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 December 25, 2005
¨	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 large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act) (Check one);

Large accelerated filer    x                    Accelerated filer    ¨                    Non-accelerated filer    ¨

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 February 1, 2006
Common Stock — $0.00067 par value	3,460,992,501

INDEX

PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements:
	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
	Independent Registered Public Accounting Firm’s Review Report	20
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	49
Item 4.	Controls and Procedures	50
PART II — OTHER INFORMATION
Item 1.	Legal Proceedings	51
Item 4.	Submission of Matters to a Vote of Security Holders	51
Item 6.	Exhibits	51
SIGNATURES		52

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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					Six Months Ended
	December 25, 2005			December 26, 2004		December 25, 2005			December 26, 2004
Net revenues:
Products	$	2,108		$	1,840	$	3,812		$	3,516
Services		1,229			1,001		2,251			1,953
Total net revenues		3,337			2,841		6,063			5,469
Cost of sales:
Cost of sales-products (including stock-based compensation expense of $3 and $5)(1)		1,223			1,065		2,189			2,069
Cost of sales-services (including stock-based compensation expense of $7 and $14)(1)		693			578		1,251			1,129
Total cost of sales		1,916			1,643		3,440			3,198
Gross margin		1,421			1,198		2,623			2,271
Operating expenses:
Research and development (including stock-based compensation expense of $18 and $35)(1)		541			447		980			863
Selling, general and administrative (including stock-based compensation expense of $27 and $51)(1)		1,056			726		1,884			1,396
Restructuring charges		10			24		22			132
Purchased in-process research and development		—			—		60			—
Total operating expenses		1,607			1,197		2,946			2,391
Operating income (loss)		(186	)		1		(323	)		(120	)
Gain on equity investments, net		14			9		27			5
Interest and other income, net		25			33		69			64
Income (loss) before income taxes		(147	)		43		(227	)		(51	)
Provision for income taxes		76			39		119			78
Net income (loss)	$	(223	)	$	4	$	(346	)	$	(129	)
Net income (loss) per common share-basic	$	(0.07	)	$	—	$	(0.10	)	$	(0.04	)
Net income (loss) per common share-diluted	$	(0.07	)	$	—	$	(0.10	)	$	(0.04	)
Shares used in the calculation of net income (loss) per common share — basic		3,424			3,360		3,415			3,349
Shares used in the calculation of net income (loss) per common share — diluted		3,424			3,400		3,415			3,349

(1) For the three and six months ended December 25, 2005, respectively.

See accompanying notes.

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SUN MICROSYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in millions)

	December 25, 2005		June 30, 2005
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	1,193	$	2,051
Short-term marketable debt securities		1,256		1,345
Accounts receivable, net		2,289		2,231
Inventories		550		431
Deferred and prepaid tax assets		275		255
Prepaid expenses and other current assets		658		878
Total current assets		6,221		7,191
Property, plant and equipment, net		1,914		1,769
Long-term marketable debt securities		1,827		4,128
Goodwill		2,472		441
Other acquisition-related intangible assets, net		1,181		113
Other non-current assets, net		693		548
	$	14,308	$	14,190
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt and short-term borrowings	$	508	$	—
Accounts payable		1,214		1,167
Accrued payroll-related liabilities		673		713
Accrued liabilities and other		990		1,014
Deferred revenues		1,541		1,648
Warranty reserve		242		224
Total current liabilities		5,168		4,766
Long-term debt		593		1,123
Long-term deferred revenues		469		544
Other non-current obligations		1,585		1,083
Total stockholders’ equity		6,493		6,674
	$	14,308	$	14,190

See accompanying notes.

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SUN MICROSYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in millions)

	Six Months Ended
	December 25, 2005			December 26 2004
Cash flows from operating activities:
Net loss	$	(346	)	$	(129	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		301			331
Amortization of other acquisition-related intangible assets		153			37
Stock-based compensation expense		105			10
Purchased in-process research and development		60			—
Gain on equity investments, net		(27	)		(5	)
Deferred taxes		4			(3	)
Changes in operating assets and liabilities:
Accounts receivable, net		236			510
Inventories		66			37
Prepaid and other assets		232			(79	)
Accounts payable		(88	)		(88	)
Other liabilities		(663	)		(445	)
Net cash provided by operating activities		33			176
Cash flows from investing activities:
Increase in restricted cash		(54	)		—
Purchases of marketable debt securities		(1,227	)		(2,943	)
Proceeds from sales of marketable debt securities		3,440			2,287
Proceeds from maturities of marketable debt securities		163			508
Proceeds from sales of equity investments, net		14			13
Acquisition of property, plant and equipment, net		(130	)		(141	)
Acquisition of spare parts and other assets		(40	)		(42	)
Payments for acquisitions, net of cash acquired		(3,150	)		—
Net cash used in investing activities		(984	)		(318	)
Cash flows from financing activities:
Proceeds from issuance of common stock, net		93			114
Principal payments on borrowings		—			(250	)
Net cash provided by (used in) financing activities		93			(136	)
Net decrease in cash and cash equivalents		(858	)		(278	)
Cash and cash equivalents, beginning of period		2,051			2,141
Cash and cash equivalents, end of period	$	1,193		$	1,863
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 (net of refunds of $154 and $11, respectively)	$	(33	)	$	100
Supplemental schedule of noncash investing activities:
Stock and options issued in connection with acquisitions	$	89		$	—
Net issuance of nonvested stock awards (restricted stock)	$	69		$	—

See accompanying notes.

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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), Data Management (formerly known as Network Storage) (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 six months ended December 25, 2005 included the results for StorageTek and SeeBeyond from the date of each acquisition.

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.

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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.

If we had earned a profit during the three and six months ended December 25, 2005, we would have added 20 million and 13 million, respectively, common equivalent shares to our basic weighted-average shares outstanding to compute the diluted weighted-average shares outstanding. During the three months ended December 26, 2004, as a result of our profit, 40 million common equivalent shares were included in the quarter in the computation of diluted net income per share. If we had earned a profit during the six months ended December 26, 2004, we would have added 29 million common equivalent shares to our basic weighted-average shares outstanding to compute the diluted weighted-average shares outstanding.

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. As of June 30, 2005, Sun’s cumulative net unremitted earnings did not exceed $1,095 million. In the first quarter of fiscal 2006, we acquired an additional $120 million of unremitted earnings as a result of our acquisition of StorageTek. Should we decide to repatriate these earnings, we would be required to accrue for the additional taxes to repatriate these funds.

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 half of fiscal 2006 did not have a material impact on our results of operations and financial condition:

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

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

• Emerging Issues Task Force (EITF) Issue 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 (APB) Opinions 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.

In November 2005, the FASB issued FASB Staff Position (FSP) FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (FSP 115-1), which provides guidance on determining when investments in certain debt and equity securities are considered impaired, whether that impairment is other-than-temporary, and on measuring such impairment loss. FSP 115-1 also includes accounting considerations subsequent to the recognition of an other-than temporary impairment and requires certain disclosures about unrealized

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losses that have not been recognized as other-than-temporary impairments. FSP 115-1 is required to be applied to reporting periods beginning after December 15, 2005 and is required to be adopted by Sun in the third quarter of fiscal 2006. We are currently evaluating the effect that the adoption of FSP 115-1 will have on our consolidated results of operations and financial condition.

3.    Business Combinations

During the six months ended December 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 due to the finalization of these estimates 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.

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 and certain SeeBeyond stock option holders received cash equal to the difference between $4.25 per share and the exercise price of such stock options. In addition, 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	$	254
Other intangible assets:
Customer base and other		53
Developed technology		34
Tangible assets acquired and net liabilities assumed		24
In-process research and development		11
Total	$	376

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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.

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	$	1,758
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		(543	)
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

9

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 December 25, 2005 (dollars in millions):

	Preliminary Fair Value		Accumulated Amortization			Net Book Value as of December 25, 2005		Weighted Average Useful Life (in years)
Customer base	$	540	$	(69	)	$	471	4
Developed technology		516		(43	)		473	4
Trademarks		55		(1	)		54	16
Other		11		(1	)		10	3
Total intangible assets	$	1,122	$	(114	)	$	1,008

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 were estimated 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.

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

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periods presented. Sun’s results of operations for the three and six months ended December 25, 2005 included the results of StorageTek since August 31, 2005, the date of acquisition. The unaudited pro forma financial information for the six months ended December 25, 2005 combines Sun’s results for these periods with the results for StorageTek for the period from July 2, 2005 to August 30, 2005. The unaudited pro forma financial information for the three and six months ended December 26, 2004 combines Sun’s results for this period with StorageTek’s results for the three and six months ended December 31, 2004. The pro forma financial information presented below is 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						Six Months Ended
	December 25, 2005			December 26, 2004			December 25, 2005			December 26, 2004
Revenues	$	3,346		$	3,475		$	6,260		$	6,595
Net loss	$	(155	)	$	(6	)	$	(410	)	$	(238	)
Net loss per share — basic and diluted	$	(0.05	)	$	—		$	(0.12	)	$	(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		2,031
Balance as of December 25, 2005	$	2,472

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		December 25, 2005		June 30, 2005			Additions			December 25, 2005			December 25, 2005
Developed technology	$	437	$	559	$	996	$	(339	)	$	(72	)	$	(411	)	$	585
Customer base		55		593		648		(48	)		(77	)		(125	)		523
Trademark		6		57		63		(6	)		(1	)		(7	)		56
Acquired workforce and other		82		12		94		(74	)		(3	)		(77	)		17
	$	580	$	1,221	$	1,801	$	(467	)	$	(153	)	$	(620	)	$	1,181

Amortization expense of other acquisition-related intangible assets was $107 million and $153 million for the three and six months ended December 25, 2005, respectively, and $19 million and $37 million for the three and six months ended December 26, 2004, respectively. Our acquisition-related intangible assets are primarily amortized over periods ranging from one to five years on a straight-line basis.

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

Remainder of 2006	$	177
2007		334
2008		316
2009		263
2010		53
Thereafter		38
	$	1,181

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5.    Balance Sheet Details

Inventories

Inventories consisted of the following (in millions):

	December 25, 2005		June 30, 2005
Raw materials	$	95	$	48
Work in process		134		121
Finished goods		321		262
	$	550	$	431

Deferred Revenues

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

	Deferred services 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		1,860			591			2,451
Revenue recognized		(2,121	)		(641	)		(2,762	)
Balance at December 25, 2005		1,508			502			2,010
Less short-term portion		(1,091	)		(450	)		(1,541	)
Total long-term deferred revenues	$	417		$	52		$	469

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		162
Utilized		(179	)
Balance at December 25, 2005	$	242

6.    Restructuring Charges

In accordance with SFAS 112 “Employers’ Accounting for Post Employment Benefits” (SFAS 112) and SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146), we recognized a total of $10 million and $22 million in restructuring charges in the three and six months ended December 25, 2005, respectively, and $24 million and $132 million for the three and six months ended December 26, 2004, respectively.

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 December 25, 2005, our estimated sublease income to be generated from sublease contracts not yet negotiated approximated $64 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.

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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 three and six months ended December 25, 2005, we recognized a total of $10 million and $22 million, respectively, in charges associated with 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 December 25, 2005, 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 Restructuring 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.

The following table sets forth an analysis of our restructuring accrual activity for the six months ended December 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		17			4			—			—			—			—			21
Accrued lease costs		—			—			5			—			—			—			5
Provision adjustments		5			1			(4	)		(4	)		1			(3	)		(4	)
Total restructuring charges		22			5			1			(4	)		1			(3	)		22
Cash paid		(49	)		(20	)		(25	)		(9	)		(11	)		(8	)		(122	)
Balance as of December 25, 2005	$	17		$	22		$	133		$	64		$	119		$	15		$	370

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The remaining cash expenditures relating to workforce reductions are expected to be paid over the next few quarters. Our accrual as of December 25, 2005 for facility-related leases (net of anticipated sublease proceeds) will be paid over their respective lease terms through fiscal 2023. As of December 25, 2005, $115 million of the total $370 million accrual for workforce reductions and facility-related leases was classified as current accrued liabilities and other and the remaining $255 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. As a result, we recorded approximately $54 million of restructuring costs in connection with the StorageTek acquisition, which are based upon plans committed to 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. The following table sets forth an analysis of the components of the preliminary acquisition-related restructuring liabilities included in the purchase price allocation for StorageTek and subsequent restructuring accrual activity for the six months ended December 25, 2005 (in millions):

	Severance and Benefits			Facilities Related		Total
Balance as of June 30, 2005	$	—		$	—	$	—
Acquisition-related restructuring liabilities		16			36		52
Provision adjustments		—			2		2
Cash paid		(2	)		—		(2	)
Balance as of December 25, 2005	$	14		$	38	$	52

As of December 25, 2005, our estimated sublease income to be generated from sublease contracts not yet negotiated approximated $11 million.

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 December 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 Income (Loss)

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

	Three Months Ended						Six Months Ended
	December 25, 2005			December 26, 2004			December 25, 2005			December 26, 2004
Net income (loss)	$	(223	)	$	4		$	(346	)	$	(129	)
Change in unrealized value on investments, net		(15	)		1			(32	)		9
Change in unrealized fair value of derivative instruments and other, net		(2	)		(9	)		(3	)		(8	)
Translation adjustments, net		(69	)		108			(88	)		86
	$	(309	)	$	104		$	(469	)	$	(42	)

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

	December 25, 2005			June 30, 2005
Unrealized gains (losses) on investments, net	$	(21	)	$	11
Unrealized gains (losses) on derivative instruments and other, net		(1	)		2
Cumulative translation adjustments, net		107			195
	$	85		$	208

8.    Income Taxes

For the second quarter and first half of fiscal 2006, we recorded an income tax provision of $76 million and $119 million, respectively, as compared with $39 million and $78 million for the corresponding periods 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. Additionally, during the second quarter and first six months of fiscal 2006, our income tax provision included approximately $20 million relating to corrections of previously filed tax returns. This adjustment is immaterial to our results of operations and financial condition for the current period as well as the prior affected periods.

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 and vest 50% in two tranches within a five year period from the grant date. 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 December 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 and six months ended December 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

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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.

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 December 25, 2005		Six Months Ended December 25, 2005
Cost of sales — products	$	3	$	5
Cost of sales — services		7		14
Research and development		18		35
Selling, general and administrative		27		51
Stock-based compensation expense before income taxes		55		105
Income tax benefit		—		—
Total stock-based compensation expense after income taxes	$	55	$	105

Net cash proceeds from the exercise of stock options were $38 million and $40 million for the three and six months ended December 25, 2005, respectively, and $38 million and $53 million for the three and six months ended December 26, 2004, respectively. No income tax benefit was realized from stock option exercises during the three and six months ended December 25, 2005 and December 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 123, amended by SFAS 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (SFAS 148), which allowed companies to apply the existing accounting rules under APB 25, “Accounting for Stock Issued to Employees,” 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) for periods prior to the adoption of SFAS 123R. 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 income (loss) after tax and net income (loss) per common share as if we had applied the fair value recognition provisions of SFAS 123 to stock-based compensation during the three and six months ended December 26, 2004 (in millions, except per share amounts):

	Three Months Ended December 26, 2004			Six Months Ended December 26, 2004
Pro forma net loss:
Net income (loss) after tax	$	4		$	(129	)
Add: stock-based compensation costs included in reported net income (loss) (net of tax effects of none in all periods)		5			10
Deduct: stock-based compensation costs (net of tax effects of none in all periods) under SFAS 123		(171	)		(366	)
Pro forma net loss after tax	$	(162	)	$	(485	)
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		3,360			3,349
Pro forma net loss per common share — basic and diluted	$	(0.05	)	$	(0.14	)
Reported net income (loss) per common share — basic and diluted	$	—		$	(0.04	)

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

Options	Three Months Ended						Six Months Ended
	December 25, 2005			December 26, 2004			December 25, 2005			December 26, 2004
Expected life (in years)		4.8			5.8			4.8			6.0
Interest rate		4.42	%		3.69	%		4.14	%		3.62	%
Volatility		42.07	%		68.04	%		42.82	%		68.36	%
Dividend yield		—			—			—			—
Weighted-average fair value at grant date	$	1.65		$	2.90		$	1.57		$	2.52
Employee Stock Purchase Plan	Three Months Ended						Six Months Ended
	December 25, 2005			December 26, 2004			December 25, 2005			December 26, 2004
Expected life (in years)		0.5			0.5			0.5			0.5
Interest rate		3.77	%		1.36	%		3.49	%		1.25	%
Volatility		36.35	%		40.72	%		39.29	%		41.88	%
Dividend yield		—			—			—			—
Weighted-average fair value at grant date	$	0.96		$	1.05		$	0.97		$	1.02

Our computation of expected volatility for the three and six months ended December 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 executive officers and our 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 six months ended December 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	88			3.22
Exercises	(15	)		2.68
Forfeitures or expirations	(43	)		11.66
Outstanding at December 25, 2005	587		$	10.89	4.6	$	230
Exercisable at December 25, 2005	384		$	14.70	3.5	$	87

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 second 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 December 25, 2005. This amount changes based on the fair market value of Sun’s stock. Total intrinsic value of options exercised is $18 million and $21 million for the three and six months ended December 25, 2005, respectively. Total fair value of options vested is $38 million and $92 million for the three and six months ended December 25, 2005, respectively.

