construed under the laws of the State of Delaware, and covers the entire understanding of the parties hereto, superseding all prior written or oral agreements and no amendment or addition hereto shall be deemed effective unless agreed to in writing by the parties hereto. For purposes of litigating any dispute that arises directly or indirectly from the relationship of the parties evidenced by this grant or the Agreement, the parties hereby submit to and consent to the exclusive jurisdiction of the State of California and agree that such litigation shall be conducted only in the courts of Santa Clara County, California, or the federal courts for the United States for the Northern District of California, and no other courts, where this grant is made and/or to be performed.

10.8 Severability. If any provision of this Agreement is held by a court of competent jurisdiction to be invalid, void or unenforceable, to the extent that the economic benefits of this Agreement to both parties remain substantially unimpaired, the remaining provisions shall nevertheless continue in full force and effect without being impaired or invalidated in any way and shall be construed in accordance with the purposes and tenor and effect of this Agreement.

10.9 No Continuing Obligations. THIS AGREEMENT IS NOT AN EMPLOYMENT CONTRACT AND NOTHING IN THIS AGREEMENT SHALL BE DEEMED TO CREATE IN ANY WAY WHATSOEVER ANY OBLIGATION ON THE PART OF THE COMPANY OR THE EMPLOYER TO CONTINUE THE PURCHASER’S EMPLOYMENT WITH THE COMPANY OR THE EMPLOYER.

10.10 Electronic Delivery. The Company may, in its sole discretion, decide to deliver any documents related to the stock purchase rights or Shares granted and participation in the Plan or future stock purchase rights that may be granted under the Plan by electronic means or to request Purchaser’s consent to participate in the Plan by electronic means. Purchaser hereby consents to receive such documents by electronic delivery and, if requested, to agree to participate in the Plan through an on-line or electronic system established and maintained by the Company or another third party designated by the Company.

10.11 Language. If Purchaser has received this Agreement or any other document related to the Plan translated into a language other than English and if the translated version is different than the English version, the English version will control.

THE TERMS AND CONDITIONS OF THIS AGREEMENT MUST BE ACCEPTED BY PURCHASER BY SEPTEMBER 26, 2005, OR THE STOCK PURCHASE RIGHT WILL AUTOMATICALLY BE REVOKED.

IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first set forth above.

THE “COMPANY”	SUN MICROSYSTEMS, INC.
	A Delaware Corporation
	By:
		Michael A. Dillon
	Title:	Senior Vice President, General Counsel & Secretary
THE “PURCHASER”
	Address:
	Date:

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CONSENT

The undersigned spouse of the Purchaser agrees that my interest, if any, in the Shares subject to the foregoing Agreement shall be irrevocably bound by this Agreement and further understands and agrees that my community property interest, if any, shall be similarly bound by this Agreement.

Spouse of Purchaser

Date:

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EXHIBIT A

ASSIGNMENT SEPARATE FROM CERTIFICATE

FOR VALUE RECEIVED                                                                                                                            hereby sells, assigns and transfers unto                                                                                                                                                 (                                ) shares of the Common Stock of Sun Microsystems, Inc., a Delaware corporation, standing in the undersigned’s name on the books of said corporation represented by Certificate No.                                  herewith, and do hereby irrevocably constitute and appoint                                                                                                                                     attorney to transfer the said stock on the books of the said corporation with full power of substitution in the premises.

Date:
	(to be filled in only by Escrow Agent)

Signature:

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EXHIBIT B

ATTN: SECRETARY

Sun Microsystems, Inc.

4120 Network Circle

Santa Clara, CA 95054

RE: Joint Escrow Instructions

Dear Secretary:

As Escrow Agent for Sun Microsystems, Inc., (the “Company”) and the undersigned Purchaser (the “Purchaser”), you are hereby authorized and directed to hold the documents delivered to you pursuant to the terms of that certain Restricted Stock Purchase Agreement dated July 28, 2005 (the “Agreement”), including the stock certificate(s) evidencing shares of the Company’s Common Stock and the stock assignment(s) referred to in Section 4 of this Agreement, in accordance with the following instructions:

1. In the event the Company (or its assignee) shall elect to exercise its Repurchase Option set forth in Section 3 of the Agreement (the “Rights”) in whole or in part, the Company (or its assignee) shall give to the Purchaser and to you a written notice specifying a time and place for a closing hereunder. The Purchaser and the Company hereby irrevocably authorize and direct you to close the transaction contemplated by such notice in accordance with the terms of said notice.

2. At the closing you are directed to (a) date such of the aforesaid stock assignments as shall be necessary for the transfer in question, (b) fill in the number of shares being transferred, and (c) deliver the same, together with the aforesaid certificate(s) evidencing the shares to be transferred, to the Company (or its assignee) as provided in the Agreement against the simultaneous delivery to you of the purchase price (by Company check or in cash) for the number of shares being purchased pursuant to the Agreement.

3. The Purchaser irrevocably authorizes the Company to deposit with you any securities (including additional shares of the Company’s Common Stock) or other property (including cash) which the Purchaser would be entitled to receive on account of any shares held by you hereunder. To facilitate the performance of the Agreement, the Purchaser does hereby irrevocably constitute and appoint you as his attorney-in-fact and agent for the term of this escrow to execute with respect to such securities all stock certificates, stock assignments, or other instruments, which shall be necessary or appropriate to make such securities negotiable and to complete any transaction herein contemplated. Subject to the provisions of this paragraph 3, the Purchaser shall exercise all rights and privileges of a stockholder of the Company while the shares are held by you.

4. Upon written request from the Company and the Purchaser, you are authorized to release from escrow the number of shares indicated in that written request pursuant to the Agreement.

5. This escrow shall terminate upon the termination of the Company’s rights as provided in Section 3 of the Agreement.

6. If at the time of termination of this escrow you shall have in Purchaser’s possession any documents, securities, or other property belonging to the Purchaser, you shall deliver all of the same to the Purchaser and shall be discharged of all further obligations.

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7. Your duties hereunder may be altered, amended, modified, or revoked only by a writing signed by all of the parties hereto and approved by you.

8. You shall not be personally liable for any act you may do or omit to do hereunder as Escrow Agent or attorney-in-fact for the Purchaser while acting in good faith and in the exercise of your own good judgment and any act done or omitted by you pursuant to the advice of your own attorneys shall be conclusive evidence of such good faith.

9. You are hereby expressly authorized to disregard any and all warnings given by any of the parties hereto or by any other person or corporation, excepting only orders or process of courts of law, and are hereby expressly authorized to comply with and obey orders, judgments, or decrees of any court. In case you obey or comply with any such order, judgment, or decree of any court, you shall not be liable to any of the parties hereto or to any other person, firm, or corporation by reason of such compliance, notwithstanding any such order, judgment, or decrees shall be subsequently reversed, modified, annulled, set aside, or vacated, or found to have been entered without jurisdiction.

10. You shall not be liable in any respect on account of the identity, authorities or rights of the parties executing or delivering or purporting to execute or deliver the Agreement or any documents or papers deposited or called for hereunder.

11. You shall not be liable for the outlawing of any rights under the Statute of Limitations with respect to these escrow instructions or any documents deposited with you.

12. By signing these escrow instructions you become a party hereto only for the purpose of said joint escrow instructions, and you do not become a party to the Agreement.

13. Any notice required hereunder shall be given in writing and shall be deemed effective upon personal delivery or upon deposit in the Post Office by registered or certified mail, addressed to the other party hereto at his address hereinafter shown below his signature to this Joint Escrow Instructions or at such other address as such party may designate by ten (10) days advance written notice to the other parties hereto.