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As of December 25, 2005, $380 million of total unrecognized compensation cost related to stock options is expected to be recognized over a weighted-average period of 3.1 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 six months ended December 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	19		3.68
Vested	—		—
Forfeited	—		—
Nonvested stock at December 25, 2005	21	$	3.71

As of December 25, 2005, we retained purchase rights to 19 million shares issued pursuant to stock purchase agreements and other stock plans at a weighted-average price of approximately $0.01.

As of December 25, 2005, $51 million of total unrecognized compensation costs related to nonvested stock is expected to be recognized over a weighted-average period of one year.

10.    Operating Segments

We design, manufacture, market and service network computing infrastructure solutions that consist of Computer Systems (hardware and software), Data Management (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 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 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 Data Management product lines. In the 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 acquisition of StorageTek 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 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.

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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		Services		Other			Total
Three Months Ended:
December 25, 2005
Revenues	$	2,108	$	1,229	$	—		$	3,337
Interdivision revenues		58		89		(147	)		—
Operating income (loss)		380		469		(1,035	)		(186	)
December 26, 2004
Revenues	$	1,840	$	1,001	$	—		$	2,841
Interdivision revenues		163		100		(263	)		—
Operating income (loss)		329		388		(716	)		1
Six Months Ended:
December 25, 2005
Revenues	$	3,812	$	2,251	$	—		$	6,063
Interdivision revenues		116		181		(297	)		—
Operating income (loss)		687		866		(1,876	)		(323	)
December 26, 2004
Revenues	$	3,516	$	1,953	$	—		$	5,469
Interdivision revenues		338		204		(542	)		—
Operating income (loss)		574		752		(1,446	)		(120	)

11.    Legal Proceedings

On April 20, 2004, we were served with a complaint in a case in the United States District Court for the Eastern District of Texas entitled Gobeli Research (Gobeli) v. Sun Microsystems, Inc. and Apple Computer, Inc. (Apple). The complaint alleged that Sun products, including our Solaris^TM Operating System, infringed on a Gobeli patent related to a system and method for controlling interrupt processing. We settled all outstanding claims against us in this case subsequent to the end of our second fiscal quarter for an amount that is immaterial to our results of operations and financial condition. An accrual for the settlement is reflected in our consolidated financial statements for the fiscal quarter and six months ended December 25, 2005.

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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 December 25, 2005, and the related condensed consolidated statements of operations for the three-month and six-month periods ended December 25, 2005 and December 26, 2004, and the condensed consolidated statements of cash flows for the six-month periods ended December 25, 2005 and December 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

January 20, 2006

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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), Data Management (formerly known as Network Storage) (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^™ technology platform, the Solaris operating system (Solaris OS), Sun Java products, the N1^™ Grid architecture and the UltraSPARC^® 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.

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 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. We completed our acquisition of StorageTek on August 31, 2005. As a result, the results of operations for the six months ended December 25, 2005 included the results for StorageTek from the date of the acquisition. StorageTek has historically experienced a disproportionately high product revenue volume in the last month of each fiscal quarter. Therefore, the results of operations included for the six months ended December 25, 2005 are not indicative of the results for a full six months. StorageTek’s products revenues are included in Data Management products and StorageTek’s services revenues are included in Support services.

During the second quarter of fiscal 2006, we experienced a year over year increase in total net revenues of approximately 17.5%, which included an unfavorable foreign currency impact of approximately 3%. Our Products net revenue of $2,108 million was favorably impacted by $368 million of storage revenue related to the operations of StorageTek, offset by a continuing market shift in overall computer system demand away from our higher priced data center servers towards the usage of entry level servers. Our Services net revenue of $1,229 million was favorably impacted by $228 million of services revenue related to the operations of StorageTek and an increase in our on-site support and managed services revenue. These increases were partially offset by 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. We also experienced a sequential quarterly increase in total net revenues of approximately 22.4%, which reflects the increase in revenue related to the operations of StorageTek of approximately $382 million and the normal seasonal increase we experience between the first and second quarter, offset by an unfavorable foreign currency impact of approximately 1%. During the second quarter of fiscal 2006, we experienced an increase in our entry-level product demand due to the introduction of certain UltraSPARC IV+ and Opteron-based systems during the quarter.

During the second quarter of fiscal 2006, our year over year gross margin increased by approximately 0.4 percentage points. Our Products gross margin remained relatively flat as manufacturing and component cost reductions were partially offset by the unfavorable impact of discounting and pricing actions and an increase in amortization of our other acquisition-related intangible assets. Our Services gross margin increased by 1.3 percentage points primarily due to the favorable impact of delivery efficiencies, cost reductions and productivity measures. Our sequential quarterly Products gross margin decreased 1.3 percentage points as planned list price reductions and sales discounting actions were partially offset by cost reductions. Sequentially, Services gross margin decreased by 1.8 percentage points primarily due to 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.

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During the second quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, our research and development expenses increased $94 million and our sales, general and administrative expenses increased $330 million. These increases were primarily due to operating expenses related to StorageTek, an increase in amortization of other acquisition-related intangible assets and stock-based compensation expense. Sequentially, our research and development expenses increased $102 million and our sales, general and administrative expenses increased $228 million. These increases were primarily due to a full quarter of StorageTek and SeeBeyond Technology Corporation (SeeBeyond) operations, an increase in amortization of other acquisition-related intangible assets and an increase in salaries due to seasonal factors including the benefits of the July shutdown in the first quarter and additional pay days in the second quarter.

Our results of operations for the second quarter and first half of fiscal 2006 were significantly impacted by the adoption of Statement of Financial Accounting Standards (SFAS) 123R (revised 2004), “Share-Based Payments” (SFAS 123R) in the first quarter of fiscal 2006, which required 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 $55 million in stock-based compensation expense recognized in the second quarter of fiscal 2006, $3 million is included in cost of goods sold-products, $7 million is included in cost of goods sold-services, $18 million is included in research and development expense and $27 million is included in sales, general and administrative expense. Of the $105 million in stock-based compensation expense recognized in the first half of fiscal 2006, $5 million is included in cost of goods sold-products, $14 million is included in cost of goods sold-services, $35 million is included in research and development expense and $51 million is included in sales, general and administrative expense.

During the second quarter and first six months of fiscal 2006, our consolidated results of operations were unfavorably impacted by approximately $20 million of additional income tax expense relating to corrections of previously filed tax returns. This adjustment is immaterial to our results of operations and financial condition for the current period as well as the prior affected periods.

During the first half of fiscal 2006, our operating activities provided cash flows of $33 million. Our focus on cash management remains a top priority and we plan to continue to drive improvement in our cash conversion cycle. At December 25, 2005 we had total cash, cash equivalents and marketable debt securities of approximately $4.3 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 (U.S. 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 cannot be forecast with certainty 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 first half of fiscal 2006 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.

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In the first quarter of fiscal 2006, we determined that our equity investments in privately held companies accounting policy was no longer critical, as the remaining balance related to investments in privately held companies was no longer material.

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.

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 fair 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 requires judgment, including estimating stock price volatility, forfeiture rates and expected life.

RESULTS OF OPERATIONS

Net Revenues

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

	Three Months Ended						Change	Six Months Ended						Change
	December 25, 2005			December 26, 2004				December 25, 2005			December 26, 2004
Computer Systems products	$	1,438		$	1,505		(4.5)%	$	2,712		$	2,859		(5.1)%
Data Management products		670			335		100%		1,100			657		67.4%
Products net revenue	$	2,108		$	1,840		14.6%	$	3,812		$	3,516		8.4%
Percentage of total net revenues		63.2	%		64.8	%	(1.6) pts		62.9	%		64.3	%	(1.4) pts
Support services	$	953		$	774		23.1%	$	1,788		$	1,519		17.7%
Client solutions and Educational services		276			227		21.6%		463			434		6.7%
Services net revenue	$	1,229		$	1,001		22.8%	$	2,251		$	1,953		15.3%
Percentage of total net revenues		36.8	%		35.2	%	1.6 pts		37.1	%		35.7	%	1.4 pts
Total net revenues	$	3,337		$	2,841		17.5%	$	6,063		$	5,469		10.9%
Revenue per employee(1)	$	86		$	88		(2.3)%	$	165		$	166		(0.6)%

(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.

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In recent periods, our services business has evolved as we have increased our emphasis on our solutions-based selling model and offerings, such as Managed services, that are not easily measured using prior disclosed 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 strengthened U.S. dollar during the second quarter and first half of fiscal 2006, as compared with the corresponding periods of fiscal 2005, our total net revenues were unfavorably 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 second quarter and first half of fiscal 2006, as compared with the corresponding periods of fiscal 2005, approximated 3% and 1%, respectively, of Products net revenue and approximated 3% and 1%, respectively, of Services net revenue.

Products Net Revenue

Products net revenue consists of revenue generated from the sale of Computer Systems and Data Management products.

During the second quarter and first half of fiscal 2006, as compared with the corresponding periods 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 AMD’s Opteron processors. During the second quarter of fiscal 2006, we experienced an increase in our entry-level product demand due to the introduction of certain UltraSPARC IV+ and Opteron-based systems during the quarter.

During the second quarter and first half of fiscal 2006, as compared with the corresponding periods in fiscal 2005, Data Management Products revenue included $368 million and $495 million, respectively, related to the operations of StorageTek, primarily the sales of their tape and network storage products. Excluding the revenues from StorageTek, Data Management revenue decreased by $33 million and $52 million, respectively, primarily due to intense competition and reduced sales of our entry level storage systems, low-end storage components and our tapes and other storage hardware. These decreases were partially offset by increased unit sales of our data center storage systems in the second quarter and first half of fiscal 2006.

Services Net Revenue

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

Support services revenue consists primarily of maintenance contract revenue, which is recognized ratably over the contractual period. During the second quarter and first half of fiscal 2006, Support services net revenue included $193 million and $280 million, respectively, related to the operations of StorageTek. Excluding the impact of this acquisition, Support services revenues decreased by $14 million and $11 million during the second quarter and first half of fiscal 2006, respectively, as compared with the corresponding periods in fiscal 2005. These changes were primarily due to 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. These decreases were offset by increases in our site support and managed services revenues.

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. During the second quarter and first half of fiscal 2006, Client solutions and Educational services revenue included $35 million in each period, respectively, related to the operations of StorageTek. Excluding the revenues from StorageTek, Client solutions and Educational services revenue increased by $14 million and decreased by $6 million during the second quarter and first half of fiscal 2006, respectively, as compared with the corresponding periods in fiscal 2005. The increase during the second quarter of fiscal 2006 was primarily due to an increase in employee development and web-learning initiatives adopted by our customers. The decrease during the first half of fiscal 2006,

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as compared with the first half of 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 which did not recur in the first quarter of fiscal 2006.

Net Revenues by Geographic Area

(dollars in millions)

	Three Months Ended						Change	Six Months Ended						Change
	December 25, 2005			December 26, 2004				December 25, 2005			December 26, 2004
United States (U.S.)	$	1,373		$	1,130		21.5%	$	2,532		$	2,235		13.3%
Percentage of total net revenues		41.2	%		39.8	%	1.4 pts		41.8	%		40.9	%	0.9 pts
International Americas (Canada and Latin America)	$	194		$	165		17.6%	$	335		$	275		21.8%
Percentage of total net revenues		5.8	%		5.8	%	- pts		5.5	%		5.0	%	0.5 pts
EMEA (Europe, Middle East and Africa)	$	1,239		$	1,037		19.5%	$	2,209		$	2,010		9.9%
Percentage of total net revenues		37.1	%		36.5	%	0.6 pts		36.4	%		36.7	%	(0.3) pts
APAC (Asia, Australia and New Zealand)	$	531		$	509		4.3%	$	987		$	949		4.0%
Percentage of total net revenues		15.9	%		17.9	%	(2.0) pts		16.3	%		17.4	%	(1.1) pts
Total International revenues	$	1,964		$	1,711		14.8%	$	3,531		$	3,234		9.2%
Percentage of total net revenues		58.8	%		60.2	%	(1.4) pts		58.2	%		59.1	%	(0.9) pts
Total net revenues	$	3,337		$	2,841		17.5%	$	6,063		$	5,469		10.9%

United States (U.S.)

During the second quarter and first half of fiscal 2006, as compared with the corresponding periods of fiscal 2005, net revenues in the U.S. included $306 million and $396 million, respectively, related to the operations of StorageTek and $12 million and $17 million, respectively, related to the operations of SeeBeyond. Excluding revenues from StorageTek and SeeBeyond, net revenues in the U.S. decreased $75 million and $116 million, respectively, 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, during the second quarter, we experienced strong demand for certain entry level servers that was not fully realized due to supply constraints. 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. In the financial services sector, we experienced weak demand during the second quarter of fiscal 2006 with customers continuing to concentrate on cost reductions and spending controls. Additionally, in the first half of fiscal 2006, merger and acquisition activity in the telecommunication sector was correlated to reduced customer spending patterns in key accounts. Excluding revenues from StorageTek and SeeBeyond, services revenues in the U.S remained relatively flat during the second quarter and first half of fiscal 2006, as compared to the corresponding periods in fiscal 2005.

The following table sets forth net revenues in those geographic markets that contributed significantly to international net revenues during the second quarter and first half of fiscal 2006:

(dollars in millions)

	Three Months Ended				Change		Six Months Ended				Change
	December 25, 2005		December 26, 2004				December 25, 2005		December 26, 2004
United Kingdom (UK)	$	282	$	222	27.0	%	$	516	$	514	0.4	%
Germany	$	257	$	228	12.7	%	$	473	$	419	12.9	%
Central and Northern Europe	$	213	$	181	17.7	%	$	369	$	333	10.8	%
Japan	$	193	$	190	1.6	%	$	359	$	373	(3.8	)%

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United Kingdom (UK)

During the second quarter and first half of fiscal 2006, as compared with the corresponding periods of fiscal 2005, net revenues in the UK included $45 million and $64 million, respectively, related to the operations of StorageTek and $9 million and $11 million, respectively, related to the operations of SeeBeyond. Excluding the revenues from StorageTek and SeeBeyond, net revenues in the UK increased by $6 million and decreased by $73 million, respectively. The increase in the second quarter of fiscal 2006 was primarily due to moderate growth in Products and Client Solutions revenue and improvements in the financial services and telecommunications sectors, offset by the unfavorable impact of foreign currency exchange. The decrease in the first half of fiscal 2006 was due to revenue related to two large solution-based sales recognized in the first quarter of fiscal 2005 which did not recur in the first quarter of fiscal 2006.

Germany

During the second quarter and first half of fiscal 2006, as compared with the corresponding periods of fiscal 2005, net revenues in Germany included $34 million and $51 million, respectively, related to the operations of StorageTek. Excluding the revenues from StorageTek, net revenues in Germany during the second quarter and first half of fiscal 2006 was relatively flat. Net revenues in Germany were impacted by the increase in sales of our entry-level products, partially offset by intense competition, continuing weak demand for our data center servers in certain industry sectors and the unfavorable impact of foreign currency exchange.

Central and Northern Europe (CNE)

During the second quarter and first half of fiscal 2006, as compared with the corresponding periods of fiscal 2005, net revenues in CNE included $43 million and $61 million, respectively related to the operations of StorageTek. Excluding the revenues from StorageTek, net revenues in CNE decreased by $11 million and $25 million, respectively, primarily due to the weak demand for our data center servers and a challenging macroeconomic environment.

Japan

During the second quarter and first half of fiscal 2006, as compared with the corresponding periods of fiscal 2005, net revenues in Japan included $27 million and $42 million related to the operations of StorageTek. Excluding the revenues from StorageTek, net revenues in Japan decreased by $24 million and $56 million, respectively, primarily due to a decrease in Products net revenue. The decrease in Products net revenue in Japan was due to our second quarter of fiscal 2006 product transition to UltraSPARC IV+, the unfavorable impact of foreign currency exchange and continued weak demand in the telecommunication sector as a result of intense competition.

Gross Margin

(dollars in millions)

	Three Months Ended						Change	Six Months Ended						Change
	December 25, 2005			December 26, 2004				December 25, 2005			December 26, 2004
Products gross margin	$	885		$	775		14.2%	$	1,623		$	1,447		12.2%
Percentage of products net revenue		42.0	%		42.1	%	(0.1) pts		42.6	%		41.2	%	1.4pts
Services gross margin	$	536		$	423		26.7%	$	1,000		$	824		21.4%
Percentage of services net revenue		43.6	%		42.3	%	1.3pts		44.4	%		42.2	%	2.2pts
Total gross margin	$	1,421		$	1,198		18.6%	$	2,623		$	2,271		15.5%
Percentage of total net revenues		42.6	%		42.2	%	0.4pts		43.3	%		41.5	%	1.8pts

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

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(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 second quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, our Products gross margin remained relatively flat. Cost reductions resulting from supply chain restructuring and product cost engineering which collectively benefited gross margin by approximately 8 percentage points, were offset by planned list price reductions and sales discounting actions of approximately 6 percentage points and an increase in amortization of acquisition-related intangible assets of approximately 2 percentage points.

During the first half of fiscal 2006, as compared with the corresponding period of fiscal 2005, our Products gross margin increased 1.4 percentage points due to cost reductions resulting from supply chain restructuring and product cost engineering which collectively benefited gross margin by approximately 3 percentage points and a reduction in channel program and other reserves of approximately 1 percentage point. Offsetting these increases were changes in product mix to a greater proportion of lower-margin products of approximately 2 percentage points and an increase in amortization of acquisition-related intangible assets of approximately 1 percentage point.

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 second quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, our Services gross margin increased by 1.3 percentage points due to cost savings associated with our workforce reductions of approximately 2 percentage points and cost savings associated with delivery efficiencies of approximately 2 percentage points. Offsetting these increases were sales discounting actions of approximately 1 percentage point.

During the first half of fiscal 2006, as compared with the corresponding period of fiscal 2005, our Services gross margin increased by 2.2 percentage points due to savings associated with our workforce reductions of approximately 2 percentage points and cost savings associated with delivery efficiencies of approximately 2 percentage points. Offsetting these increases were sales discounting actions of approximately 1 percentage point and revenue volume inefficiencies of approximately 1 percentage point.

Operating Expenses

(dollars in millions)

	Three Months Ended						Change		Six Months Ended						Change
	December 25, 2005			December 26, 2004					December 25, 2005			December 26, 2004
Research and development	$	541		$	447		21.0	%	$	980		$	863		13.6	%
Percentage of total net revenues		16.2	%		15.7	%				16.2	%		15.8	%
Selling, general and administrative	$	1,056		$	726		45.5	%	$	1,884		$	1,396		35.0	%
Percentage of total net revenues		31.6	%		25.6	%				31.1	%		25.5	%
Restructuring charges	$	10		$	24		(58.3	)%	$	22		$	132		(83.3	%)
Percentage of total net revenues		0.3	%		0.8	%				0.4	%		2.4	%
Purchased in-process research and development	$	—		$	—		N/M	*	$	60		$	—		N/M	*
Percentage of total net revenues		—	%		—	%				1.0	%		—	%
Total operating expenses	$	1,607		$	1,197		34.3	%	$	2,946		$	2,391		23.2	%

* N/M - Not meaningful

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Research and Development (R&D) Expenses

R&D expenses increased by $94 million during the second quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, primarily due to $69 million associated with the operating expenses of StorageTek and SeeBeyond, a $23 million increase in salaries and $18 million of stock-based compensation expense. These increases were partially offset by a $14 million decrease in depreciation and amortization.

R&D expenses increased by $117 million during the first half of fiscal 2006, as compared with the corresponding period of fiscal 2005, primarily due to $86 million associated with the operating expenses of StorageTek and SeeBeyond, $35 million of stock-based compensation expense and a $19 million increase in salaries. These increases were partially offset by a $25 million decrease in depreciation and amortization.

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 $330 million during the second quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, primarily due to $206 million associated with the operating expenses of StorageTek and SeeBeyond and $58 million in other acquisition-related intangible asset amortization resulting from these acquisitions. The remainder of the increase is due to $27 million of stock-based compensation expense, a $27 million increase in outside services costs and a $10 million increase in compensation costs associated with salaries and bonuses. These increases were partially offset by a $12 million decrease in depreciation and amortization and $28 million in cost savings resulting from workforce reductions.

SG&A expenses increased by $488 million during the first half of fiscal 2006, as compared with the corresponding period of fiscal 2005, primarily due to $275 million associated with the operating expenses of StorageTek and SeeBeyond and $77 million in other acquisition-related intangible asset amortization resulting from these acquisitions. The remainder of the increase is due to a $63 million increase in outside services costs, $51 million of stock-based compensation expense and a $34 million increase in compensation costs associated with salaries and bonuses. These increases were partially offset by a $18 million decrease in depreciation and amortization and $38 million in cost savings resulting from workforce reductions.

We are continuing to focus our efforts on achieving additional operating efficiencies by reviewing and improving upon our existing business processes and cost structure.

Restructuring Charges

In accordance with SFAS 112, “Employers’ Accounting for Post Employment Benefits” (SFAS 112) and SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146), we recognized a total of $10 million and $22 million in restructuring charges in the three and six months ended December 25, 2005, respectively, and $24 million and $132 million for the three and six months ended December 26, 2004, respectively.

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 December 25, 2005, our estimated sublease income to be generated from sublease contracts not yet negotiated approximated $64 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

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the three and six months ended December 25, 2005, we recognized a total of $10 million and $22 million, respectively, in charges associated with 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 December 25, 2005, 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 Restructuring 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.

The following table sets forth an analysis of our restructuring accrual activity for the six months ended December 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		17			4			—			—			—			—			21
Accrued lease costs		—			—			5			—			—			—			5
Provision adjustments		5			1			(4	)		(4	)		1			(3	)		(4	)
Total restructuring charges		22			5			1			(4	)		1			(3	)		22
Cash paid		(49	)		(20	)		(25	)		(9	)		(11	)		(8	)		(122	)
Balance as of December 25, 2005	$	17		$	22		$	133		$	64		$	119		$	15		$	370

The remaining cash expenditures relating to workforce reductions are expected to be paid over the next few quarters. Our accrual as of December 25, 2005 for facility-related leases (net of anticipated sublease proceeds) will be paid over their respective lease terms through fiscal 2023. As of December 25, 2005, $115 million of the total $370 million accrual for workforce reductions and facility-related leases was classified as current accrued liabilities and other and the remaining $255 million was classified as other non-current obligations.

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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. As a result, we recorded approximately $54 million of restructuring costs in connection with the StorageTek acquisition, which are based upon plans committed to by management. These costs are accounted for under Emerging Issues Task Force Issue 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. The following table sets forth an analysis of the components of the preliminary acquisition-related restructuring liabilities included in the purchase price allocation for StorageTek and subsequent restructuring accrual activity for the six months ended December 25, 2005 (in millions):

	Severance and Benefits			Facilities Related		Total
Balance as of June 30, 2005	$	—		$	—	$	—
Acquisition-related restructuring liabilities		16			36		52
Provision adjustments		—			2		2
Cash paid		(2	)		—		(2	)
Balance as of December 25, 2005	$	14		$	38	$	52

As of December 25, 2005, our estimated sublease income to be generated from sublease contracts not yet negotiated approximated $11 million.

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 December 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 half 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 use 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

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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 of fiscal 2006 to the second quarter of 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.

Gain on Equity Investments

(dollars in millions)

	Three Months Ended						Change		Six Months Ended						Change
	December 25, 2005			December 26, 2004					December 25, 2005			December 26, 2004
Gain on equity investments, net	$	14		$	9		55.6	%	$	27		$	5		N/M	*
Percentage of total net revenues		0.4	%		0.3	%				0.4	%		0.1	%

* N/M — Not meaningful

In the second quarter of fiscal 2006, our gain on equity investments, net, was favorably impacted by gains on warrants of $8 million and gains on sale of certain marketable equity investments in publicly traded companies of $5 million. In the first half of fiscal 2006, our gain on equity investment, net, was favorably impacted by gains on sale of certain marketable equity investments in publicly traded companies of $11 million, gains on warrants of $11 million and gains on sale of certain equity investments in privately held companies of $3 million. Our portfolio primarily consists of investments in privately held and publicly traded technology companies. In the second quarter of fiscal 2005, our gain on equity investments, net, was favorably impacted by gains on sale of certain marketable equity investments in privately held companies of $9 million. In the first half of fiscal 2005, our gain on equity investment, net, was favorable impacted by gains of sale of certain marketable equity investments of $10 million, and unfavorably impacted by losses on warrants of $4 million.

As of December 25, 2005, our equity investment portfolio of $66 million consisted of $17 million in marketable equity securities, $30 million in equity investments in privately held companies and $19 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.

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Interest and Other Income, net

(dollars in millions)

	Three Months Ended						Change		Six Months Ended						Change
	December 25, 2005			December 26, 2004					December 25, 2005			December 26, 2004
Interest and other income, net	$	25		$	33		(24.2	)%	$	69		$	64		7.8	%
Percentage of total net revenues		0.7	%		1.2	%				1.1	%		1.2	%

In the second quarter of fiscal 2006, as compared with the corresponding period of fiscal 2005, interest and other income, net, decreased $8 million. This decrease was primarily due to the reduction in cash equivalents and marketable debt securities following the acquisitions of StorageTek and SeeBeyond. In the first half of fiscal 2006, as compared with the corresponding period of fiscal 2005, interest and other income, net, increased by $5 million. This increase was primarily due to higher yields on our cash equivalents and marketable debt securities partially offset by higher realized losses on the sale of certain marketable debt securities and interest expense on debt.

As of December 25, 2005, the average duration of our portfolio of marketable debt securities increased to 0.79 years from 0.67 years at December 26, 2004. The increase of 0.12 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				Change		Six Months Ended				Change
	December 25, 2005		December 26, 2004				December 25, 2005		December 26, 2004
Income tax provision	$	76	$	39	94.9	%	$	119	$	78	52.6	%

For the second quarter and first half of fiscal 2006, we recorded an income tax provision of $76 million and $119 million, respectively, as compared with $39 million and $78 million for the corresponding periods 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. Additionally, during the second quarter and first six months of fiscal 2006, our income tax provision included approximately $20 million relating to corrections of previously filed tax returns. This adjustment is immaterial to our results of operations and financial condition for the current period as well as prior affected periods.

We are currently evaluating whether to repatriate accumulated income earned outside the U.S. as permitted under the American Jobs Creation Act of 2004. Should we decide to repatriate any earnings in fiscal 2006, we would record a charge for the additional tax incurred to repatriate such funds.

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.

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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 and six months ended December 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 December 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)	509	$	11.95	244
Equity compensation plans not approved by security holders (excluding ESPP)(1)	80	$	3.80	28
Total (excluding ESPP)	589	$	10.85	272
Equity compensation plans approved by security holders (ESPP only)	N/A		N/A	115
Equity compensation plans not approved by security holders (ESPP only)	N/A		N/A	N/A
Total (ESPP only)	N/A		N/A	115
All Plans	589	$	10.85	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 Six Months Ended December 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)

	December 25, 2005			June 30, 2005			Change
Cash and cash equivalents	$	1,193		$	2,051		$	(858	)
Marketable debt securities		3,083			5,473			(2,390	)
Total cash, cash equivalents and marketable debt securities	$	4,276		$	7,524		$	(3,248	)
Percentage of total assets		29.9	%		53.0	%		(23.1	)pts

	Six Months Ended						Change
	December 25, 2005			December 26, 2004
Cash provided by operating activities	$	33		$	176		$	(143	)
Cash used in investing activities	$	(984	)	$	(318	)	$	(666	)
Cash provided by (used in) financing activities	$	93		$	(136	)	$	229
Net decrease in cash and cash equivalents	$	(858	)	$	(278	)	$	(580	)

Changes in Cash Flow

During the first half of fiscal 2006, our operating activities generated cash flows of $33 million. The following items significantly impacted our cash provided by operating activities:

• Net loss of $346 million, which included purchased IPRD of $60 million and non-cash charges of approximately $536 million, comprised primarily of depreciation and amortization of $301 million, amortization of acquisition-related other intangible assets of $153 million and stock-based compensation expense of $105 million;

• Receipt of $154 million associated with an international income tax refund; and

• Payments associated with severance and facilities restructuring liabilities totaling $124 million.

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

During the first half of fiscal 2006, our cash used in investing activities of $984 million was primarily attributable to cash used for acquisitions, net of $3,150 million, offset by proceeds from sales and maturities of marketable debt securities, net of purchases, of $2,376 million.

Cash Conversion Cycle

	December 25, 2005		June 30, 2005		Change
Days sales outstanding (DSO)(1)	62		68		6
Days of supply in inventory (DOS)(2)	26		22		(4	)
Days payable outstanding (DPO)(3)	(57	)	(60	)	(3	)
Cash conversion cycle	31		30		(1	)
Inventory turns — products only	8.8		9.3		(0.5	)

(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 second quarter of fiscal 2006 with a cash conversion cycle of 31 days. 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

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services and is a quarterly 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 August 31, 2005 acquisition of StorageTek. Excluding the impact of our acquisition of StorageTek, DSO improved 10 days due to improved billings and collections throughout the first half of fiscal 2006. Excluding the impact of our acquisition of StorageTek, DOS worsened by 1 day. Our products inventory turn rate remained relatively flat from 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. Excluding the impact of our acquisition of StorageTek, DPO improved by 1 day due to negotiation of more favorable terms with our vendors.

Acquisitions

We completed three acquisitions during the first half of fiscal 2006. On July 13, 2005, we acquired Tarantella, Inc. (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 half 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 December 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 $481 million and no amounts were drawn from these lines of credit as of December 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 services where we would incur a penalty if the agreement was canceled prior to a contractual minimum term. We estimate that such contractual obligations at December 25, 2005

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were no more than $702 million substantially due within the following twelve months. This amount does not include contractual obligations recorded on the balance sheet as current or long-term liabilities. As part of our acquisitions of StorageTek and SeeBeyond, we have also assumed operating lease obligations of $78 million as of December 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 December 25, 2005 and June 30, 2005, respectively.

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 $1,193 million in cash and cash equivalents, at December 25, 2005 we had approximately $3,083 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 $4,276 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 the first quarter of fiscal 2006, we acquired an additional $120 million of unremitted earnings as a result of our acquisition of StorageTek. Should we decide to repatriate these earnings, we would be required to accrue for the 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 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.

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.

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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 Data Management (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), Hitachi Data Systems, Inc. and the Fujitsu-Siemens joint venture. We also compete with systems manufacturers and resellers of systems based on microprocessors from Intel Corporation (Intel), the Windows family of operating systems software from Microsoft Corporation (Microsoft) and the Linux family of operating systems software. 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 Data Management products business, including through the acquisition of StorageTek, 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 Data Management 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 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, 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 certain UltraSPARC microprocessors 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 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.

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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.

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.

We have licensed significant elements of our intellectual property, including our Solaris operating system, as open source software and intend to license additional intellectual property in the future under open source licenses, which could reduce the competitive advantage we derive from this intellectual property.

We have released significant elements of our intellectual property, including the Solaris OS, the Java Enterprise System infrastructure software platform, the N1 Management software and various developer tools, to the open source development community as open source software under an open source license. We also recently announced our intention to make the hardware source code of our UltraSPARC T1 processor available 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 this intellectual property, and we may no longer be able to exercise control over some aspects of the future development of this intellectual property. In particular, 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, licensing and sale of the Solaris OS and system products based on the UltraSPARC family of microprocessors, 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^Tm 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.

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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 (including, 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.

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.

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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. Defects in our products can harm our reputation, delay or prevent sales, result in significant expense and could materially and adversely affect our business.

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 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 laws applicable to us such as the Foreign Corrupt Practices Act. Although we implement policies, training, 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 violation of the law or 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. We rely on partners or third party service providers for the provision of certain key business process functions, including IT services and the human resources function, and as a result, 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

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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 I, Item 3. “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 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.

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 December 25, 2005, we had a goodwill balance of $2,472 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.

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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 endeavor to comply 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 than we do or that we will comply in all respects with applicable tax laws, which could result in additional taxes. We regularly review the likelihood of adverse outcomes resulting from tax 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 Products and 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 our relationships with our channel partners or their effectiveness decline, we face risk of declining demand which could affect our results of operations.

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

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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 December 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.

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

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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 and our ordering process 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 Data Management 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 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.