14. If prior to the termination of this Escrow you shall die or shall cease to be Secretary of the Company your successor as Secretary of the Company may, from time to time, at the request of the Company’s Board of Directors discharge any of the duties and perform any of the acts to be performed by you as Escrow Agent.

Dated: July 28, 2005	SUN MICROSYSTEMS, INC.
	A Delaware corporation
	By:
		Michael A. Dillon
	Title:	Senior Vice President, General Counsel & Secretary
	Address:	4120 Network Circle
		Santa Clara, CA 95054

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ESCROW AGENT
	Michael A. Dillon
	Secretary of Sun Microsystems, Inc.
Address:	4120 Network Circle
	Santa Clara, CA 95054
PURCHASER
Address:

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EX-10.2

Exhibit 10.2

Chief Executive Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

Plan Objective

Sun’s Chief Executive Officer Bonus Terms for FY06 under its Section 162(m) Executive Officer Performance-Based Bonus Plan (the “Plan”) are designed to compensate the Chief Executive Officer (“CEO”) for contributions to Sun during the fiscal year. The Plan provides for quarterly cash compensation based on performance against the Plan measures.

Plan Year/Performance Periods

The Plan year is Sun’s fiscal year 2006. The Performance Periods (as such term is defined in the Plan) are each of Sun’s four fiscal quarters during that fiscal year.

Eligibility

These terms apply to the person serving as Sun’s CEO as of July 1, 2005. In order to receive a bonus payment with respect to any fiscal quarter, the participant must be serving as Sun’s CEO as of the last day of that fiscal quarter, except as provided below.

A participant who retires, becomes disabled, or dies during any fiscal quarter may receive a prorated bonus for the period of time during the fiscal quarter that the participant provided services to Sun. A participant who leaves Sun prior to the end of a fiscal quarter for any other reason, including but not limited to a reduction in force, voluntary resignation, or termination by Sun, will be ineligible for a bonus payment with respect to that fiscal quarter and any subsequent fiscal quarter during fiscal year 2006.

Bonus Target

The participant’s bonus target under the Plan is 2,500% of the participant’s Eligible Wages for fiscal year 2006, as determined below (the “Bonus Target”). The Bonus Target is divided between the four fiscal quarters of fiscal year 2006 as follows (each, a “Quarterly Bonus Target”):

Fiscal Quarter	Percentage		Quarterly Bonus Target
FY06 Q1	10	%	250	%
FY06 Q2	25	%	625	%
FY06 Q3	25	%	625	%
FY06 Q4	40	%	1,000	%

For example, for FY06 Q1, the Quarterly Bonus Target would be 2,500% multiplied by 10%, or 250% of Eligible Wages for that quarter.

Payouts under the Plan are capped at the lesser of 300% of the Bonus Target or $7.5 million for fiscal year 2006.

Eligible Wages

Eligible Wages with respect to any fiscal quarter in fiscal year 2006 (“Eligible Wages”) shall be determined based upon the participant’s annual base salary on the last day of such fiscal quarter (September 25, 2005 for FY06 Q1, December 25, 2005 for FY 06 Q2, March 26, 2006 for FY06 Q3, and June 30, 2006 for FY06 Q4).

Page 1 of 4

Chief Executive Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

For example, for FY06 Q2, assuming the participant’s annual base salary on December 25, 2005 was $127,000, the participant’s Eligible Wages would be $127,000.

Eligible Wages exclude relocation allowances, expense reimbursements, tuition reimbursement, car/transportation allowances, expatriate allowances, long-term disability payments, or other commissions and bonuses paid during each quarter of FY06.

Company Performance Measures

The Plan is based on performance against the following measures:

1. FY06 Q1- quarterly Operating Income;

2. FY06 Q2 - quarterly Operating Income;

3. FY06 Q3 – quarterly Operating Income; and

4. FY06 Q4- quarterly Operating Income, annual Free Cash Flow, and annual Revenue.

For FY06 Q4, quarterly Operating Income, annual Free Cash Flow, and annual Revenue are relatively weighted as follows: 50%, 25% and 25%.

Operating Income: “Operating Income” is defined as Operating Income, calculated on a GAAP basis, adjusted to exclude the impact of the following:

• Restructuring charges

• In-process R & D charges

• Intangible impairment charges

• Stock compensation expense

• FY06 bonus accrual

Free Cash Flow: “Free Cash Flow” is defined as Cash Flow from Operations, calculated on a GAAP basis, less expenditures for Capital and Spares, adjusted to exclude cash flow associated with:

• Restructuring activity

• Real estate transactions

Revenue: “Revenue” is defined as net revenue as reported in Sun’s consolidated operations analysis.

Bonus Plan Funding Percentage

Attached hereto is a schedule (the “Schedule”), which provides percentages based upon Sun’s actual performance against the Company’s goal(s) with respect to the Company Performance Measures for each quarter. The Bonus Plan Funding Percentage is determined for each fiscal quarter as follows:

1. With respect to the first three fiscal quarters: By referring to the Schedule, which provides a percentage based on Sun’s actual performance against its goal with respect to quarterly Operating Income.

Page 2 of 4

Chief Executive Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

2. With respect to the fourth fiscal quarter: By referral to the Schedule, which provides percentages based on Sun’s actual performance against its goals with respect to quarterly Operating Income, annual Free Cash Flow and annual Revenue and then relatively weighting these percentages as described above under the heading “Company Performance Measures.”

With respect to each fiscal quarter, this percentage is referred to as the “Bonus Plan Funding Percentage”.

Bonus Calculation

The participant’s quarterly bonus payment for each fiscal quarter of fiscal year 2006 will be calculated as follows:

   Quarterly Bonus Target

x Bonus Plan Funding Percentage

x Eligible Wages

= Actual Quarterly Bonus Payment*

1 Example: In FY06 Q2, if Sun achieves 100% of its Operating Income goal, the participant’s actual quarterly bonus payment will be calculated as follows:

Quarterly Bonus Target			625	%
Bonus Plan Funding Percentage	X		100	%
Eligible Wages	X	$	127,000
Actual Quarterly Bonus Payment for FY06 Q2*		$	793,750

2 Example: In FY06 Q4, if Sun achieves 100% of its quarterly Operating Income goal, 70% of its annual Free Cash Flow goal, and 90% of its Revenue goal, the actual participant’s quarterly bonus payment will be calculated as follows:

Step One – Determine Bonus Plan Funding Percentage:

Company Actual Performance for FY06 Q4	Percentage from Schedule		Relative Weighting
Quarterly Operating Income – 100%	100	%	50	%
Annual Free Cash Flow – 70%	70	%	25	%
Annual Revenue – 90%	90	%	25	%
Bonus Plan Funding Percentage			90	%

Page 3 of 4

Chief Executive Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

Step Two – Determine actual quarterly bonus payment:

Quarterly Bonus Target			1,000	%
Bonus Plan Funding Percentage	X		90	%
Eligible Wages	X	$	127,000
Actual Quarterly Bonus Payment for FY06 Q4*		$	1,143,000

* Before applicable taxes and other withholdings, if any.

Bonus Payment

In the U.S., bonus awards are taxable income, and should be paid within two and one-half months after the close of each fiscal quarter. Bonuses are paid in accordance with local payroll schedules in countries outside the U.S and subject to local and regional tax provisions.

Communication of Results

With respect to any particular fiscal quarter during fiscal year 2006, results will be communicated as soon as possible after Sun’s quarterly financial results are publicly announced.

General

This Plan is in all respects subject to the terms, definitions and provisions of Sun’s Section 162(m) Executive Officer Performance-Based Bonus Plan, which is incorporated herein by reference.