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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 generally 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 implemented 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 impacted our reported earnings by $55 million and $105 million for the second quarter and first half of fiscal year 2006, respectively. 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

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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.

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.

Commercial real estate market 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 commercial real estate market 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 ability to manage excess and obsolete non-compliant inventory; 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 manage the supply of compliant and non-compliant components or introduce new products to conform to the RoHS Directive substance restrictions, sales of our products and services 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.

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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.

Certain member states within the EU have begun to promulgate national enabling legislation under both the RoHS and the WEEE Directives, which may contain more stringent requirements or conditions or otherwise vary from the terms of the Directives themselves. These unique member states’ laws add complexity making it more difficult to determine the amount of expenses necessary to comply with these Directives, but will likely increase the cost of compliance. In addition, similar environmental legislation has been or may be enacted in other jurisdictions, including the U.S. (under federal and state laws), China, Japan, Canada, and certain Latin American countries, 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.

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 plan to eliminate excess facility capacity in light of revised facility requirements; regarding our estimate of our ability to generate sublease income; 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 expect to recognize certain unrecognized compensation costs related to stock options and nonvested stock over certain future periods; that 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; that we anticipate incurring additional charges associated with productivity improvement initiatives and expense reduction measures; that the balance of the StorageTek workforce reduction assumed liabilities is expected to be utilized during the remainder of fiscal 2006 and fiscal 2007 and is expected to be funded through cash flows from operations; 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 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 service sales 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 manage our business and anticipate change; that we plan to continue to drive improvement in our cash conversion cycle; 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 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

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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; 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; that we intend to license additional intellectual property under open source licenses, including the hardware source code of our UltraSPARC T1 processor; 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.

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, reduction in the competitive advantages we derive from certain elements of our intellectual property, including the Solaris operating system, the Java Enterprise System infrastructure software platform, the N1 Management software and various developer tools, as a result of licensing such intellectual property under open source licenses to the open source development community, reliance on single source suppliers, lack of acceptance of new products and services, unexpected changes in the demand for our products and services, the difficulties in forecasting demand for and obtaining adequate supply of components from suppliers, 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, the effects of 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 commercial real estate market conditions could affect our ability to sublease properties in our portfolio, and the risks and costs of complying with environmental laws and regulations.

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 December 25, 2005. Actual results may differ materially.

Interest Rate Sensitivity

Our investment portfolio consists primarily of fixed income instruments with an average duration of 0.79 years as of December 25, 2005 as compared with 0.67 years as of December 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 $40 million decrease in the fair value of our investments in debt securities as of December 25, 2005.

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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 December 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 December 25, 2005, we estimate a maximum potential one-day loss in fair value of approximately $2 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 $3 million decrease in the fair value of our available-for-sale equity investments as of December 25, 2005, as compared with $6 million as of December 26, 2004. At December 25, 2005, one equity security represented substantially of the $17 million total fair value of the marketable equity securities.

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 half of fiscal 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 December 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 in the United States District Court for the Eastern District of Texas entitled Gobeli Research (Gobeli) v. Sun Microsystems, Inc. and Apple Computer, Inc. (Apple). The complaint alleged that Sun products, including our SolarisTM Operating System, infringed on a Gobeli patent related to a system and method for controlling interrupt processing. We settled all outstanding claims against us in this case subsequent to the end of our second fiscal quarter for an amount that is immaterial to our results of operations and financial condition. An accrual for the settlement is reflected in our consolidated financial statements for the fiscal quarter and six months ended December 25, 2005.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

We held our Annual Meeting of Stockholders on October 27, 2005. At the meeting, stockholders voted upon the following actions:

(1) Election of Directors:

	FOR	WITHHELD
Scott G. McNealy	2,630,962,853	65,094,987
James L. Barksdale	2,644,035,157	52,022,683
Stephen M. Bennett	2,357,454,124	338,603,716
L. John Doerr	2,329,661,556	366,396,284
Robert J. Fisher	2,632,497,357	63,560,483
Michael E. Lehman	2,053,321,855	642,735,985
Patricia E. Mitchell	2,643,336,742	52,721,098
M. Kenneth Oshman	2,345,367,311	350,690,529
Naomi O. Seligman	2,635,163,101	60,894,739

The nine nominees who received the highest number of votes (all of the above individuals) were elected to the Board of Directors, and will serve as directors until our next annual meeting and until his or her successor is elected and qualified.

(2) Ratification of the appointment of Ernst & Young LLP as our independent registered public accounting firm for the fiscal year ending June 30, 2006:

FOR	AGAINST	ABSTAIN	NON-VOTES
2,496,772,296	177,640,411	21,645,133	0

The appointment was ratified.

(3) Stockholder proposal regarding performance-based compensation:

FOR	AGAINST	ABSTAIN	NON-VOTES
643,614,223	859,721,397	24,999,419	1,167,722,801

The proposal was not approved.

(4) Stockholder proposal regarding Sun’s stockholder rights plan:

FOR	AGAINST	ABSTAIN	NON-VOTES
1,260,684,735	239,923,432	27,726,872	1,167,722,801

The proposal was approved.

ITEM 6.    EXHIBITS

See Index to Exhibits on Page 53 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/    BARRY J. PLAGA
	Barry J. Plaga
	Corporate Controller and Vice President, Finance (Principal Accounting Officer)

Dated: February 3, 2006

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INDEX TO EXHIBITS

Exhibit Number	Description
10.1*	1990 Employee Stock Purchase Plan, amended and restated on June 22, 2005
10.2*	2005 U.S. Non-Qualified Deferred Compensation Plan
10.3*	Amendment to U.S. Non-Qualified Deferred Compensation Plan, dated as of December 23, 2005.
10.4*	U.S. Vice President Severance Plan, as amended and restated on October 27, 2005.
10.5*	FY06 Quarterly Bonus Plan, amended and restated as of December 26, 2005
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.

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EX-10.1

Exhibit 10.1

SUN MICROSYSTEMS, INC.

1990 EMPLOYEE STOCK PURCHASE PLAN

(Amended and Restated on June 22, 2005, to be effective as of May 1, 2006)

1. Purpose. The purpose of the Plan is to provide Employees of the Company and its Designated Subsidiaries with an opportunity to purchase Common Stock through accumulated payroll deductions or other approved contributions. The Plan consists of two programs, which are referred to as the U.S. Program and the Global Program. The U.S. Program is intended to qualify as an employee stock purchase plan under Code Section 423(b) and the Global Program is not intended to so qualify.

2. Definitions.

(a) “Board” shall mean the Board of Directors of the Company.

(b) “Code” shall mean the Internal Revenue Code of 1986, as amended.

(c) “Committee” shall mean a Committee designated by the Board to administer the Plan. If at any time no Committee shall be in office, then the Board shall exercise the functions of the Committee specified in the Plan and any references herein to the Committee shall be construed as references to the Board.

(d) “Common Stock” shall mean the Company’s common stock, $0.00067 par value (as adjusted from time to time).

(e) “Company” shall mean Sun Microsystems, Inc., a Delaware corporation.

(f) “Compensation” shall mean regular straight time gross earnings, variable compensation for field sales personnel, broad-based Company bonus programs, payments for overtime, shift premiums and lead pay, but shall exclude other compensation.

(g) “Corporate Affiliate” shall mean (i) for purposes of the U.S. Program any parent or subsidiary corporation of the Company (as determined in accordance with Code Section 424), whether now existing or subsequently established, (ii) for purposes of the Global Program any affiliate controlling the Company or controlled by the Company directly or indirectly through one or more intermediaries.

(h) “Designated Subsidiary” shall mean any Corporate Affiliate as may be authorized from time to time by the Board to extend the benefits of the Plan to their Employees.

(i) “Employee” shall mean, subject to Section 11(c), any employee (including officers and directors who are also employees) of the Company or a Designated Subsidiary.

(j) “Enrollment Date” shall mean the first Trading Day of each Offering Period.

(k) “Exercise Date” shall mean the last Trading Day of each Exercise Period.

(l) “Exercise Period” shall mean a period commencing on an Enrollment Date and which is of such duration as the Committee shall determine.

(m) “Fair Market Value” per share of Common Stock on any relevant date shall be determined in accordance with the following provisions:

(i) If the Common Stock is at the time traded on the Nasdaq National Market, then the Fair Market Value shall be the U.S. Dollar closing selling price per share of Common Stock on the date in question, as such price is reported by the National Association of Securities Dealers on the Nasdaq National Market and published in The Wall Street Journal. If there is no closing selling price for the Common Stock on the date in question, then the Fair Market Value shall be the U.S. Dollar closing selling price on the last preceding date for which such quotation exists.

(ii) If the Common Stock is at the time listed on any Stock Exchange, then the Fair Market Value shall be the U.S. Dollar closing selling price per share of Common Stock on the date in question on the Stock Exchange determined by the Committee to be the primary market for the Common Stock, as such price is officially quoted in the composite tape of transactions on such exchange and published in The Wall Street Journal. If there is no closing selling price for the Common Stock on the date in question, then the Fair Market Value shall be the U.S. Dollar closing selling price on the last preceding date for which such quotation exists.

(n) “Global Program” shall mean the component of the Plan intended to provide Employees of the Company and its Designated Subsidiaries who are not subject to United States income tax the opportunity to purchase Common Stock through accumulated payroll deductions or other approved contributions. This component of the Plan is not intended to qualify for special tax treatment under Code Section 423.

(o) “Offering Period” shall mean the period beginning with the date an option is granted under the Plan and ending with the date determined by the Committee. During the term of the Plan, the duration of each Offering Period shall be determined from time to time by the Committee, provided that no Offering Period may exceed 27 months in duration. If determined by the Committee, an Offering Period may include one or more Exercise Periods.

(p) “Plan” shall mean this 1990 Employee Stock Purchase Plan and shall apply to both the U.S. Program and the Global Program.

(q) “Purchase Price” shall mean an amount equal to 85% of the Fair Market Value of a share of Common Stock on the Exercise Date; provided however, that the Purchase Price may be adjusted by the Committee pursuant to Section 20.

(r) “Reserves” shall mean the number of shares of Common Stock covered by each option under the Plan which has not yet been exercised and the number of shares of Common Stock which have been authorized for issuance under the Plan but not yet placed under option.

(s) “Stock Exchange” shall mean any national securities exchange registered under Section 6 of the Securities Exchange Act of 1934, as amended, including, but not limited to the American Stock Exchange and the New York Stock Exchange.

(t) “Subsidiary” shall mean a corporation, domestic or foreign, of which not less than 50% of the voting stock is held by the Company or by a Subsidiary, whether or not such corporation now exists or is hereafter organized or acquired by the Company or by a Subsidiary.

(u) “Trading Day” shall mean a day on which the Common Stock is open for trading on a Stock Exchange or the Nasdaq National Market, as the case may be.

(v) “U.S. Program” shall mean the component of the Plan intended to provide Employees of the Company and its Designated Subsidiaries who are subject to United States income tax with the opportunity to purchase Common Stock through accumulated payroll deductions or other approved contributions. This component of the Plan is intended to qualify for special tax treatment under Code Section 423(b).

3. Stock Subject to the Plan.

(a) Subject to the provisions of Section 13 of the Plan, the total number of shares of Common Stock reserved and available for issuance pursuant to the Plan shall not exceed 616,400,000 shares. The shares purchasable under the Plan may be either authorized but unissued or reacquired Common Stock, including shares of Common Stock purchased on the open market.

(b) A Plan participant will have no voting, dividend, or other stockholder rights with respect to any shares of Common Stock covered by his or her option until such option has been exercised and such shares have been purchased and delivered to the participant as provided in Section 10.

(c) Shares of Common Stock to be delivered to a participant under the Plan will be registered in the name of the participant.

4. Eligibility. Any Employee of the Company or a Designated Subsidiary is eligible to participate in an Offering Period (as hereinafter defined) under the Plan except the following:

(a) Employees who are not employed by the Company or a Designated Subsidiary on the fifteenth (15th) day of the month preceding the beginning of such Offering Period;

(b) Employees who would, by virtue of their participation in such Offering Period, be participating simultaneously in more than one Offering Period under the Plan;

(c) Unless otherwise prohibited by the laws of the local jurisdiction, Employees who are customarily employed for less than twenty (20) hours per week or who are customarily employed for less than five (5) months in a calendar year; and

(d) Notwithstanding any provision of the Plan to the contrary, no Employee shall be granted an option under the Plan (i) to the extent that, immediately after such grant, such Employee (or any other person whose stock would be attributed to such Employee pursuant to Code Section 424(d)) would own capital stock of the Company or any Corporate Affiliate and/or hold outstanding options to purchase such stock possessing five percent (5%) or more of the total combined voting power or value of all classes of capital stock of the Company or any Corporate Affiliate, or (ii) to the extent that his or her rights to purchase stock under all employee stock purchase plans (as defined in Code Section 423) of the Company or any Corporate Affiliate accrues at a rate which exceeds $25,000 worth of Common Stock (determined on the basis of the Fair Market Value of the stock at the time such option is granted) for each calendar year in which such option is outstanding at any time.

5. Offering Periods. The Plan shall be implemented by consecutive Offering Periods, each consisting of such number of Exercise Periods as the Committee shall determine, and shall continue until terminated in accordance with Section 21 hereof. The first Offering Period shall commence on a date to be determined by the Committee. The Committee shall have the power to change the duration of Offering Periods and Exercise Periods with respect to future offerings without stockholder approval if such change is announced at least 15 days prior to the scheduled beginning of the first Offering Period and Exercise Period to be affected.

6. Participation.

(a) An Employee who is eligible under Section 4 of the Plan may become a participant in any Offering Period under the Plan only by completing a subscription agreement authorizing payroll deductions or other approved contributions in form and substance satisfactory to the Committee and filing it with the Company during the open enrollment period prior to the applicable Enrollment Date, unless a later time for filing the subscription agreement is set by the Committee for all eligible Employees with respect to a given Offering Period.

(b) Payroll deductions or other approved contributions for a participant shall commence on the first payday following the Enrollment Date and shall continue until terminated by the participant as provided in Section 11.

7. Payroll Deductions.

(a) Except as otherwise prohibited by the laws of the local jurisdiction, at the time a participant files his or her subscription agreement, he or she shall elect to have payroll deductions made (under this Plan and all employee stock purchase plans of the Company) on each payday during the Offering Period in an amount not exceeding a total of ten percent (10%) (or such other percentage as the Committee may determine) of the Compensation which he or she receives on each payday during the Offering Period, and the aggregate of such payroll deductions (under this Plan and all employee stock purchase plans of the Company) during the Offering Period shall not exceed a total of ten percent (10%) (or such other percentage as the Committee may determine) of the participant’s Compensation during said Offering Period.

(b) In jurisdictions where payroll deductions are not permitted under local law, the eligible Employees may participate in the Plan by making contributions in the form that is acceptable and approved by the Board or Committee. Other approved contributions are subject to the same restrictions as set forth in this Section 7.

(c) Only payroll deductions or other approved contributions made for a participant shall be credited to his or her account under the Plan and will be withheld in whole percentages of Compensation only.

(d) A participant may discontinue his or her participation in the Plan as provided in Section 11. A participant’s subscription agreement shall remain in effect for successive Offering Periods unless terminated as provided in Section 11. To increase or decrease the rate of payroll deductions or other approved contributions (within the limitations of Section 7(a)), (i) with respect to the next Offering Period, a participant must complete and file with the Company during the open enrollment period prior to the Enrollment Date for such Offering Period, or (ii) with respect to the next Exercise Period within the same Offering Period, a participant must complete and file with the Company prior to the commencement of the new Exercise Period within such Offering Period, a new subscription agreement authorizing a change in the payroll deduction or other approved contributions rate. Except in the case of authorized leaves of absence (which shall be governed by Section 11(c) below), such change in rate shall be effective at the beginning of the next Offering Period or Exercise Period, as the case may be, following the Company’s receipt of the new subscription agreement.

(e) Notwithstanding the foregoing, to the extent necessary to comply with Code Section 423(b)(8) and Section 4(d) herein, a participant’s payroll deductions or other approved contributions may be decreased to zero percent (0%) by the Company at such time during any Exercise Period. Payroll deductions shall recommence at the rate provided in such participant’s subscription agreement at the beginning of the first Exercise Period which is scheduled to end in the following calendar year, unless terminated by the participant as provided in Section 11.

(f) The Company will assess its requirements regarding tax, social insurance and payroll tax withholding (collectively the “Tax-Related Items”) in connection with the participant’s participation in the Plan, including the grant of purchase rights, the exercise of such

purchase rights, or the subsequent sale of shares of Common Stock acquired under the Plan. Prior to each of the aforementioned events, each participant must make adequate arrangements satisfactory to the Company and/or the Designated Subsidiary employing the participant to satisfy all withholding obligations of the Company and/or the Designated Subsidiary employing the participant. At such time, the Company and/or Designated Subsidiary may withhold all applicable Tax-Related Items (including any withholding required to make available to the Company or any Designated Subsidiary any tax deductions or benefit attributable to the sale or early disposition by the participant of Common Stock under the Plan) and the Company and/or Designated Subsidiary may sell or arrange for the sale of Common Stock purchased by the participant to meet the minimum withholding obligations for Tax-Related Items. The Company and/or the Designated Subsidiary employing the participant will return to the participant any estimated withholding which is collected but not required in satisfaction of the Tax-Related Items. To the extent that a participant is unable to satisfy the payment of Tax-Related Items by the foregoing methods, the participant shall pay to the Company or the Designated Subsidiary employing the participant any amount of the Tax-Related Items that such entity may be required to withhold as a result of participant’s participation in the Plan.

8. Grant of Option.

(a) On the Enrollment Date of each Offering Period, each eligible participant in such Offering Period shall be granted an option to purchase on each Exercise Date during such Offering Period (at the applicable Purchase Price) up to the number of shares of Common Stock determined by dividing such participant’s payroll deductions or other approved contributions accumulated prior to or on such Exercise Date and retained in the participant’s account as of the Exercise Date by the applicable Purchase Price. Such purchase shall be subject to the limitations set forth in Sections 4(d), 7(e) and 13 hereof.

(b) No participant shall be permitted to purchase more than twenty-five thousand (25,000) shares of Common Stock on any one Exercise Date, subject to any adjustments pursuant to Section 20. In addition, the maximum number of shares of Common Stock that may be purchased in total by all participants on any one Exercise Date shall not exceed forty-five million (45,000,000) shares, subject to any adjustments pursuant to Section 20. The Committee may, for subsequent Offering Periods, increase or decrease, in its absolute discretion, the maximum number of shares of Common Stock that may be purchased per participant or in total by all participants on each Exercise Date of such Offering Period.

(c) Exercise of the option shall occur as provided in Section 9, unless the participant has withdrawn pursuant to Section 11, and such option shall expire on the last day of the Offering Period.

9. Exercise of Option. Unless a participant withdraws from the Plan as provided in Section 11 below, his or her option for the purchase of shares of Common Stock will be exercised automatically on the Exercise Date, and the maximum number of full shares subject to option shall be purchased for such participant at the applicable Purchase Price with the accumulated

payroll deductions or other approved contributions in his or her account, subject to the other limitations in the Plan. No fractional shares will be purchased. Any payroll deductions or other approved contributions left over in a participant’s account after the Exercise Date shall be returned to the participant. During a participant’s lifetime, a participant’s option to purchase Common Stock hereunder is exercisable only by him or her.

10. Delivery. As promptly as practicable after each Exercise Date on which a purchase of Common Stock occurs, the Company shall arrange the delivery to each participant, as appropriate, the shares purchased upon exercise of his or her option in a form determined by the Committee in its sole discretion.

11. Withdrawal; Termination of Employment.

(a) A participant may withdraw all (but not less than all) the payroll deductions credited to his or her account and not yet used to exercise his or her option under the Plan at any time prior to the close of an Exercise Period by (i) providing a written notice of withdrawal in the form prescribed by the Committee for such purpose, or (ii) following an electronic or other withdrawal procedure prescribed by the Committee, provided such procedure is legally recognized by the laws of the local jurisdiction. Such notice shall state whether the participant is withdrawing only from the applicable Exercise Period or entirely from the Offering Period. All of the participant’s payroll deductions or other approved contributions credited to his or her account will be paid to such participant as promptly as practicable after receipt of notice of withdrawal and such participant’s option for the current Offering Period or Exercise Period (as specified in the notice) will be automatically terminated, and no further payroll deductions or other approved contributions for the purchase of shares of Common Stock will be made during the Offering Period or Exercise Period, as applicable. If a participant withdraws from an Offering Period, payroll deductions will not resume at the beginning of the succeeding Offering Period unless the participant delivers to the Company a new subscription agreement during the open enrollment period preceding the commencement of a subsequent Offering Period in accordance with Section 6. If a participant withdraws from an Exercise Period, payroll deductions or other approved contributions will not resume at the beginning of any succeeding Exercise Period within the same Offering Period unless written notice is delivered to the Company in form and substance satisfactory to the Committee within the open enrollment period preceding the commencement of the Exercise Period directing the Company to resume payroll deductions.

(b) Upon a participant’s ceasing to be an Employee for any reason, the payroll deductions or other approved contributions credited to such participant’s account during the Offering Period but not yet used to exercise the option will be returned to such participant or, in the case of his or her death, to the person or persons entitled thereto under Section 16, and such participant’s option will be automatically terminated.

(c) Subject to the laws of the local jurisdiction, in the event an Employee’s customary employment with the Company or a Designated Subsidiary is reduced below twenty (20) hours per week or five (5) months per calendar year during an Offering Period, he or she will be deemed to have elected to withdraw from the Plan and the payroll deductions or other approved contributions credited to his or her account will be returned to such participant and such participant’s option terminated; provided that (i) if an Employee shall take an unpaid leave of absence approved by the Company of more than thirty (30) days during an Offering Period in which the Employee is a participant, and the Employee’s right to re-employment is not guaranteed by statute or contract, he or she will be deemed to have withdrawn from the applicable Exercise Period on the thirty-first (31st) day of such leave, (ii) if an Employee shall take a paid leave of absence approved by the Company of more than ninety (90) days during an Offering Period in which the Employee is a participant, and the Employee’s right to re-employment is not guaranteed by statute or contract, he or she will be deemed to have withdrawn from the applicable Exercise Period on the earlier of (aa) the ninety-first (91st) day if the Employee is paid for the entire ninety (90) day leave, or (bb) the last day upon which the Employee is paid provided he or she is paid for at least thirty (30) days; and (iii) if an Employee shall take a paid or unpaid leave of absence of any duration during an Offering Period, and the Employee’s right to re-employment is guaranteed by statute or contract, he or she shall not be deemed to have withdrawn from the applicable Exercise Period and his or her option for the purchase of shares of Common Stock will be exercised in accordance with Section 9 hereof. On the date, if any, upon which the Employee shall be deemed to have withdrawn from the applicable Exercise Period, the payroll deductions or other approved contributions credited to his or her account will be returned to him or her, but he or she shall continue to be a participant in the applicable Offering Period during such authorized leave of absence until and unless such authorized leave of absence terminates without his or her returning to his or her employment with the Company.

(d) A participant’s withdrawal from an Exercise Period (but not from the Offering Period) will not have any effect upon his or her ability to participate in subsequent Exercise Periods during the same Offering Period. However, a participant’s withdrawal from an Offering Period makes him or her ineligible for future participation in that Offering Period. Withdrawal from an Exercise Period or from an Offering Period will not have any effect upon a participant’s eligibility to participate in a succeeding Offering Period of the Plan or in any similar plan which may hereafter be adopted by the Company, provided that a participant may elect to participate in a succeeding Offering Period only during the open enrollment period for such Offering Period and may not participate concurrently in more than one Offering Period.

(e) Notwithstanding the foregoing, unless otherwise determined by the Committee, if the Fair Market Value on the Enrollment Date of an Offering Period in which a participant is enrolled (the “Current Offering Period”) is greater than the Fair Market Value on the Enrollment Date of a succeeding Offering Period (the “Succeeding Offering Period”), the participant’s enrollment in the Current Offering Period automatically will be terminated immediately following the exercise of his or her option under the Current Offering Period on the Exercise Date that occurs immediately prior to the Enrollment Date of the Succeeding Offering Period,

and the participant automatically will be enrolled in the Succeeding Offering Period, unless the participant elects to remain in the former Offering Period by delivery to the Company of a written notice in form and substance satisfactory to the Committee.

12. Interest. Unless otherwise required by the laws of the local jurisdiction, no interest shall accrue on the payroll deductions of a participant in the Plan.

13. Stock.

(a) The maximum number of shares of Common Stock which shall be made available for sale under the Plan, as set forth in Section 3 hereof, is subject to adjustment upon changes in capitalization of the Company as provided in Section 20.

(b) If the Committee determines that the total number of shares of Common Stock to be purchased pursuant to outstanding purchase rights on any particular date exceed the number of shares then available for issuance under the Plan (an “over-subscription”), the Committee shall make a pro rata allocation of the available shares on a uniform and nondiscriminatory basis and the payroll deductions of each participant, to the extent in excess of the aggregate purchase price payable for the Common Stock pro-rated to such individual, shall be refunded.

14. Administration. The Plan shall be administered by the Board or the Committee appointed by the Board. The Committee shall consist of not less than two (2) persons (who are members of the Board), each of whom is an independent director. As used in this Plan, references to the “Committee” shall mean either the Committee appointed by the Board to administer this Plan or the Board if no Committee has been established. Subject to the provisions of the Plan and the limitations of Code Section 423 or any successor provision in the Code, if applicable, all questions of interpretation or application of the Plan shall be determined by the Committee and its decisions shall be final and binding upon all participants. Members of the Committee shall receive no compensation for their services in connection with the administration of the Plan, other than standard fees as established from time to time by the Board for services rendered by Board members serving on Board committees. All expenses incurred in connection with the administration of the Plan shall be paid by the Company.

15. Rules for Foreign Jurisdictions.

(a) The Board or Committee may adopt rules or procedures relating to the operation and administration of the Plan to accommodate the specific requirements of the law and procedures of foreign jurisdictions. Without limiting the generality of the foregoing, the Board or Committee is specifically authorized to adopt rules and procedures regarding handling of payroll deductions or other approved contributions, payment of interest, conversion of local currency, payroll tax, withholding procedures and handling of stock certificates that vary with local requirements.

(b) The Board or Committee may also adopt rules, procedures or sub-plans applicable to particular Designated Subsidiaries or jurisdiction as part of the Global Program. The rules of such sub-plans under the Global Program may take precedence over other provisions of this Plan, with the exception of Section 3, but unless otherwise superseded by the terms of such sub-plan, the provisions of the Plan shall govern the operation of such sub-plan.

16. Designation of Beneficiary.

(a) A participant may file a written designation of a beneficiary who is to receive any stock and cash, if any, from the participant’s account under the Plan in the event of such participant’s death subsequent to an Exercise Date on which the option is exercised but prior to delivery to such participant of such stock and cash. In addition, a participant may file a written designation of a beneficiary who is to receive any cash from the participant’s account under the Plan in the event of such participant’s death prior to exercise of the option. If a participant is married and the designated beneficiary is not the spouse, spousal consent shall be required for such designation to be effective.

(b) Such designation of beneficiary may be changed by the participant at any time by written notice. In the event of the death of a participant and in the absence of a beneficiary validly designated under the Plan who is living at the time of such participant’s death, the Company shall deliver such stock and/or cash to the executor or administrator of the estate of the participant, or if no such executor or administrator has been appointed (to the knowledge of the Company), the Company, in its discretion, may deliver such stock and/or cash to the spouse or to any one or more dependents or relatives of the participant, or if no spouse, dependent or relative is known to the Company, then to such other person as the Company may designate.

(c) All beneficiary designations herein shall be made in such form and manner as the Committee may prescribe from time to time.

17. Transferability. Neither payroll deductions nor other approved contributions credited to a participant’s account nor any rights with regard to the exercise of an option or to receive shares of Common Stock under the Plan may be assigned, transferred, pledged or otherwise disposed of in any way (other than by will, the laws of descent and distribution or as provided in Section 16 hereof) by the participant. Any such attempt at assignment, transfer, pledge or other disposition shall be without effect, except that the Company may treat such act as an election to withdraw from an Offering Period in accordance with Section 11.

18. Use of Funds. Except as prohibited by the laws of a local jurisdiction, all payroll deductions or other approved contributions received or held by the Company under the Plan may be used by the Company for any corporate purpose, and the Company shall not be obligated to segregate funds from such payroll deductions or other approved contributions.

19. Reports. Individual accounts will be maintained for each participant in the Plan. Statements of account will be given to participating Employees at least annually, which statements will set forth the amounts of payroll deductions, the Purchase Price, the number of shares of Common Stock purchased and the remaining cash balance, if any.

20. Adjustments Upon Changes in Capitalization, Dissolution, Liquidation, Merger or Asset Sale.

(a) Changes in Capitalization. Subject to any required action by the stockholders of the Company, the Reserves, the price per share of Common Stock covered by each outstanding option under the Plan which has not yet been exercised, and the numerical limits of Sections 3 and 8 shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of shares of Common Stock effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been “effected without receipt of consideration.” Such adjustment shall be made by the Committee, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of stock of any class, or securities convertible into stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an option.

(b) Dissolution or Liquidation. In the event of the proposed dissolution or liquidation of the Company, the Offering Period then in progress shall be shortened by setting a new Exercise Date (the “New Exercise Date”), and shall terminate immediately prior to the consummation of such proposed action, unless otherwise provided by the Committee. The New Exercise Date shall be before the date of the Company’s proposed dissolution or liquidation. The Committee shall make its best efforts to notify each participant in writing, at least ten (10) business days prior to the New Exercise Date, that the Exercise Date for the participant’s option has been changed to the New Exercise Date and that the participant’s option shall be exercised automatically on the New Exercise Date, unless prior to such date the participant has withdrawn from the Offering Period as provided in Section 11.

(c) Merger or Asset Sale. In the event of a proposed sale of all or substantially all of the assets of the Company, or the merger of the Company with or into another corporation, each option under the Plan shall be assumed or an equivalent option shall be substituted by such successor corporation or a parent or subsidiary of such successor corporation, unless the Committee determines, in the exercise of its sole discretion and in lieu of such assumption or substitution, to shorten the Offering Period (and, if applicable, the Exercise Period) then in progress by setting a new Exercise Date (the “New Exercise Date”) and any Offering Periods then in progress shall end on the New Exercise Date. The New Exercise Date shall be before the date of the Company’s proposed sale or merger. If the Committee shortens the Offering Period (and the Exercise Period, if applicable) then in progress in lieu of assumption or substitution in the event of a merger or sale of assets, the Committee shall make its best efforts to notify each participant in writing, at least ten (10) days prior to the New Exercise Date, that the Exercise

Date for his or her option has been changed to the New Exercise Date and that his or her option will be exercised automatically on the New Exercise Date, unless prior to such date he or she has withdrawn from the Offering Period or the Exercise Period as provided in Section 11. For purposes of this paragraph, an option granted under the Plan shall be deemed to be assumed if, following the sale of assets or merger, the option confers the right to purchase, for each share of Common Stock subject to the option immediately prior to the sale of assets or merger, the consideration (whether stock, cash or other securities or property) received in the sale of assets or merger by holders of Common Stock for each share of Common Stock held on the effective date of the transaction (and if such holders were offered a choice of consideration, the type of consideration chosen by the holders of a majority of the outstanding shares of Common Stock); provided, however, that if such consideration received in the sale of assets or merger was not solely common stock of the successor corporation or its parent (as defined in Code Section 424(e)), the Committee may, with the consent of the successor corporation and the participant, provide for the consideration to be received upon exercise of the option to be solely common stock of the successor corporation or its parent equal in fair market value to the per share consideration received by holders of Common Stock in the sale of assets or merger.

21. Amendment or Termination.

(a) The Board may at any time and for any reason amend or terminate the Plan to become effective following the close of any Exercise Period. However, the Plan may be amended or terminated immediately upon Board action, if and to the extent necessary to assure that the Company will not recognize, for financial reporting purposes, any compensation expense in connection with the shares of Common Stock offered for purchase under the Plan, should the financial accounting rules applicable to the Plan be subsequently revised so as to require the Company to recognize a compensation expense in the absence of such amendment or termination. Except as provided in Section 20 or herein, no such termination can affect options previously granted, provided that an Offering Period may be terminated by the Committee on any Exercise Date if the Committee determines that the termination of the Plan is in the best interests of the Company and its stockholders. Except as provided in Section 20, no amendment may make any change in any option theretofore granted which adversely affects the rights of any participant. To the extent necessary and desirable to comply with Code Section 423 (or any successor rule or provision or any other applicable law or regulation), the Company shall obtain stockholder approval in such a manner and to such a degree as is required thereby.