Page 4 of 4

EX-10.3

Exhibit 10.3

Chief Operating Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

Plan Objective

Sun’s Chief Operating Officer Bonus Terms for FY06 under its Section 162(m) Executive Officer Performance-Based Bonus Plan (the “Plan”) are designed to compensate the Chief Operating Officer (“COO”) for contributions to Sun during the fiscal year. The Plan provides for quarterly cash compensation based on performance against the Plan measures.

Plan Year/Performance Periods

The Plan year is Sun’s fiscal year 2006. The Performance Periods (as such term is defined in the Plan) are each of Sun’s four fiscal quarters during that fiscal year.

Eligibility

These terms apply to the person serving as Sun’s COO as of July 1, 2005. In order to receive a bonus payment with respect to any fiscal quarter, the participant must be serving as Sun’s COO as of the last day of that fiscal quarter, except as provided below.

A participant who retires, becomes disabled, or dies during any fiscal quarter may receive a prorated bonus for the period of time during the fiscal quarter that the participant provided services to Sun. A participant who leaves Sun prior to the end of a fiscal quarter for any other reason, including but not limited to a reduction in force, voluntary resignation, or termination by Sun, will be ineligible for a bonus payment with respect to that fiscal quarter and any subsequent fiscal quarter during fiscal year 2006.

Bonus Target

The participant’s bonus target under the Plan is 200% of the participant’s Eligible Wages for fiscal year 2006, as determined below (the “Bonus Target”). The Bonus Target is divided between the four fiscal quarters of fiscal year 2006 as follows (each, a “Quarterly Bonus Target”):

Fiscal Quarter	Percentage		Quarterly Bonus Target
FY06 Q1	10	%	20	%
FY06 Q2	25	%	50	%
FY06 Q3	25	%	50	%
FY06 Q4	40	%	80	%

For example, for FY06 Q1, the Quarterly Bonus Target would be 200% multiplied by 10%, or 20% of Eligible Wages for that quarter.

Payouts under the Plan are capped at the lesser of 300% of the Bonus Target or $7.5 million for fiscal year 2006.

Eligible Wages

Eligible Wages with respect to any fiscal quarter in fiscal year 2006 (“Eligible Wages”) shall be determined based upon the participant’s annual base salary on the last day of such fiscal quarter (September 25, 2005 for FY06 Q1, December 25, 2005 for FY 06 Q2, March 26, 2006 for FY06 Q3, and June 30, 2006 for FY06 Q4).

Page 1 of 4

Chief Operating Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

For example, for FY06 Q2, assuming the participant’s annual base salary on December 25, 2005 was $900,000, the participant’s Eligible Wages would be $900,000.

Eligible Wages exclude relocation allowances, expense reimbursements, tuition reimbursement, car/transportation allowances, expatriate allowances, long-term disability payments, or other commissions and bonuses paid during each quarter of FY06.

Company Performance Measures

The Plan is based on performance against the following measures:

1. FY06 Q1- quarterly Operating Income;

2. FY06 Q2 - quarterly Operating Income;

3. FY06 Q3 – quarterly Operating Income; and

4. FY06 Q4- quarterly Operating Income, annual Free Cash Flow, and annual Revenue.

For FY06 Q4, quarterly Operating Income, annual Free Cash Flow, and annual Revenue are relatively weighted as follows: 50%, 25% and 25%.

Operating Income: “Operating Income” is defined as Operating Income, calculated on a GAAP basis, adjusted to exclude the impact of the following:

• Restructuring charges

• In-process R & D charges

• Intangible impairment charges

• Stock compensation expense

• FY06 bonus accrual

Free Cash Flow: “Free Cash Flow” is defined as Cash Flow from Operations, calculated on a GAAP basis, less expenditures on Capital and Spares, adjusted to exclude cash flow associated with:

• Restructuring Activity

• Real Estate Transactions

Revenue: “Revenue” is defined as net revenue as reported in Sun’s consolidated operations analysis.

Bonus Plan Funding Percentage

Attached hereto is a schedule (the “Schedule”), which provides percentages based upon Sun’s actual performance against the Company’s goal(s) with respect to the Company Performance Measures for each quarter. The Bonus Plan Funding Percentage is determined for each fiscal quarter as follows:

1. With respect to the first three fiscal quarters: By referring to the Schedule, which provides a percentage based on Sun’s actual performance against its goal with respect to quarterly Operating Income.

Page 2 of 4

Chief Operating Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

2. With respect to the fourth fiscal quarter: By referral to the Schedule, which provides percentages based on Sun’s actual performance against its goals with respect to quarterly Operating Income, annual Free Cash Flow and annual Revenue and then relatively weighting these percentages as described above under the heading “Company Performance Measures.”

With respect to each fiscal quarter, this percentage is referred to as the “Bonus Plan Funding Percentage”.

Bonus Calculation

The participant’s quarterly bonus payment for each fiscal quarter of fiscal year 2006 will be calculated as follows:

   Quarterly Bonus Target

x Bonus Plan Funding Percentage

x Eligible Wages

= Actual Quarterly Bonus Payment*

1 Example: In FY06 Q2, if Sun achieves 100% of its Operating Income goal, the participant’s actual quarterly bonus payment will be calculated as follows:

Quarterly Bonus Target			50	%
Bonus Plan Funding Percentage	X		100	%
Eligible Wages	X	$	900,000
Actual Quarterly Bonus Payment for FY06 Q2*		$	450,000

2 Example: In FY06 Q4, if Sun achieves 100% of its quarterly Operating Income goal, 70% of its annual Free Cash Flow goal, and 90% of its Revenue goal, the actual participant’s quarterly bonus payment will be calculated as follows:

Step One – Determine Bonus Plan Funding Percentage:

Company Actual Performance for FY06 Q4	Percentage from Schedule		Relative Weighting
Quarterly Operating Income – 100%	100	%	50	%
Annual Free Cash Flow – 70%	70	%	25	%
Annual Revenue – 90%	90	%	25	%
Bonus Plan Funding Percentage			90	%

Page 3 of 4

Chief Operating Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

Step Two – Determine actual quarterly bonus payment:

Quarterly Bonus Target			80	%
Bonus Plan Funding Percentage	X		90	%
Eligible Wages	X	$	900,000
Actual Quarterly Bonus Payment for FY06 Q4*		$	648,000

* Before applicable taxes and other withholdings, if any.

Bonus Payment

In the U.S., bonus awards are taxable income, and should be paid within two and one-half months after the close of each fiscal quarter. Bonuses are paid in accordance with local payroll schedules in countries outside the U.S and subject to local and regional tax provisions.

Communication of Results

With respect to any particular fiscal quarter during fiscal year 2006, results will be communicated as soon as possible after Sun’s quarterly financial results are publicly announced.

General

This Plan is in all respects subject to the terms, definitions and provisions of Sun’s Section 162(m) Executive Officer Performance-Based Bonus Plan, which is incorporated herein by reference.

Page 4 of 4

EX-10.4

Exhibit 10.4

SMX Staff Executive Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

Plan Objective

Sun’s SMX Staff Executive Officer Bonus Terms for FY06 under its Section 162(m) Executive Officer Performance-Based Bonus Plan (the “Plan”) are designed to compensate Executive Officers who are SMX Staff members, other than the Chief Executive Officer (“SMX Staff”) for contributions to Sun during the fiscal year. The Plan provides for quarterly cash compensation based on performance against the Plan measures.

Plan Year/Performance Periods

The Plan year is Sun’s fiscal year 2006. The Performance Periods (as such term is defined in the Plan) are each of Sun’s four fiscal quarters during that fiscal year.