(b) Without stockholder consent and without regard to whether any participant rights may be considered to have been “adversely affected,” the Committee shall be entitled to change the Offering Periods, establish the exchange ratio applicable to amounts withheld in a currency other than United States Dollars, permit payroll withholding in excess of the amount designated by a participant in order to adjust for delays or mistakes in the Company’s processing of properly completed withholding elections, establish reasonable waiting and adjustment periods and/or accounting and crediting procedures to ensure that amounts applied toward the purchase of Common Stock for each participant properly correspond with amounts withheld from the participant’s Compensation, and establish such other limitations or procedures as the Committee determines in its sole discretion advisable which are consistent with the Plan.

(c) In no event may the Board effect any of the following amendments or revisions to the Plan without the approval of the Company’s stockholders: (i) increase the number of shares of Common Stock issuable under the Plan, except for permissible adjustments in the event of certain changes in the Company’s capitalization pursuant to Sections 20(a) or 20(c), (ii) alter the purchase price formula so as to reduce the purchase price payable for the shares of Common Stock available for purchase under the Plan, (iii) modify the eligibility requirements for participation in the Plan, or (iv) extend the duration of the Plan.

22. Notices. All notices or other communications by a participant to the Company under or in connection with the Plan shall be deemed to have been duly given when received in the form specified by the Company at the location, or by the person, designated by the Company for the receipt thereof.

23. Conditions Upon Issuance of Shares. Shares of Common Stock shall not be issued with respect to an option unless the exercise of such option and the issuance and delivery of such stock pursuant thereto shall comply with all applicable provisions of law of the United States or other country or jurisdiction, including, without limitation, the Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, the rules and regulations promulgated thereunder, and the requirements of any stock exchange or quotation system upon which the stock may then be listed or quoted, and shall be further subject to the approval of counsel for the Company with respect to such compliance.

As a condition to the exercise of an option, the Company may require the person exercising such option to represent and warrant at the time of any such exercise that the stock is being purchased only for investment and without any present intention to sell or distribute such stock if, in the opinion of counsel for the Company, such a representation is required by any of the aforementioned applicable provisions of law.

24. Applicable Law. Except as otherwise expressly required under the laws of the local jurisdiction, the Plan and all rights hereunder shall be governed by and construed in accordance with the laws of the state of California, United States of America without resort to that state’s conflict-of-laws rules. Should any provision of this Plan be determined by a court of competent jurisdiction to be unlawful or unenforceable for a country, such determination shall in no way affect the application of that provision in any other country, or any of the remaining provisions of the Plan.

25. Designation of Subsidiaries. The Board or Committee may extend or terminate the benefits of the Plan to any Designated Subsidiary at any time without the approval of the stockholders of the Company.

26. Equal Rights and Privileges. All eligible Employees participating in the U.S. Program shall have equal rights and privileges under the Plan to the extent necessary to comply with Code Section 423(b)(5) and any related regulations.

27. Term of Plan. The Plan was adopted by the Board on October 16, 1990 and was subsequently approved by the Company’s stockholders at the 1990 Annual Meeting of Stockholders held on December 13, 1990. Unless sooner terminated by the Board, the Plan shall terminate on December 12, 2010. No further purchase rights shall be granted or exercised, and no further payroll deductions shall be collected under the Plan following such termination.

EX-10.2

Exhibit 10.2

SUN MICROSYSTEMS, INC.

2005 U.S. NON-QUALIFIED DEFERRED COMPENSATION PLAN

Effective January 1, 2005

Sun Microsystems, Inc. (the “Company”), acting on behalf of itself and its U.S. subsidiaries, hereby adopts the Sun Microsystems, Inc. 2005 U.S. Non-Qualified Deferred Compensation Plan (the “Plan”) effective January 1, 2005.

RECITALS

1. The Company maintains the Plan, a deferred compensation plan for the benefit of a select group of management or highly compensated employees of the Company as well as members of the Company’s Board of Directors.

2. The Plan is the successor plan to the Sun Microsystems, Inc. U.S. Non-Qualified Deferred Compensation Plan (the “Prior Plan”). Effective December 31, 2004, the U.S. Non-Qualified Deferred Compensation Plan shall be frozen and no new contributions shall be made to it; provided, however, that any deferrals made under the Prior Plan before January 1, 2005 shall continue to be governed by the terms and conditions of the Prior Plan as in effect on December 31, 2004.

3. Any deferrals made under the Prior Plan after December 31, 2004 shall be deemed to have been made under the Plan and all such deferrals shall be governed by the terms and conditions of the Plan as it may be amended from time to time.

4. Under the Plan, the Company is obligated to pay vested accrued benefits to Plan Participants and their Beneficiary or Beneficiaries from the Company’s general assets.

5. The Company has entered into an agreement (the “Trust Agreement”) with Wells Fargo Bank, N.A. pursuant to which Wells Fargo Bank, N.A., serves as the trustee (the “Trustee”) under an irrevocable trust, to be used in connection with the Plan (the “Trust”).

6. The Company intends to make contributions to the Trust so that such contributions will be held by the Trust and invested, reinvested and distributed, all in accordance with this Plan and the Trust Agreement.

7. The Company intends that amounts contributed to the Trust and the earnings thereon shall be used by the Trustee to satisfy the liabilities of the Company under the Plan with respect to each Plan Participant for whom an Account (as defined below) has been established and such utilization shall be in accordance with the procedures set forth herein.

8. The Company intends that the Trust be a “grantor trust” with the principal and income of the Trust treated as assets and income of the Company for federal and state income tax purposes.

9. The Company intends that the assets of the Trust shall at all times be subject to the claims of the general creditors of the Company as provided in the Trust Agreement.

10. The Company intends that the existence of the Trust shall not alter the characterization of the Plan as “unfunded” for purposes of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), and shall not be construed to provide income to Plan Participants under the Plan prior to actual payment of the vested accrued benefits hereunder.

11. The Company intends that the Plan comply with the requirements of Section 409A of the Code.

NOW THEREFORE, the Company does hereby adopt this Plan as follows and does also hereby agree that the Plan shall be structured, held and disposed of as follows:

1. Purpose. The Plan provides Participants an opportunity to defer payment of a portion of Employee salary and incentive bonus/commissions (for Sales Vice Presidents and Directors); Employee annual and quarterly bonus awards; and Board of Directors’ Director Fees.

2. Definitions.

(a) Account means a bookkeeping account established pursuant to Section 5(a) of the Plan for Compensation that is subject to a Participant’s Deferred Compensation Election.

(b) Administrator means the Compensation Committee or such other person, company or entity as may be designated from time to time by the Compensation Committee except as otherwise provided herein.

(c) Beneficiary means the person or persons designated by the Participant or by the Plan under Section 11(b) of the Plan to receive payment of the Participant’s Account in the event of the Participant’s death.

(d) Board means the Board of Directors of the Company, as constituted from time to time.

(e) Change of Control. A “Change of Control” shall be deemed, consistent with Section 409A of the Code and the proposed regulations promulgated thereunder, to occur on the date that:

(i) Any one person, or more than one person acting as a group (as defined in Proposed Regulation Section 1.409A-3(g)(5)(v)(B)), acquires ownership of stock of the Company, that together with

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stock held by such person or group, constitutes more than fifty percent (50%) of the total fair market value or total voting power of the stock of the Company. However, if any one person, or more than one person acting as a group, is considered to own more than fifty percent (50%) of the total fair market value or total voting power of the stock of the Company, the acquisition of additional stock by the same person or persons is not considered a Change of Control. This Section 2(e)(i) applies only when there is a transfer of stock of the Company (or the issuance of stock of the Company) and stock in the Company remains outstanding after the transaction; or

(ii) Any one person, or more than one person acting as a group (as defined in Proposed Regulation Section 1.409A-3(g)(5)(v)(B)), acquires (or has acquired during the twelve-month period ending on the date of the most recent acquisition by such person or persons) assets from the Company that have a total “Gross Fair Market Value” (as defined in Proposed Regulation Section 1.409A-3(g)(5)(vii)(A)) equal to or more than forty percent (40%) of the total Gross Fair Market Value of all of the assets of the Company immediately prior to such acquisition or acquisitions; or

(iii) Any one person, or more than one person acting as a group (as defined in Proposed Regulation Section 1.409A-3(g)(5)(v)(B)), acquires (or has acquired during the twelve-month period ending on the date of the most recent acquisition by such person or persons) ownership of stock of the Company possessing thirty-five percent (35%) or more of the total voting power of the stock of the Company; or

(iv) A majority of the members of the Board is replaced during any twelve-month period by directors whose appointment or election is not endorsed by a majority of the members of the Board prior to the date of the appointment or election; provided, however, that no Change of Control shall be deemed to have occurred if any other corporation is a majority shareholder of the Company.

(f) Code means the Internal Revenue Code of 1986, as amended.

(g) Compensation Committee means the Leadership Development and Compensation Committee of the Board, appointed by the Board from time to time.

(h) Company means Sun Microsystems, Inc. and its U.S. subsidiaries, and any successor organization thereto.

(i) Compensation means:

(i) The amount paid by the Company to an Eligible Employee as base salary; and

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(ii) The amount paid by the Company to an Eligible Employee as an annual or quarterly corporate bonus award and any other bonus/incentive award that is approved by the Administrator as earnings that can be deferred under the Plan (some incentive/bonus awards will not be eligible for deferral); and

(iii) For Sales Vice Presidents and Directors, incentive bonus/commissions; and

(iv) In the case of an Eligible Board Member, the amount of his or her Director Fees from the Company.

For purposes of the foregoing, Compensation as described in clauses (i), (ii) and (iii) shall be eligible for deferral only to the extent such amounts are otherwise subject to U.S. payroll reporting and withholding.

(j) Deferred Compensation Election means an election by an Eligible Employee or Eligible Board Member to participate in the Plan in accordance with Section 4 of the Plan.

(k) Determination Date means each December 31.

(l) Director Fees means any compensation payable with respect to an Eligible Board Member’s service as a member of the Board, including, but not limited to, meeting fees and annual retainer fees. Director Fees do not include directors’ expense reimbursements, stock options, or other stock-based compensation.

(m) Election Period means November/December of each Plan Year.

(n) Eligible Board Member means a member of the Board (other than a member who is also an Eligible Employee) who meets the requirements set forth in Section 3 of the Plan.

(o) Eligible Employee means an officer of the Company or other common-law employee of the Company whose position is approved as a director level or higher and who otherwise meets the requirements set forth in Section 3 of the Plan.

(p) ERISA means the Employee Retirement Income Security Act of 1974, as amended.

(q) Investment Committee means the Administrative Committee of the Sun Microsystems, Inc. Tax Deferred Retirement Savings Plan.

(r) Key Employee means an Eligible Employee who, on a Determination Date, is

(i) An officer of the Company having annual compensation greater than the compensation limit in Section 416(i)(1)(A)(i) of the Code, provided that no more than fifty officers of the Company shall be determined to be Key Employees as of any Determination Date;

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(ii) A five percent owner of the Company; or

(iii) A one percent owner of the Company having annual compensation from the Company of more than $150,000.

If an Eligible Employee is determined to be a Key Employee on a Determination Date, then such Eligible Employee shall be considered a Key Employee for purposes of the Plan during the period beginning on the first April 1 following the Determination Date and ending on the next March 31.

(s) Participant means an Eligible Board Member or an Eligible Employee who has elected to defer Compensation.

(t) Plan means this Sun Microsystems, Inc. 2005 U.S. Non-Qualified Deferred Compensation Plan, as amended from time to time.

(u) Plan Year means the calendar year.

(v) Prior Plan means the Sun Microsystems, Inc. U.S. Non-Qualified Deferred Compensation Plan, as amended from time to time.

(w) Retirement Date means the last day of the month coinciding with or following the Participant’s separation from Service following the earlier of his or her

(i) 55th birthday, if the Participant’s full years of Service with the Company and its non-U.S. subsidiaries added to Participant’s age (in full years) equals or exceeds 65; or

(ii) 20th year anniversary of Service (including Service with businesses acquired by the Company and designated by the Administrator for this purpose).

(x) Service means:

(i) Employment as a common-law employee of the Company or one of its non-U.S. subsidiaries; or

(ii) Period served as an elected Board Member.

A Participant’s Service shall be determined by the Administrator in its sole discretion. A Participant’s Service shall not be deemed to have separated from Service merely because the capacity in which the Participant renders Service to the Company or any of its non-U.S. subsidiaries changes from Eligible Employee to Eligible Board Member or vice-versa. Notwithstanding the foregoing, a separation from Service will not be deemed to have occurred if

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an Eligible Employee continues to provide services to the Company or any of its non-U.S. subsidiaries in a capacity other than as an employee and if the former Eligible Employee is providing services at an annual rate that is fifty percent or more of the services rendered, on average, during the immediately preceding three full calendar years of employment with the Company or any of its non-U.S. subsidiaries (or if employed by the Company or any of its non-U.S. subsidiaries less than three years, such lesser period) and the annual remuneration for such services is fifty percent or more of the annual remuneration earned during the final three full calendar years of employment (of if less, such lesser period); provided, however, that a separation from Service will be deemed to have occurred if an Eligible Employee’s service with the Company or any of its non-U.S. subsidiaries is reduced to an annual rate that is less than twenty percent of the services rendered, on average, during the immediately preceding three full calendar years of employment with the Company or any of its non-U.S. subsidiaries (or if employed by the Company or any of its non-U.S. subsidiaries less than three years, such lesser period) or the annual remuneration for such services is less than twenty percent of the annual remuneration earned during the three full calendar years of employment with the Company or any of its non-U.S. subsidiaries (or if less, such lesser period).

In addition to the foregoing, a separation from Service will not be deemed to have occurred while an Eligible Employee is on military leave, sick leave, or other bona fide leave of absence if the period of such leave does not exceed six months, or if longer, so long as the Eligible Employee’s right to reemployment with the Company or any of its non-U.S. subsidiaries is provided either by statute or contract. If the period of leave exceeds six months and the Eligible Employee’s right to reemployment is not provided either by statute or contract, then the employee is deemed to have separated from Service on the first day immediately following such six-month period.

(y) Unforeseeable Emergency means a severe financial hardship to the Participant or Beneficiary resulting from:

(i) An illness or accident of the Participant or Beneficiary, the Participant’s or Beneficiary’s spouse, or the Participant’s or Beneficiary’s dependent (as defined in Section 152(a) of the Code); or

(ii) Loss of the Participant’s or Beneficiary’s property due to casualty (including the need to rebuild a home following damage to a home not otherwise covered by insurance); or

(iii) Other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant or Beneficiary.

Hardship shall not constitute an Unforeseeable Emergency under the Plan to the extent that it is, or may be, relieved by:

(i) Reimbursement or compensation, by insurance or otherwise;

(iv) Liquidation of the Participant’s or Beneficiary’s assets to the extent that the liquidation of such assets would not itself cause severe financial hardship. Such assets shall include but not be limited to stock options, Company stock, and 401(k) plan balances; or

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(v) Cessation of deferrals under the Plan.

An Unforeseeable Emergency under the Plan does not include (among other events):

(ii) Sending a child to college; or

(vi) Purchasing a home.

3. Eligibility. Participation in the Plan is limited to Eligible Board Members, and Eligible Employees who are members of a select group of management or highly compensated employees. Such Eligible Board Member or Eligible Employee is eligible to participate in the Plan if he or she is paid through the Company’s U.S. payroll and not covered under a non-U.S. retirement plan.

4. Election to Participate in Plan.

(a) Deferral Election. An Eligible Employee or an Eligible Board Member may elect to participate in the Plan by submitting a Deferred Compensation Election in such form as the Company may specify during any Election Period. Subject to the provisions of Sections 4(b) below, a Deferral Election must be made and become irrevocable not later than last day of the Plan Year preceding the Plan Year in which the Compensation being deferred is earned. A Deferred Compensation Election made in the 2006 Plan Year or thereafter will remain in force until it is amended or revoked. Any such amendment or revocation will take affect on the first day of the Plan Year following the Plan Year in which the Participant elects to amend or revoke the outstanding Deferred Compensation Election. In addition to the foregoing, a Participant’s Deferred Compensation Election shall be suspended if such Participant applies for and is otherwise eligible to receive a distribution on account of an Unforeseeable Emergency. Such suspension shall continue through the end of Plan Year in which the Participant applies for a distribution due to an Unforeseeable Emergency and the Participant must submit a new Deferred Compensation Election during an Election Period to resume participation in the Plan.