Eligibility

These terms apply to persons serving as members of Sun’s SMX Staff as of July 1, 2005. In order to receive a bonus payment with respect to any fiscal quarter, the participant must be serving as a member of Sun’s SMX Staff as of the last day of that fiscal quarter, except as provided below.

A participant who retires, becomes disabled, or dies during any fiscal quarter may receive a prorated bonus for the period of time during the fiscal quarter that the participant provided services to Sun. A participant who leaves Sun prior to the end of a fiscal quarter for any other reason, including but not limited to a reduction in force, voluntary resignation, or termination by Sun, will be ineligible for a bonus payment with respect to that fiscal quarter and any subsequent fiscal quarter during fiscal year 2006.

Bonus Target

The bonus target under the Plan for members of SMX Staff is 90% of the participant’s Eligible Wages for fiscal year 2006, as determined below (the “Bonus Target”). The Bonus Target is divided between the four fiscal quarters of fiscal year 2006 as follows (each, a “Quarterly Bonus Target”):

Fiscal Quarter	Percentage		Quarterly Bonus Target
FY06 Q1	10	%	9	%
FY06 Q2	25	%	22.5	%
FY06 Q3	25	%	22.5	%
FY06 Q4	40	%	36	%

For example, for FY06 Q1, the Quarterly Bonus Target would be 90% multiplied by 10%, or 9% of Eligible Wages for that quarter.

Payouts under the Plan are capped at the lesser of 300% of the Bonus Target or $7.5 million for fiscal year 2006.

Eligible Wages

Eligible Wages with respect to any fiscal quarter in fiscal year 2006 (“Eligible Wages”) shall be determined based upon the participant’s annual base salary on the last day of such fiscal quarter (September 25, 2005 for FY06 Q1, December 25, 2005 for FY 06 Q2, March 26, 2006 for FY06 Q3, and June 30, 2006 for FY06 Q4).

Page 1 of 4

SMX Staff Executive Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

For example, for FY06 Q2, assuming the participant’s annual base salary on December 25, 2005 was $400,000, the participant’s Eligible Wages would be $400,000.

Eligible Wages exclude relocation allowances, expense reimbursements, tuition reimbursement, car/transportation allowances, expatriate allowances, long-term disability payments, or other commissions and bonuses paid during each quarter of FY06.

Company Performance Measures

The Plan is based on performance against the following measures:

1. FY06 Q1- quarterly Operating Income;

2. FY06 Q2 - quarterly Operating Income;

3. FY06 Q3 – quarterly Operating Income; and

4. FY06 Q4- quarterly Operating Income, annual Free Cash Flow, and annual Revenue.

For FY06 Q4, quarterly Operating Income, annual Free Cash Flow, and annual Revenue are relatively weighted as follows: 50%, 25% and 25%.

Operating Income: “Operating Income” is defined as Operating Income, calculated on a GAAP basis, adjusted to exclude the impact of the following:

• Restructuring charges

• In-process R & D charges

• Intangible impairment charges

• Stock compensation expense

• FY06 bonus accrual

Free Cash Flow: “Free Cash Flow” is defined as Cash Flow from Operations, calculated on a GAAP basis, less expenditures on Capital and Spares, adjusted to exclude cash flow associated with:

• Restructuring activity

• Real estate transactions

Revenue: “Revenue” is defined as net revenue as reported in Sun’s consolidated operations analysis.

Bonus Plan Funding Percentage

Attached hereto is a schedule (the “Schedule”), which provides percentages based upon Sun’s actual performance against the Company’s goal(s) with respect to the Company Performance Measures for each quarter. The Bonus Plan Funding Percentage is determined for each fiscal quarter as follows:

1. With respect to the first three fiscal quarters: By referring to the Schedule, which provides a percentage based on Sun’s actual performance against its goal with respect to quarterly Operating Income.

Page 2 of 4

SMX Staff Executive Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

2. With respect to the fourth fiscal quarter: By referral to the Schedule, which provides percentages based on Sun’s actual performance against its goals with respect to quarterly Operating Income, annual Free Cash Flow and annual Revenue and then relatively weighting these percentages as described above under the heading “Company Performance Measures.”

With respect to each fiscal quarter, this percentage is referred to as the “Bonus Plan Funding Percentage”.

Bonus Calculation

The participant’s quarterly bonus payment for each fiscal quarter of fiscal year 2006 will be calculated as follows:

   Quarterly Bonus Target

x Bonus Plan Funding Percentage

x Eligible Wages

= Actual Quarterly Bonus Payment*

1 Example: In FY06 Q2, if Sun achieves 100% of its Operating Income goal, the participant’s actual quarterly bonus payment will be calculated as follows:

Quarterly Bonus Target			22.5	%
Bonus Plan Funding Percentage	X		100	%
Eligible Wages	X	$	400,000
Actual Quarterly Bonus Payment for FY06 Q2*		$	90,000

2 Example: In FY06 Q4, if Sun achieves 100% of its quarterly Operating Income goal, 70% of its annual Free Cash Flow goal, and 90% of its Revenue goal, the actual participant’s quarterly bonus payment will be calculated as follows:

Step One – Determine Bonus Plan Funding Percentage:

Company Actual Performance for FY06 Q4	Percentage from Schedule		Relative Weighting
Quarterly Operating Income – 100%	100	%	50	%
Annual Free Cash Flow – 70%	70	%	25	%
Annual Revenue – 90%	90	%	25	%
Bonus Plan Funding Percentage			90	%

Page 3 of 4

SMX Staff Executive Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

Step Two – Determine actual quarterly bonus payment:

Quarterly Bonus Target			36	%
Bonus Plan Funding Percentage	X		90	%
Eligible Wages	X	$	400,000
Actual Quarterly Bonus Payment for FY06 Q4*		$	129,600

* Before applicable taxes and other withholdings, if any.

Bonus Payment

In the U.S., bonus awards are taxable income, and should be paid within two and one-half months after the close of each fiscal quarter. Bonuses are paid in accordance with local payroll schedules in countries outside the U.S and subject to local and regional tax provisions.

Communication of Results

With respect to any particular fiscal quarter during fiscal year 2006, results will be communicated as soon as possible after Sun’s quarterly financial results are publicly announced.

General

This Plan is in all respects subject to the terms, definitions and provisions of Sun’s Section 162(m) Executive Officer Performance-Based Bonus Plan, which is incorporated herein by reference.

Page 4 of 4

EX-10.5

Exhibit 10.5

EMG Staff Executive Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

Plan Objective

Sun’s EMG Staff Executive Officer Bonus Terms for FY06 under its Section 162(m) Executive Officer Performance-Based Bonus Plan (the “Plan”) are designed to compensate Executive Officers who are EMG Staff members (“EMG Staff”) for contributions to Sun during the fiscal year. The Plan provides for quarterly cash compensation based on performance against the Plan measures.

Plan Year/Performance Periods

The Plan year is Sun’s fiscal year 2006. The Performance Periods (as such term is defined in the Plan) are each of Sun’s four fiscal quarters during that fiscal year.

Eligibility

These terms apply to persons serving as members of Sun’s EMG Staff as of July 1, 2005. In order to receive a bonus payment with respect to any fiscal quarter, the participant must be serving as a member of Sun’s EMG Staff as of the last day of that fiscal quarter, except as provided below.

A participant who retires, becomes disabled, or dies during any fiscal quarter may receive a prorated bonus for the period of time during the fiscal quarter that the participant provided services to Sun. A participant who leaves Sun prior to the end of a fiscal quarter for any other reason, including but not limited to a reduction in force, voluntary resignation, or termination by Sun, will be ineligible for a bonus payment with respect to that fiscal quarter and any subsequent fiscal quarter during fiscal year 2006.

Bonus Target

The bonus targets under the Plan for members of EMG Staff range from 55% to 85% of the participant’s Eligible Wages for fiscal year 2006, as determined below (the “Bonus Target”). The Bonus Target is divided between the four fiscal quarters of fiscal year 2006 as provided in the table below (each, a “Quarterly Bonus Target”). For example, if a participant’s Bonus Target is 60%, the participant’s Bonus Target would be divided into Quarterly Bonus Targets as follows:

Fiscal Quarter	Percentage		Quarterly Bonus Target
FY06 Q1	10	%	6	%
FY06 Q2	25	%	15	%
FY06 Q3	25	%	15	%
FY06 Q4	40	%	24	%

Payouts under the Plan are capped at the lesser of 300% of the Bonus Target or $7.5 million for fiscal year 2006.

Eligible Wages

Eligible Wages with respect to any fiscal quarter in fiscal year 2006 (“Eligible Wages”) shall be determined based upon the participant’s annual base salary on the last day of such fiscal quarter (September 25, 2005 for FY06 Q1, December 25, 2005 for FY 06 Q2, March 26, 2006 for FY06 Q3, and June 30, 2006 for FY06 Q4).

Page 1 of 4

EMG Staff Executive Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

For example, for FY06 Q2, assuming the participant’s annual base salary on December 25, 2005 was $300,000, the participant’s Eligible Wages would be $300,000.

Eligible Wages exclude relocation allowances, expense reimbursements, tuition reimbursement, car/transportation allowances, expatriate allowances, long-term disability payments, or other commissions and bonuses paid during each quarter of FY06.

Company Performance Measures

The Plan is based on performance against the following measures:

1. FY06 Q1- quarterly Operating Income;

2. FY06 Q2 - quarterly Operating Income;

3. FY06 Q3 – quarterly Operating Income; and

4. FY06 Q4- quarterly Operating Income, annual Free Cash Flow, and annual Revenue.

For FY06 Q4, quarterly Operating Income, annual Free Cash Flow, and annual Revenue are relatively weighted as follows: 50%, 25% and 25%.

Operating Income: “Operating Income” is defined as Operating Income, calculated on a GAAP basis, adjusted to exclude the impact of the following:

• Restructuring charges

• In-process R & D charges

• Intangible impairment charges

• Stock compensation expense

• FY06 bonus accrual

Free Cash Flow: “Free Cash Flow” is defined as Cash Flow from Operations, calculated on a GAAP basis, less expenditures on Capital and Spares, adjusted to exclude cash flow associated with:

• Restructuring activity

• Real estate transactions

Revenue: “Revenue” is defined as net revenue as reported in Sun’s consolidated operations analysis.

Bonus Plan Funding Percentage

Attached hereto is a schedule (the “Schedule”), which provides percentages based upon Sun’s actual performance against the Company’s goal(s) with respect to the Company Performance Measures for each quarter. The Bonus Plan Funding Percentage is determined for each fiscal quarter as follows:

1. With respect to the first three fiscal quarters: By referring to the Schedule, which provides a percentage based on Sun’s actual performance against its goal with respect to quarterly Operating Income.

Page 2 of 4

EMG Staff Executive Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

2. With respect to the fourth fiscal quarter: By referral to the Schedule, which provides percentages based on Sun’s actual performance against its goals with respect to quarterly Operating Income, annual Free Cash Flow and annual Revenue and then relatively weighting these percentages as described above under the heading “Company Performance Measures.”

With respect to each fiscal quarter, this percentage is referred to as the “Bonus Plan Funding Percentage”.

Bonus Calculation

The participant’s quarterly bonus payment for each fiscal quarter of fiscal year 2006 will be calculated as follows:

   Quarterly Bonus Target

x Bonus Plan Funding Percentage

x Eligible Wages

= Actual Quarterly Bonus Payment*

1 Example: In FY06 Q2, if Sun achieves 100% of its Operating Income goal, the participant’s actual quarterly bonus payment will be calculated as follows:

Quarterly Bonus Target			15	%
Bonus Plan Funding Percentage	X		100	%
Eligible Wages	X	$	300,000
Actual Quarterly Bonus Payment for FY06 Q2*		$	45,000

2 Example: In FY06 Q4, if Sun achieves 100% of its quarterly Operating Income goal, 70% of its annual Free Cash Flow goal, and 90% of its Revenue goal, the actual participant’s quarterly bonus payment will be calculated as follows:

Step One – Determine Bonus Plan Funding Percentage:

Company Actual Performance for FY06 Q4	Percentage from Schedule		Relative Weighting
Quarterly Operating Income – 100%	100	%	50	%
Annual Free Cash Flow – 70%	70	%	25	%
Annual Revenue – 90%	90	%	25	%
Bonus Plan Funding Percentage			90	%

Page 3 of 4

EMG Staff Executive Officer Bonus Terms for FY06 Under the

Section 162(m) Executive Officer Performance-Based Bonus Plan

Step Two – Determine actual quarterly bonus payment:

Quarterly Bonus Target			24	%
Bonus Plan Funding Percentage	X		90	%
Eligible Wages	X	$	300,000
Actual Quarterly Bonus Payment for FY06 Q4*		$	64,800

* Before applicable taxes and other withholdings, if any.

Bonus Payment

In the U.S., bonus awards are taxable income, and should be paid within two and one-half months after the close of each fiscal quarter. Bonuses are paid in accordance with local payroll schedules in countries outside the U.S and subject to local and regional tax provisions.

Communication of Results

With respect to any particular fiscal quarter during fiscal year 2006, results will be communicated as soon as possible after Sun’s quarterly financial results are publicly announced.

General

This Plan is in all respects subject to the terms, definitions and provisions of Sun’s Section 162(m) Executive Officer Performance-Based Bonus Plan, which is incorporated herein by reference.

Page 4 of 4

EX-10.6

Exhibit 10.6

FY06 Quarterly SMI Bonus Plan

Director, Principal, Staff, Staff Associate, and Associate/Clerical

Plan Objective

The Quarterly SMI Bonus Plan “(the Plan)” is designed to reward eligible employees (“Participants”) for their contribution to Sun’s success through the achievement of specific SMI financial goals in each quarter during the Fiscal year of 2006. The Company retains the right to amend, supplement, supersede, or terminate the Plan at any time and for any reason. Exceptions to this policy may exist based upon local laws and regulations.

Plan Year/Performance Periods

The Plan year is Sun’s fiscal year 2006. The performance periods are each of Sun’s four fiscal quarters during that fiscal year.

Eligibility

To be eligible, employees and new hires must be in a Plan-eligible position as of:

• September 1^st, 2005 to participate in the FY06 Q1 Bonus.

• December 1^st, 2005 to participate in the FY06 Q2 Bonus

• March 1^st, 2006 to participate in the FY06 Q3 Bonus

• June 1^st, 2006 to participate in the FY06Q4 Bonus

And employees must be on Company Payroll through the following dates, respectively:

• September 25^th, 205 for FY06 Q1 Bonus

• December 25^th, 2005 for FY06 Q2 Bonus

• March 26^th, 2006 for FY06 Q3 Bonus

• June 30^th, 2006 for FY06 Q4 Bonus

Note: In the U.S., only regular active employees who are scheduled to work twenty (20) or more hours per week are eligible to participate in the Plan. Outside the U.S., eligibility is determined by job grade and local legislation.