(b) Deferral Election for Newly Eligible Employees and Newly Eligible Board Members. In the Administrator’s discretion, a newly Eligible Employee or a newly Eligible Board Member may elect to participate in the Plan by submitting a Deferred Compensation Election in such form as the Company may specify; provided that such Deferred Compensation Election is made and becomes irrevocable not later than thirty days following the date such newly Eligible Employee or Board Member first becomes eligible to participate in the Plan and provided further that such

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Deferred Compensation Election applies only to Compensation earned after the date of the election. In compliance with this Section 4(b), only a prorated portion of a Participant’s bonus may be deferred if the Participant’s initial Deferred Compensation Election is made after the performance period applicable to the bonus has begun. Effective January 1, 2006 only a newly Eligible Employee whose position is approved as a vice president level or higher shall be permitted in the Administrator’s discretion to make a Deferred Compensation Election pursuant to this Section 4(b).

(c) Special Elections in 2005 regarding Deferrals. In accordance with IRS Notice 2005-1, A-20, (i) on or before March 11, 2005, Eligible Employees were permitted to terminate Deferred Compensation Elections made with respect to salary and incentive award/commission Compensation earned during the period January 1, 2005 through March 20, 2006 and Deferred Compensation Elections made with respect to fiscal year 2005 bonus Compensation that was otherwise payable in 2005 and (ii) on or before November 25, 2005 certain Eligible Employees were permitted to terminate Deferred Compensation Elections made with respect to 2005 bonus Compensation, notwithstanding the fact that such Deferred Compensation Elections otherwise would have been irrevocable under Section 4(a) above. Elections made pursuant to this Section 4(c) are irrevocable and subject to any special administrative rules imposed by the Administrator consistent with Section 409A of the Code and Notice 2005-1, A-20. No special election under this Section 4(c) shall be permitted after December 31, 2005.

(d) Initial Deferral Election. Any Deferred Compensation Election under this Section 4 that is an initial Deferred Compensation Election also will include an election as to the time and form of payment of the deferred Compensation.

(e) Election Form. All Deferred Compensation Elections under this Section 4 shall be made in a manner prescribed for these purposes by the Administrator.

5. Accounts.

(a) Establishment of Account. The Company shall establish an Account for the terms of the Deferred Compensation Election.

(b) Credits to Account. A Participant’s Account shall be credited with an amount equal to the percentage of each Compensation payment which would have been payable currently to the Participant but for the terms of the Deferred Compensation Election. Deferred Compensation for Participants shall be credited to the Participant’s Account as of the first day of the month in which such deferred amounts would otherwise be paid to the Participant.

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(c) Vesting. Participants shall at all times be 100% vested in their deferrals under the Plan and all earnings or losses allocable thereto.

6. Deferral Increments.

(a) Minimum Deferral. The minimum deferral per Plan Year will be determined by the Administrator.

(b) Maximum Deferral – Eligible Employees. The Participant who is an Eligible Employee may elect to defer (less any withholding requirements):

(i) Up to 75% of any eligible annual or quarterly bonus award; and

(ii) Up to 60% of base salary and incentive awards/commissions.

(c) Maximum Deferral – Eligible Board Members. A Participant who is an Eligible Board Member may elect to defer (less any withholding requirements), up to 100% of his or her Director Fees (to be credited to the account quarterly).

7. Earnings or Losses on Accounts.

(a) General Rule. Except as otherwise provided in the Plan, the amount in a Participant’s Account shall be adjusted for gain or loss based on the performance of the investment options selected by the Participant (or Beneficiary following a Participant’s death) in accordance with Section 7(b) below. Gain or loss shall be computed daily. All distributions from the Account will be valued as of the end of the last day of the month preceding the payment date.

(b) Designation of Investment Indices by the Investment Committee. The Investment Committee shall specify two or more investment funds that shall serve as benchmarks for the investment performance of amounts credited to the Accounts. Accounts shall be adjusted to reflect the gain or loss, net of any allocable costs or expenses, such accounts would experience had they actually been invested in the specified funds at the relevant times. The Investment Committee may vary the available investment funds from time to time, but not more frequently than quarterly. A Participant (or Beneficiary following a Participant’s death) may select his or her investment options for new deferrals or for amounts already credited to his or her Account, once per month effective as of the first day of the following month and in such manner as the Investment Committee may specify.

8. Certain In-Service Account Distributions.

(a) In-Service Account Distribution Elections. Each Participant may elect at the time of his or her initial Deferred Compensation Election or in accordance with Section 8(c) below, to have one or more distributions of a

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specified percentage or dollar amount of his or her Account commencing in his or her third year of Plan participation, provided that the Participant has not separated from Service with the Company or any of its non-U.S. subsidiaries prior to the elected in-service distribution date. A Participant may delay once or cancel such in-service account distribution election at any time, provided that such election must be made at least one year prior to the first day of the Plan Year in which the original distribution date was scheduled, and provided further that the newly elected distribution date is at least five years after the originally scheduled distribution date. A Participant may not receive an in-service account distribution more frequently than once in a Plan Year whether such distribution is on account of an initial in-service account distribution election or a modified in-service account distribution election. Any in-service account distribution shall be paid with the last payroll of the month following the distribution date elected by the Participant.

(b) Previously Scheduled In-Service Account Distributions. In-service account distribution elections in effect under the Prior Plan and not otherwise modified pursuant to Section 8(c) below shall remain in full force and effect with respect to the Plan. Notwithstanding the foregoing, in-service account distributions elections in effect under the Prior Plan pursuant to which distributions were scheduled to occur in 2005 shall not apply to Compensation deferred in 2005 (and earnings thereon); provided, however, that if a Participant elected a distribution of one hundred percent of his Account in 2005 pursuant to an in-service account distribution election in effect under the Prior Plan, then such election shall apply to Compensation deferred in 2005 (and earnings thereon). In-service account distribution elections in effect under the Prior Plan that apply, pursuant to this Section 8(b), to Compensation deferred under the Plan and to Compensation deferred under the Prior Plan and pursuant to which distributions shall be made in 2006 and later, shall be applied pro rata to Compensation deferred under the Plan and the Prior Plan based on the relative values of the Plan and Prior Plan accounts.

(c) Special In-Service Account Distribution Election. Notwithstanding any other provision of the Plan to the contrary, a Participant may elect an in-service account distribution or change the time of an in-service account distribution as elected in accordance with Section 8(a) or 8(b) above, provided that the election is made at least twelve months prior to the originally scheduled distribution date and the election is made not later than December 31, 2006. An elections made pursuant to this Section 8(c) shall be treated as an initial in-service account distribution election and shall be subject to any special administrative rules imposed by the Administrator including rules intended to comply with Section 409A of the Code and Notice 2005-1, A-19. No election under this Section 4(c) shall (i) result in an in-service distribution before the Participant’s third year of Plan participation, (ii) result in a Participant receiving an in-service distribution more frequently than once in a Plan Year, (iii) change the

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payment date of any distribution otherwise scheduled to be paid in 2006 or cause a payment to be paid in 2006, or (iv) be permitted after December 31, 2006.

9. Statements. Quarterly, and/or at intervals determined by the Administrator, the Company shall prepare and deliver to each Participant a statement listing the amount credited to such Account as of the applicable date.

10. Form and Time of Payment of Accounts.

(a) Distribution of Account upon Retirement. In the event of a Participant’s separation from Service on or after his or her Retirement Date, distribution of the Participant’s Account shall begin with the last payroll of the month following the month in which the Participant separates from Service, and shall be made consistent with the form of distribution specified on the Participant’s Deferred Compensation Election. After the first installment, future installments shall be paid with the second payroll of each Plan Year. Available forms shall include either a lump sum payment or a series of approximately equal annual installments over a period of five years, ten years or fifteen years. For purposes of the Plan, installment payments shall be treated as a single distribution under Section 409A of the Code. Accounts subject to installment payouts shall continue to be adjusted for gains or losses in the same manner as active Accounts. A Participant may modify his or her elected form of distribution (i.e., lump sum or installments) at any time prior to the date that is at least one year before the date the Participant separates from Service, provided that the Participant’s distribution is delayed at least five years from the originally scheduled distribution date. If a Participant modifies his or her elected form of distribution but he or she separates from Service less than one year following the date of the modification election, his or her prior elected form of distribution shall apply to any distribution.

(b) Distribution Prior to Retirement. If a Participant separates from Service with the Company or any of its non-U.S. subsidiaries prior to his or her Retirement Date (other than on account of death), distribution of the Participant’s Account shall begin with the last payroll of the month following the month in which the Participant separates from Service and shall be made consistent with the form of distribution specified on the Participant’s Deferred Compensation Election. After the first installment, future installments shall be paid with the second payroll of each Plan Year. Available forms of distribution shall include either a lump sum payment or a series of approximately equal annual installments over a period of five years. For purposes of the Plan, installment payments shall be treated as a single distribution under Section 409A of the Code. Accounts subject to installment payouts shall continue to be adjusted for gains or losses in the same manner as active Accounts. A Participant may modify his or her elected form of distribution (i.e. lump sum or installments) at any time prior to the date that is at least one year before the date the Participant separates from Service, provided that the

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Participant’s distribution is delayed at least five years from the originally scheduled distribution date. If a Participant modifies his or her elected form of distribution but he or she separates from Service less than one year following the date of the modification election, his or her prior elected form of distribution shall apply to any distribution.

(c) Previously Scheduled Distribution Elections. A distribution election applicable to a Participant’s separation from Service on or after his or her Retirement Date or a Participant’s separation from Service prior to his or her Retirement Date in effect under the Prior Plan shall remain in full force and effect with respect to the Plan subject to the terms and conditions of Sections 10(a) and (b) above.

(d) Default Distribution Election. In the absence of an effective Deferred Compensation Election as to the timing and/or method of distribution of a Participant’s Account, distribution of the Participant’s Account shall be made in one lump sum payment with the last payroll of the month following the month in which the Participant separates from Service.

(e) Delayed Distribution to Key Employees. Notwithstanding any other provision of Sections 10(a), (b), (c) or (d) above, a distribution made to a Participant who is designated as a Key Employee shall be delayed for a minimum of sixth months following the Participant’s separation from Service. Any payment that otherwise would have been made pursuant to Sections 10(a), (b), (c) or (d) above during such sixth month period shall be made in one lump sum payment with the last payroll of the seventh month following the month in which the Participant separates from Service. The determination of which Participants are Key Employees shall be made by the Administrator in its sole discretion in accordance with Section 2(r) of the Plan and Sections 416(i) and 409A of the Code and the regulations promulgated thereunder.

(f) Separation from Service on account of Leave of Absence or Reduction in Service. Notwithstanding any other provision of this Section 10, any distribution triggered under the Plan on account of a Participant’s separation from Service following (i) a military leave, sick leave, or other bona fide leave of absence that is more than six months in duration where the Participant’s right to reemployment with the Company or any of its non-U.S. subsidiaries is not provided either by statute or contract or (ii) a reduction in the Participant’s service with the Company or any of its non-U.S. subsidiaries to an annual rate that is less than twenty percent of the services rendered, on average, during the immediately preceding three full calendar years of employment with the Company or any of its non-U.S. subsidiaries (or if employed by the Company or any of its non-U.S. subsidiaries less than three years, such lesser period) or the annual remuneration for such services is less than twenty percent of the annual remuneration earned during the three full calendar years of employment (or if less, such lesser period), shall begin with the last payroll of the month following the month in which the Participant is no longer paid through the Company’s or any of its non-U.S. subsidiaries’ payroll.

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(g) Unforeseeable Emergency. In the event of a Participant’s Unforeseeable Emergency, and upon application by such Participant, the Administrator may determine at its sole discretion that payment of all, or part, of such Participant’s Account shall be made in one lump sum payment with the last payroll of the month following the month in which the distribution is approved by the Administrator. Payments due to a Participant’s Unforeseeable Emergency shall be permitted only to the extent reasonably required to satisfy the Participant’s need.

(h) Prohibition on Acceleration. Notwithstanding any other provision of the Plan to the contrary, no distribution shall be made from the Plan that would constitute an impermissible acceleration of payment as defined in Section 409A(3) of the Code and the regulations promulgated thereunder.

11. Effect of Death of Participant.

(a) Distributions. In the event of a Participant’s death while an Eligible Employee or Eligible Board Member (except in the case of a Participant’s suicide during the first two years of his or her participation in the Plan), the Participant’s Account, together with an amount equal to two times the Participant’s actual deferrals under the Plan (exclusive of earnings) (the “supplemental survivor benefit”) shall be distributed to the Participant’s Beneficiary. Notwithstanding the foregoing, the total supplemental survivor benefit shall not exceed Three Million Dollars ($3,000,000). In the event of (i) a Participant’s death while no longer an Eligible Employee or Eligible Board Member (as applicable), or (ii) a Participant’s suicide during the first two years of his or her participation in the Plan, only the Participant’s Account, if any, shall be distributed to the Beneficiary. The Participant’s supplemental survivor benefit shall be paid in a lump sum not later than twelve months following the Participant’s death and the Participant’s Account, if any, shall be distributed to the Participant’s Beneficiary in three annual installments commencing with the last payroll of the month following the month in which the Participant dies. After the first installment, future installments shall be paid with the second payroll of each Plan Year. The remaining Account balance (during the period of the installment payouts) shall continue to be adjusted for gains or losses in the same manner as active Accounts.

(b) Beneficiary Designation. Upon enrollment in the Plan, each Participant shall file a prescribed form with the Company naming a person or persons as the Beneficiary who will receive distributions payable under the Plan in the event of the Participant’s death. If the Participant does not name a Beneficiary, or if none of the named Beneficiaries is living at the time payment is due, then the Beneficiary shall be the Participant’s spouse, or if none, the Participant’s children in equal shares, or if none, the Participant’s estate.

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The Participant may change the designation of a Beneficiary at any time in accordance with procedures established by the Administrator. Designation of a Beneficiary, or an amendment or revocation thereof, shall be effective only if made in the prescribed manner and received by the Company prior to the Participant’s death.

12. General Duties of Trustee. The Trustee shall manage, invest and reinvest the Trust Fund as provided in the Trust Agreement. The Trustee shall collect the income on the Trust Fund, and make distributions therefrom, all as provided in the Plan and in the Trust Agreement

13. Withholding Taxes. All distributions under the Plan shall be subject to reduction in order to reflect tax withholding obligations imposed by law.

14. Participant’s Unsecured Rights. The Account of any Participant, and such Participant’s right to receive distributions from his or her Account, shall be considered an unsecured claim against the general assets of the Company; such Accounts are unfunded bookkeeping entries. The Company considers the Plan to be unfunded for tax purposes and for purposes of Title I of ERISA. No Participant shall have an interest in, or make claim against, any specific asset of the Company pursuant to the Plan.

15. Non-assignability of Interests. Except as provided under Section 19 of the Plan, the interest of a Participant under the Plan is not subject to option or assignable by either voluntary or involuntary assignment or by operation of law, including without limitation to: bankruptcy, garnishment, attachment or other creditor’s process. Any act in violation of this Section 15 shall be void and without effect.

16. Limitation of Rights.

(a) Bonuses. Nothing in this Plan shall be construed to give any Eligible Employee any right to be granted a bonus award.

(b) Employment Rights. Neither the Plan nor deferral of any Compensation, nor any other action taken pursuant to the Plan, shall constitute, or be evidence of, any agreement or understanding, express or implied, that the Company will employ an Eligible Employee for any period of time, in any position at any particular rate of compensation. The Company reserves the right to terminate an Eligible Employee’s Service at any time for any reason, except as otherwise expressly provided in a written employment agreement.

17. Administration of the Plan. The Plan shall be administered by the Administrator. The Administrator shall have full power and authority to administer, construe and determine all questions that shall arise as to interpretations of the Plan’s provisions, including determination of eligibility, allocation of assets, method of payment, participation and benefits under the terms of the Plan, establish procedures for administering the Plan, prescribe forms, and take any and all necessary actions in connection with the Plan. The Administrator’s interpretation and construction of the Plan shall be conclusive and binding on all persons, and

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will be given the maximum possible deference allowed by law. The Administrator may appoint such agents, counsel, accountants, consultants and other persons as may be required to assist in administering the Plan and to allocate and delegate its power and authority described herein to one or more employees, officers or agents or to one or more persons or organizations that it has employed to perform its administrative responsibilities. In the event that any Participants are found to be ineligible, that is, not members of a select group of management or highly compensated employees, according to a determination made by the U.S. Department of Labor, the Administrator shall take whatever steps it deems necessary, in its sole discretion, to equitably protect the interests of the affected Participants.

18. Amendment or Termination of the Plan.

(a) General Rule. The Compensation Committee may amend, suspend, or terminate the Plan at any time; provided, however, that no such action shall reduce a Participant’s Account under the Plan without the Participant’s written consent. In the event of termination of the Plan, the Accounts of Participants shall be distributed within the period beginning twelve months after the date the Plan was terminated and ending twenty-four months after the date the Plan was terminated, or pursuant to Sections 8 or 10 of the Plan, if earlier. If the Plan is terminated and Accounts are distributed, the Company shall terminate all account balance non-qualified deferred compensation plans with respect to all participants and shall not adopt a new account balance non-qualified deferred compensation plan for at least five years after the date the Plan was terminated.