The following employees are ineligible for Plan participation (Exceptions to this policy may exist outside of the U.S. based upon local laws and regulations.) :

• Employees who are scheduled to work fewer than twenty (20) hours per week (U.S. only)

• Sun temporary workers, contractors, vendors, partners, interns, visiting professors and all other workers who are non-regular employees as determined by Sun, in its sole discretion. If Sun has not classified you as an employee on the date your service with Sun is terminated and, for that reason, has not withheld employment taxes with respect to you, and you are later determined retroactively to have been a common-law employee of Sun, whether by Sun, a governmental agency or a court, you will nevertheless be ineligible to receive Plan benefits.

• Employees at the principal worldwide (WW) job level or below who are eligible for Incentive Bonus (IB)* plans

• Employees who are eligible for any other plan designed to replace the Quarterly SMI Bonus Plan as determined by Sun, in its sole discretion. STK & SeeBeyond legacy employees will not be eligible for the FY06 Quarterly Bonus Plan so long as they are covered by pre-existing StorageTek and SeeBeyond Bonus plans.

• Employees who received a “3” rating for the Fiscal Year of FY05 in FY06 Q1-Q3

• Non- U.S employees at the Staff level and below

* Director level employees who are IB plan eligible participate in the Quarterly SMI Bonus Plan, but with a reduced target bonus percentage as defined in the Quarterly SMI Bonus Plan.

Page 1 of 8

FY06 Quarterly SMI Bonus Plan

Director, Principal, Staff, Staff Associate, and Associate/Clerical

Eligible Employees who are in a Plan-eligible position for only part of the quarter will be eligible for a prorated bonus. Examples include, but are not limited to: being hired after the beginning of the quarter but before the end of the quarter, moving from working fewer than 20 hours per week in the U.S to working 20 hours or more per week in the U.S in a Plan-eligible position, moving from an IB-eligible position to a Quarterly SMI Bonus-eligible position, etc. Individuals hired or rehired, or promoted from a position not eligible for the Quarterly SMI Bonus Plan into an eligible position after the eligibility start date specified for each quarter are not eligible for participation in that quarter. Any changes in the number of hours of work scheduled to be worked per week, with an accompanying change in compensation, will result in a prorated Quarterly SMI Bonus based upon the Plan, reflecting the Participant’s eligible wages earned at the different schedules for hours of work and accompanying compensation rates. The Company reserves the right to further prorate Quarterly SMI Bonus amounts based upon any material changes (as defined by the Company) in the Participant’s position or annual compensation.

Employees must be on Sun’s payroll through the end of each fiscal quarter of FY06 in order to be eligible for that quarter’s bonus payout. However, an otherwise eligible Participant who retires, becomes disabled, takes a Company approved unpaid leave or dies during a quarter within the fiscal year may receive a prorated bonus for that quarter.

An employee on a paid leave of absence during any quarter of the Plan year will be eligible for a bonus to reflect eligible wages for the entire time the employee was both actively working and designated on a paid leave status. “Paid leave” will not include earnings from short-term and/or long-term disability except, as required by law.

Employees who, during a fiscal quarter, transition to an Outsourcing Service Provider in order to provide services as part of a Business Process Outsourcing (BPO), as determined by Global Business Services (GBS) in its sole discretion, and who remain employed by that Outsourcing Service Provider through the end of the fiscal quarter in which they transitioned are eligible for a pro-rated Quarterly SMI Bonus for that quarter. In order to be eligible, those employees must have been employed by Sun in a plan- eligible position during the quarter in which they transfer. The pro-ration will be based on the eligible wages earned at, and paid by, Sun whilst in the Plan-eligible position during that quarter. Employees who are hired by the Outsourcing Service Provider to do work which is not part of the BPO and employees whose jobs are outsourced, but who do not transition to the Outsourcing Service Provider are not eligible for a Quarterly SMI bonus for any quarter during which they fail to meet the eligibility criteria. Exceptions to this policy may exist outside of the U.S. based upon local laws and regulations. Employees outside of the U.S. should contact their local Human Resources representative upon termination of employment from Sun for details.

Target Bonus Opportunity

Participants are eligible for the following annual target bonus percentages, based on WW job level and location:

Location	WW Job Level	U.S. Salary Grade	Target Bonus %
Worldwide	Director – Non-IB Director – IB	E13 – E15 E00	25 15	% %
U.S	Principal – Non-IB	E/Z-10 to12	15	%
Outside of U.S	Principal – Non-IB	E/Z-10 to 12	12	%
U.S Only (defined as employees paid on U.S Payroll)	Staff – Non-IB Staff Associate – Non-IB Associate/Clerical – Non-IB	E/S/Z-7 to 9 E/S/Z-4 to 6 E/S/Z-1-3 and N	8 8 3	% % %

Page 2 of 8

FY06 Quarterly SMI Bonus Plan

Director, Principal, Staff, Staff Associate, and Associate/Clerical

The annual bonus target percentage is adjusted further for each fiscal quarter by a funding percentage of each quarter (Q1: 10%; Q2: 25%; Q3: 25%; Q4: 40%), which results in quarterly bonus target percentages as follows-

WWJob Level	WW Job level	Annual Bonus Target Percentage		FY06Q1 Bonus Target Percentage		FY06Q2 Bonus Target Percentage		FY06Q3 Bonus Target Percentage		FY06Q4 Bonus Target Percentage
Director	C	25	%	2.5	%	6.25	%	6.25	%	10	%
Director- IB	C	15	%	1.5	%	3.75	%	3.75	%	6	%
Principal (U.S)	D	15	%	1.5	%	3.75	%	3.75	%	6	%
Principal (Non U.S.)	D	12	%	1.2	%	3.00	%	3.00	%	4.80	%
Staff (U.S.)	E	8	%	0.8	%	2.00	%	2.00	%	3.20	%
Staff Associate (U.S)	F	8	%	0.8	%	2.00	%	2.00	%	3.20	%
Associate/Clerical (U.S)	G/H	3	%	0.3	%	0.75	%	0.755		1.20	%

For example, a U.S.-based Participant who moves from one Plan-eligible position to another Plan-eligible position with a different target bonus percentage will be eligible for a bonus prorated to reflect the Participant’s eligible wages earned in each of the two positions.

Plan Performance Measures

The Quarterly SMI Bonus Plan considers performance against the following measures:

1. Operating Income

2. Free Cash Flow

3. Revenue

4. Individual Performance

For FY06 Q1-Q3, Sun’s quarterly Operating Income is the sole financial measure. For FY06 Q4, the performance measures are Q4 Operating Income, annual Free Cash Flow, and annual Revenue, as well as Individual Performance.

The SMI Bonus Funding Schedule provides percentages based upon Sun’s actual performance against the Company’s financial goal(s) for each quarter. Employee payouts under the Plan are capped at 300% of the employee’s annual bonus target.

1. Free Cash Flow: For purposes of calculating the bonus accrual under the Plan, “Cash Flow” is defined as Cash Flow from Operations calculated on a GAAP basis less expenditures on Capital and Spares “Free Cash Flow”, adjusted for cash flow associated with:

• Restructuring Activity

• Real Estate Transactions

• Stock Based Compensation

Page 3 of 8

FY06 Quarterly SMI Bonus Plan

Director, Principal, Staff, Staff Associate, and Associate/Clerical

In addition, the cash flows related to any significant one-time event in excess of $20 million (positive or negative) may be included or excluded at the discretion of the Leadership Development and Compensation Committee (LDCC) of the Board of Directors. Significant changes to operations may result in changes to the operating plan at LDCC discretion.

2. Operating Income: For purposes of calculating the bonus accrual under the Plan, “Operating Income” is defined as GAAP Operating Income adjusted to exclude the impact of the following:

• Restructuring charges

• In process R & D charges

• Intangible impairment charges

• Stock Based Compensation

• FY06 Bonus accrual

In addition, any significant one-time event in excess of $20 million (income or expense) may be included or excluded at the discretion of the Leadership Development and Compensation Committee (LDCC) of the Board of Directors. Significant changes to operations may result in changes to the operating plan at LDCC discretion.

3. Revenue: “Revenue” is defined as net revenue as reported in Sun’s consolidated operations analysis.

3. Individual Performance: A Participant’s performance during the year will be used to modify his or her FY06 Q4 actual bonus award ranging from 0%-200% and may preclude the participant from receiving bonuses. Some participants may not receive a bonus award based on individual performance. At the beginning of the fiscal year, employees and managers should meet to discuss and document expected performance outcomes for the year using the Sun Performance Management process. Employees and managers should periodically review progress against the performance outcomes and establish specific action plans to achieve the performance priorities. At the end of the Plan year, the manager will conduct an assessment of how the employee performed in the Sun Performance Management process which will provide guidance regarding the appropriate bonus modification percentage the employee should receive for FY06 Q4.

Bonus Calculation

he Participant’s quarterly bonus payout will be calculated as follows:

  Funding % Per SMI Bonus Funding Schedule

x Quarterly Bonus Target Percentage

x Individual Performance % (Q4 Only)

x Eligible Wages

= Actual Bonus Payment

1. SMI Funding Schedule: Sun has established target levels for payout based upon the achievements of SMI Financial Performance of quarterly Operating Income for FY06 Q1-Q3. The SMI Bonus Funding Schedule provides percentages based upon Sun’s actual performance against the Company’s financial goal(s) for each quarter. For FY06 Q4, the financial measures are quarterly Operating Income, annual Free Cash Flow, and Annual Revenue with weighting of 50%, 25%, and 25% respectively.

2. Individual Performance: For FY06 Q4, a Participant’s final bonus award can be modified from 0% to 200% of target based on annual individual performance. The range varies based upon guidelines established by the Total Rewards Group. The guidelines are based on achievement of objectives and performance rating. Using the guidelines, the manager determines the appropriate award modification percentage based on the Participant’s performance against the Sun Performance Management process during the year. Some Participants may not receive a bonus award based on individual performance.

Page 4 of 8

FY06 Quarterly SMI Bonus Plan

Director, Principal, Staff, Staff Associate, and Associate/Clerical

3. Eligible Wages: Except as set forth above under Target Bonus Opportunity, identifying certain circumstances where bonuses will be prorated taking into account actual earnings during each quarter of FY06, for employees with exempt status, eligible wages are generally based on the Participant’s ending salary of record at the end of each quarter and on the number of days in a specific Plan in the quarter. Eligible wages are calculated by dividing the number of days the Participant is in the eligible position in the fiscal quarter of the Plan by the number of days in the same quarter and multiplying the resulting percentage by the Participant’s final salary at the end of the fiscal quarter, except as otherwise set forth herein. Bonus awards for Participants who move from one target award level to another will be based on separate calculations for each level, using the above formula with looking at ending salary of each applicable level. For U.S. non-exempt and non-exempt salaried Participants, eligible wages also include overtime pay (e.g. Shift-differential, Standby/Call-out pay) earned during the Plan year.

For those who were on an unpaid leave of absence during any quarter in the Plan year, eligible wages are calculated and prorated by dividing the number of days the Participant actively worked at Sun in the eligible position in the quarter by the number of days in the same quarter and multiplying the resulting percentage by the Participant’s final salary while an active employee receiving compensation. Sun will also calculate eligible wages on a prorated basis under the following circumstances:

-The Participant changes from a Plan-ineligible position to a Plan-eligible position where eligible wages are calculated by dividing the numbers of days of the quarter the Participant is in the Plan-eligible position and multiplying the resulting percentage by the Participant’s final salary.

-The Participant changes from a Plan-eligible position to another Plan-eligible position with a different target bonus percentage where eligible wages are calculated by dividing the number of days the Participant is in the eligible position in the quarter by the number of days of the quarter and multiplying the resulting percentage by the Participant’s final salary of each Plan-eligible position.

-Change in scheduled hours for work per week where eligible wages are calculated by dividing the number of day the Participant is in each eligible position of hours-per-week work schedule in the quarter by the number of days in the same quarter and multiplying the resulting percentage by the Participant’s final salary of each eligible position of hours- per- week work schedule.

-The Company exercises its discretion due to material change in employee compensation.

Eligible wages exclude relocation allowances, expense reimbursements, tuition reimbursement, car/transportation allowances, expatriate allowances, long-term disability payments, or other commissions and bonuses paid during the Plan year. Eligible wages are calculated at OTE for SMI bonus plan participants who are on IB plans. For countries outside of the U.S., eligible wage calculation is subject to local regulations and practices.

Bonus Calculation Example:

1. An employee joins Sun on July 15, 2004 with an annual salary of $60,000, and no changes in scheduled work hours, work status, salary, or bonus target percentage took place during Q1. He is a U.S. Staff level employee with an annual bonus target of 8%. If Sun achieves 100% of its Operating Income goal which results in a 100% funding per SMI Bonus Funding schedule, this employee’s Q1 Bonus would be calculated as follows-

Page 5 of 8

FY06 Quarterly SMI Bonus Plan

Director, Principal, Staff, Staff Associate, and Associate/Clerical

Calculation

Eligible Wages:
1)	Number of Days in the Eligible Position (07/15/05- 09/25/05)		73
	Number of days in the Quarter		÷87
	% For the Quarter		84	%
2)	Salary as of September 25, 2005	$	60,000
	% in Q1	x	84	%
	Eligible Wages Earned	$	50,400
Bonus Amount:
Funding % Per SMI Bonus Funding Schedule			100	%
Q1 Bonus Target (8%*10%)			0.8	%
Eligible Wages		x	$50,400
Actual Bonus Payment*		$	403.2

Note: Methodology for bonus calculation for FY06Q2 and Q3 Bonus is the same as for FY06 Q1, with potentially differing funding % per SMI Financial Performance.

2. An employee has an annual salary of $90,000 as of June 30^th 2005, and no changes in scheduled work hours, work status, salary or bonus target percentage took place during FY06 Q4. He is a U.S. Principal level employee with an annual bonus target of 15%. If Sun achieves 120% of its SMI Financial Goals which results in a 100% funding per SMI Bonus Funding schedule and the employee was assigned 120% individual performance multiplier due to over-achievement, this employee’s Q4 Bonus would be calculated as follows-

Calculation

Eligible Wages:
1)	Number of Days in the Eligible Position (03/27/05- 06/30/05)		95
	Number of days in the Quarter		÷95
	% For the Quarter		100	%
2)	Salary as of June 30, 2005	$	90,000
	% in Q4	x	100	%
	Eligible Wages Earned	$	90,000
Bonus Amount:
Funding % Per SMI Bonus Funding Schedule			120	%
Q4 Bonus Target (15%*40%)			6	%
Individual Performance Multiplier			120	%
Eligible Wages		x	$90,000
Actual Bonus Payment*		$	7,776

* Before applicable taxes and other withholdings, if any.

Page 6 of 8

FY06 Quarterly SMI Bonus Plan

Director, Principal, Staff, Staff Associate, and Associate/Clerical

Bonus Payment

In the U.S., bonus awards are taxable income, and will generally be paid within 2 and half months after the close of each fiscal quarter. Bonuses are paid in accordance with local payroll schedules in countries outside the U.S and subject to local and regional tax provisions.

Communication of Results

With respect to any particular fiscal quarter during fiscal year 2006, results will be communicated as soon as possible after Sun’s quarterly financial results are publicly announced.

General Provisions and Plan Governance

The Company is the Plan Administrator. The Company shall make such rules, regulations, interpretations and computations and shall take such other action to administer the Plan as it may deem appropriate. The Board of Directors and Management have the discretion to include or exclude any non-operating items for funding purposes. The establishment of the Plan shall not confer any legal rights upon any employee or other person for a continuation of employment, nor shall it interfere with the rights of the Company to discharge any employee and to treat him or her without regard to the effect which that treatment might have upon him or her as a participant in the Plan. This Plan shall be construed, administered and enforced by the Company, in its sole discretion. The laws of the State of California will govern any legal dispute involving the Plan. The Company may at any time alter, amend or terminate the Plan.

Glossary of Terms

The Company: Sun Microsystems, Inc. and its subsidiaries.

Full-time Regular Employee: A regular employee, as internally designated by Sun in its sole discretion, who is paid directly through Sun Microsystems’ payroll who is scheduled to work 20 or more hours per week and is not an intern, visiting professor, vendor, consultant, or contractor.

Incentive Bonus (IB): Variable sales compensation in the form of a bonus based on the achievement of financial metrics such as revenue or contribution, or other performance measures.

On Target Earnings (OTE): For employees on an incentive bonus (IB) plan, the sum of the annual base salary and the target annual incentive bonus.

Eligible Part-Time Regular Employee: A regular employee, as designated by Sun in its sole discretion, who is paid directly through Sun Microsystems’ payroll and who is scheduled to work 20 hours or more but less than 40 hours per week and is not an intern, visiting professor, vendor, consultant, or contractor.

Ineligible Part-time Employee: A regular employee, as internally designated by Sun in its sole discretion, who is paid directly through Sun Microsystems’ payroll who is scheduled to work fewer than 20 hours per week.

Regular Employee: An individual employed by Sun Microsystems and paid directly through Sun Microsystems’ payroll and not an intern, visiting professor, vendor, consultant or contractor, as identified by Sun.

Business Process Outsourcing (BPO): an SMI-wide initiative, as determined by Global Business Services (GBS) in its sole discretion, which identifies and implements alternative resourcing strategies that will help Sun’s efforts to develop a flexible, highly scalable workforce that takes advantage of the best available talent worldwide.

Global Business Services (GBS): The organization that develops and implements an SMI global resourcing strategy and a model aimed at increasing workforce effectiveness and scalability, and improving overall competitiveness by making cost improvements and taking advantage of the best talent and skills worldwide.

Page 7 of 8

FY06 Quarterly SMI Bonus Plan

Director, Principal, Staff, Staff Associate, and Associate/Clerical

Outsourcing Service Provider: The third party vendor with whom Sun has contracted for the BPO.

SMI: Sun Microsystems, Inc. and its subsidiaries.

Sun: Sun Microsystems, Inc. and its subsidiaries.

WW Job Level: A universal worldwide global grouping of jobs into broadly defined categories, typically based on the degree of skill/competency/responsibility required for the position.

Page 8 of 8

EX-10.7

Exhibit 10.7

Fiscal Year 2006

Base Salaries and Target Annual Incentive Awards

for Sun Microsystems, Inc.’s

Named Executive Officers

On July 28, 2005, the Leadership Development and Compensation Committee of Sun Microsystems, Inc. (“Sun”) approved base salaries and target annual incentive awards for its named executive officers for fiscal 2006. Jonathan I. Schwartz will receive a base salary of $900,000 and his target annual incentive award will be 200% of his base salary; Scott G. McNealy’s base salary and target annual incentive award were not changed from those for fiscal 2005; Crawford W. Beveridge’s and Stephen T. McGowan’s base salaries were not changed from those for fiscal 2005, but each received a customary annual increase of his target annual incentive award; and Gregory M. Papadopoulos received customary annual increases in his base salary and target annual incentive award.

EX-10.8

Exhibit 10.8

Fiscal Year 2005

Discretionary Bonus Payments

for Sun Microsystems, Inc.’s

Named Executive Officers

For fiscal 2005, Sun did not meet all its performance objectives. However, on July 28, 2005, in recognition of progress made during the past fiscal year and for employee retention purposes, Sun’s management and Board of Directors approved a broad-based bonus with respect to fiscal 2005 under Sun’s SMI Bonus Plan (the “Discretionary Bonus”). Sun’s named executive officers received the following amounts under the Discretionary Bonus:

Name	Position	Amount
Scott G. McNealy	Chairman of the Board of Directors and Chief Executive Officer	$	1,111,250
Crawford W. Beveridge	Executive Vice President, People and Places, and Chief Human Resources Officer	$	160,650
Stephen T. McGowan	Chief Financial Officer and Executive Vice President, Corporate Resources	$	177,013
Gregory M. Papadopoulos	Executive Vice President and Chief Technology Officer	$	160,650
Jonathan I. Schwartz	President and Chief Operating Officer	$	280,000

EX-15.1

EXHIBIT 15.1

November 2, 2005

The Board of Directors and Stockholders, Sun Microsystems, Inc.

We are aware of the incorporation by reference in the Registration Statements (Form S-8 Nos. 33-18602, 33-25860, 33-33344, 33-38220, 33-51129, 33-56577, 333-09867, 333-34543, 333-34651, 333-38163, 333-40677, 333-40675, 333-59503, 333-62987, 333-65531, 333-67183, 333-72413, 333-86267, 333-89391, 333-90907, 333-35796, 333-45540, 333-48080, 333-49788, 333-52314, 333-56358, 333-59466, 333-61120, 333-62034, 333-68140, 333-73218, 333-98097, 333-100189, 333-101332, 333-101323, 333-108639, 333-109303, 333-111968, 333-114550, 333-114551, 333-122586, 333-127063, 333-128324 and 333-128325; and Form S-3 Nos. 333-81101 and 333-63716) of Sun Microsystems, Inc. of our report dated November 2, 2005 relating to the unaudited condensed consolidated interim financial statements of Sun Microsystems, Inc. that are included in its Form 10-Q for the quarter ended September 25, 2005.

Pursuant to Rule 436(c) of the Securities Act of 1933, our reports are not a part of the registration statements prepared or certified by accountants within the meaning of Section 7 or 11 of the Securities Act of 1933.

Very truly yours,

/s/ Ernst & Young LLP

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Scott G. McNealy, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Sun Microsystems, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 3, 2005

/s/ SCOTT G. MCNEALY

Scott G. McNealy

Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Stephen T. McGowan, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Sun Microsystems, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 3, 2005

/s/ STEPHEN T. MCGOWAN

Stephen T. McGowan

Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, Scott G. McNealy, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Sun Microsystems, Inc. on Form 10-Q for the period ended September 25, 2005 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents in all material respects the financial condition and results of operations of Sun Microsystems, Inc.

Date: November 3, 2005	By:	/s/ SCOTT G. MCNEALY
	Name:	Scott G. McNealy
	Title:	Chief Executive Officer

EX-32.2

Exhibit 32.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, Stephen T. McGowan, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Sun Microsystems, Inc. on Form 10-Q for the period ended September 25, 2005 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents in all material respects the financial condition and results of operations of Sun Microsystems, Inc.

Date: November 3, 2005	By:	/s/ STEPHEN T. MCGOWAN
	Name:	Stephen T. McGowan
	Title:	Chief Financial Officer