(b) Change of Control. The Compensation Committee may terminate the Plan thirty days prior to or twelve months following a Change of Control and distribute the Accounts of the Participants within the twelve-month period following the termination of the Plan. If the Plan is terminated and Accounts are distributed, the Company shall terminate all substantially similar non-qualified deferred compensation plans sponsored by the Company and all of the benefits of the terminated plans shall be distributed within twelve months following the termination of the plans.

(c) Dissolution or Bankruptcy. The Plan shall automatically terminate upon a corporation dissolution of the Company that is taxed under Section 331 of the Code or with the approval of a bankruptcy court pursuant to 11 U.S.C. Section 503(b)(1(A), provided that the Participants’ Accounts are distributed and included in the gross income of the Participants by the latest of (i) the Plan Year in which the Plan terminates or (ii) the first Plan Year in which payment of the Accounts is administratively practicable.

19. Domestic Relations Orders.

(a) In General. The procedures established by the Company for the determination of the qualified status of domestic relations orders and for making distributions under qualified domestic relations orders, as provided in Section 206(d) of ERISA, shall apply to the Plan, to the extent applicable.

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(b) Distributions. To the extent required to comply with a qualified domestic relations order, amounts awarded to an alternate payee under a qualified domestic relations order shall be distributed in the form of a lump sum distribution as soon as administratively feasible following the determination of the qualified status of the domestic relations order. To the extent that the qualified domestic relations order does not require an immediate lump sum distribution, the alternate payee shall have all rights regarding investment elections and distribution elections and withdrawal rights as if such alternate payee were a Participant. For purposes of determining distributions to an alternate payee, “separation from Service” or “Retirement Date” shall be the separation from Service or Retirement Date of the Participant whose Account was the subject of the qualified domestic relations order.

20. Incompetency. In the event a benefit is payable to a minor or person declared incompetent or incapable of handling the disposition of his property, the Administrator may pay such benefit to the guardian, legal representative or person having the care or custody of such minor, incompetent or incapable person. The Administrator may require proof of incompetency, minority or guardianship as it may deem appropriate prior to distribution of the benefit. Such distribution shall completely discharge the Company from all liability with respect to such benefit.

21. Choice of Law. The validity, interpretation, construction and performance of the Plan shall be governed by ERISA and the Code, and, to the extent that they are not preempted, by the laws of the State of California, excluding California’s choice-of-law provisions.

22. Claims and Review Procedure.

(a) Informal Resolution of Questions. Any Participant or Beneficiary who has questions or concerns about his or her benefits under the Plan is encouraged to communicate with the Administrator. If this discussion does not give the Participant or Beneficiary satisfactory results, a formal claim for benefits may be made within one year of the event giving rise to the claim in accordance with the procedures of this Section 22.

(b) Formal Benefits Claim – Review by Administrator. A Participant or Beneficiary may make a written request for review of any matter concerning his or her benefits under this Plan. The claim must be addressed to the Administrator, 2005 U.S. Non-qualified Deferred Compensation Plan, Sun Microsystems, Inc., 4230 Network Circle, M\S USCA23-106, Santa Clara, California 95054. The Administrator shall decide the action to be taken with respect to any such request and may require additional information if necessary to process the request. The Administrator shall review the request and shall issue his or her decision, in writing, no later than 90 days after the date the request is received,

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unless the circumstances require an extension of time. If such an extension is required, written notice of the extension shall be furnished to the person making the request within the initial 90-day period, and the notice shall state the circumstances requiring the extension and the date by which the Administrator expects to reach a decision on the request. In no event shall the extension exceed a period of 90 days from the end of the initial period.

(c) Notice of Denied Request. If the Administrator denies a request in whole or in part, he or she shall provide the person making the request with written notice of the denial within the period specified in Section 22(b) above. The notice shall set forth the specific reason for the denial, reference to the specific Plan provisions upon which the denial is based, a description of any additional material or information necessary to perfect the request, an explanation of why such information is required, and an explanation of the Plan’s appeal procedures and the time limits applicable to such procedures, including a statement of the claimant’s right to bring a civil action under Section 502(a) of ERISA following an adverse benefit determination on review.

(d) Appeal to Administrator.

(i) A person whose request has been denied in whole or in part (or such person’s authorized representative) may file an appeal of the decision in writing with the Administrator within 60 days of receipt of the notification of denial. The appeal must be addressed to: Administrator, 2005 U.S. Non-qualified Deferred Compensation Plan, Sun Microsystems, Inc., 4230 Network Circle, M\S USCA23-106, Santa Clara, California 95054. The Administrator, for good cause shown, may extend the period during which the appeal may be filed for another 60 days. The appellant and/or his or her authorized representative shall be permitted to submit written comments, documents, records and other information relating to the claim for benefits. Upon request and free of charge, the applicant should be provided reasonable access to and copies of, all documents, records or other information relevant to the appellant’s claim.

(ii) The Administrator’s review shall take into account all comments, documents, records and other information submitted by the appellant relating to the claim, without regard to whether such information was submitted or considered in the initial benefit determination. The Administrator shall not be restricted in his or her review to those provisions of the Plan cited in the original denial of the claim.

(iii) The Administrator shall issue a written decision within a reasonable period of time but not later than 60 days after receipt of the appeal, unless special circumstances require an extension of

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time for processing, in which case the written decision shall be issued as soon as possible, but not later than 120 days after receipt of an appeal. If such an extension is required, written notice shall be furnished to the appellant within the initial 60-day period. This notice shall state the circumstances requiring the extension and the date by which the Administrator expects to reach a decision on the appeal.

(iv) If the decision on the appeal denies the claim in whole or in part written notice shall be furnished to the appellant. Such notice shall state the reason(s) for the denial, including references to specific Plan provisions upon which the denial was based. The notice shall state that the appellant is entitled to receive, upon request and free of charge, reasonable access to, and copies of, all documents, records, and other information relevant to the claim for benefits. The notice shall describe any voluntary appeal procedures offered by the Plan and the appellant’s right to obtain the information about such procedures. The notice shall also include a statement of the appellant’s right to bring an action under Section 502(a) of ERISA.

(v) The decision of the Administrator on the appeal shall be final, conclusive and binding upon all persons and shall be given the maximum possible deference allowed by law.

(e) Exhaustion of Remedies. No legal or equitable action for benefits under the Plan shall be brought unless and until the claimant has submitted a written claim for benefits in accordance with Section 22(b) above, has been notified that the claim is denied in accordance with Section 22(c) above, has filed a written request for a review of the claim in accordance with Section 22(d) above, and has been notified in writing that the Administrator has affirmed the denial of the claim in accordance with Section 22(d) above; provided, however, that an action for benefits may be brought after the Administrator has failed to act on the claim within the time prescribed in Section 22(b) and Section 22(d), respectively.

(f) Statute of Limitations. No legal or equitable action for benefits under the Plan may be commenced more than two years after the Administrator denies the claim on appeal or the Administrator fails to act on the claim within the time prescribed in Section 22(b) and Section 22(d), respectively.

23. Execution and Signature. To record the adoption of the Plan by the Compensation Committee, the Company has caused its duly authorized officer to affix the corporate name hereto:

SUN MICROSYSTEMS, INC.
By:	/s/ William N. MacGowan
Printed Name: William N. MacGowan
Title:	Senior Vice President, Human Resources

18

EX-10.3

Exhibit 10.3

AMENDMENT TO THE

SUN MICROSYSTEMS, INC.

U.S. NON-QUALIFIED DEFERRED COMPENSATION PLAN

WHEREAS, Sun Microsystems, Inc. (the “Company”) has adopted the Sun Microsystems, Inc. U.S. Non-Qualified Deferred Compensation Plan (the “Plan”), which has been amended from time to time;

WHEREAS, Section 18 of the Plan provides for the amendment of the Plan by the Company;

WHEREAS, the Company intends to adopt a new nonqualified deferred compensation plan, the Sun Microsystems, Inc. 2005 U.S. Non-Qualified Deferred Compensation Plan (the “2005 Plan”) effective January 1, 2005;

WHEREAS, in accordance with IRS Notice 2005-1, A-20 and with the terms and conditions of the 2005 Plan, on or before March 11, 2005, Eligible Employees were permitted to (i) cancel Deferred Compensation Elections made with respect to salary and incentive award/commission Compensation earned during the period January 1, 2005 through March 20, 2005, and (ii) cancel Deferred Compensation Elections made with respect to fiscal year 2005 bonus Compensation that was otherwise payable in 2005;

WHEREAS, if Eligible Employees took no action with respect to Deferred Compensation Elections related to fiscal year 2005 bonus Compensation that were effective as of January 1, 2005, such Deferred Compensation Elections remained in full force and effect in 2005 under the 2005 Plan;

WHEREAS, any election made in accordance with IRS Notice 2005-1, A-20 and with the terms and conditions of the 2005 Plan became irrevocable on March 11, 2005 and was subject to special administrative rules imposed by the Administrator consistent with Section 409A of the Code and IRS Notice 2005-1, A-20;

WHEREAS, no Deferred Compensation Election or any cancellation of a Deferred Compensation Election made in accordance with IRS Notice 2005-1, A-20 shall be permitted after December 31, 2005; and

WHEREAS, the Company wishes to amend the Plan to provide for the special open enrollment period relating to compensation earned in 2005 and to provide that any supplemental survivor benefit will be paid in one lump sum as soon as reasonably practicable after a Participant’s death.

NOW THEREFORE, a new Section 4(c) is added to the Plan, effective January 1, 2005, to read as follows:

(c) March 2005 Special Open Enrollment Period. In accordance with IRS Notice 2005-1, A-21, on or before March 11, 2005, Eligible

1

Employees were permitted to make new Deferred Compensation Elections with respect to salary and incentive award/commission Compensation earned during the period March 21, 2005 through December 31, 2005. In addition, on or before March 11, 2005, Eligible Employees who were not Participants in the Plan as of January 1, 2005 were permitted to make Deferred Compensation Elections with respect to salary and incentive award/commission compensation earned during the period March 21, 2005 through December 31, 2005. Any election made pursuant to this Section 4(c) became irrevocable on March 11, 2005 and was subject to special administrative rules imposed by the Administrator consistent with Section 409A of the Code and IRS Notice 2005-1, A-21. No Deferred Compensation Election shall be permitted under this Section 4(c) after March 15, 2005.

RESOLVED FURTHER, that Section 11(a) is amended, effective January 1, 2005, to read in its entirety as follows:

(a) Distributions. In the event of a Participant’s death while an Eligible Employee or Eligible Board Member (except in the case of a Participant’s suicide during the first two years of their participation in the Plan), the Participant’s Account balance, together with an amount equal to two times the sum of (i) the Participant’s actual deferrals under the Plan after the Prior Plan Restatement Effective Date (exclusive of earnings), plus (ii) the Participant’s actual deferrals under the Plan before the Prior Plan Restatement Effective Date (exclusive of earnings) (the “supplemental survivor benefit”), to the extent such deferrals are scheduled to be distributed on or after January 1, 2000, shall be distributed to the Participant’s Beneficiary. Notwithstanding the foregoing, the total supplemental survivor benefit shall not exceed Three Million Dollars ($3,000,000). In the event of (i) a Participant’s death while no longer an Eligible Employee or Eligible Board Member (as applicable), or (ii) a Participant’s suicide during the first two years of their participation in the Plan, only the Participant’s Account shall be distributed to the Beneficiary. The supplemental survivor benefit shall be distributed to the Beneficiary in a lump sum as soon as reasonably practicable after the death of the Participant and the Participant’s remaining Account balance, if any, shall be distributed to the Beneficiary in three annual installments or, at the request of the Beneficiary and subject to the Administrator’s approval, in a single lump sum, commencing in either case as soon as reasonably practicable after the Participant’s death. If installment payments are made, the remaining Account balance (during the period of the installment payouts) shall continue to be credited with earnings and losses in the same manor as active Accounts.

RESOLVED FURTHER, that if the amendment to Section 11(a) of the Plan is deemed to be a “material modification” of the Plan which would cause amounts deferred under the plan prior to January 1, 2005 to be subject to the provisions of Section 409A of the Internal Revenue Code of 1986, as amended, then such amendment shall be null, void and without effect retroactive to January 1, 2005.

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IN WITNESS WHEREOF Sun Microsystems, Inc. has caused this amendment to be executed this 23rd day of December 2005, by its duly authorized officer.

SUN MICROSYSTEMS, INC.
By:	/s/ William N. MacGowan
Printed Name: William N. MacGowan
Title:	Senior Vice President, Human Resources

3

EX-10.4

Exhibit 10.4

SUN MICROSYSTEMS, INC.

U.S. VICE PRESIDENT SEVERANCE PLAN

AND

SUMMARY PLAN DESCRIPTION

Purpose of Plan

The Sun Microsystems, Inc. U.S. Vice President Severance Plan (the “Plan”) provides Notification Benefits and Severance Benefits if your employment terminates because of a Workforce Reduction, Retirement, Mutual Agreement or Involuntary Termination (all defined below). However, this Plan does not provide benefits if you voluntarily terminate employment or if you are terminated for Cause. You must sign, and not revoke, a Release and Waiver Agreement in order to receive Severance Benefits.

The Plan is intended to satisfy, where applicable, the obligations of Sun under the Federal Worker Adjustment and Retraining Notification (“WARN”) Act.

This Plan was originally adopted effective July 1, 2005. It is now restated effective November 1, 2005. In this document “Sun” means Sun Microsystems, Inc., its subsidiaries and its successor or successors.

This document constitutes both the official plan document and the required summary plan description under ERISA.

Highlights

Under this Plan, you are eligible to receive two types of benefits: Notification Benefits and Severance Benefits.

“Notification Benefits” consist of Notification Pay and employment transition services. You need not sign a Release and Waiver Agreement in order to receive Notification Benefits.

“Severance Benefits” consist of a lump sum Severance Payment and Severance COBRA Payment (if eligible). You will not receive Severance Benefits if you do not sign a Release and Waiver Agreement, or if you sign a Release and Waiver Agreement but revoke it within the seven (7) calendar day revocation period.

The amount of Severance Benefits available to you depends on whether you are a member of Sun’s Executive Management Group (“EMG”) or a Vice President who is not a member of the EMG.

Eligibility

You are an Eligible Employee under the Plan if you are:

• A regular full-time or part-time Sun employee on the U.S. Payroll;

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• Not on the payroll of, or considered an employee of, any Sun subsidiary outside the U.S.;

• Employed at the Vice President level or above; and

• Not a Contingent Worker or Partner Worker (includes independent contractor, consultant or vendor) as defined in Sun’s Headcount Policy.

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.

Notwithstanding any other provision of the Plan to the contrary, if you were a Storage Technology Corporation (“StorageTek”) employee who received severance benefits as a result of the acquisition of StorageTek by Sun, you will not be eligible for some or all of the benefits under the Plan for a period of time, as set forth in your offer letter from Sun dated on or around August 5-10, 2005.

Conditions For Receiving Plan Benefits

You will receive Plan benefits if you are an Eligible Employee and meet all of the following conditions:

• You receive a formal written notice that states the date your employment will terminate and that your termination is because of a Workforce Reduction, Retirement, Mutual Agreement, or Involuntary Termination (“Termination Letter”);

• You abide by any written terms and requirements that Sun may establish as a condition to your receiving Plan benefits; and

• For Severance Benefits only, you sign the Release and Waiver Agreement within a reasonable period of time (as determined by Sun in its sole discretion) after your employment termination date and do not revoke the Release and Waiver Agreement within the seven (7) calendar day revocation period.

“Workforce Reduction” for purposes of this Plan means your employment is terminated because of the elimination or coordinated reduction of jobs within your group, division, department or branch due to a corporate transaction or reorganization, technology change, funding reduction, reduced workload or similar occurrence (including an outsourcing arrangement). A Workforce Reduction also includes a Material Job Change. A Material Job Change means your job is re-leveled downward and Sun has determined, in its sole discretion, that the re-leveling constitutes a Material Job Change as described in the Global Compensation Treatment for Job Level Downgrades Policy.

“Retirement” for purposes of this Plan means your voluntary resignation from Sun at or

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after attaining age 55 and with a number of full years of service with Sun that when added to your age (in full years), the sum equals or exceeds 65. Notwithstanding the foregoing sentence, you must have a minimum of five (5) full years of service in order to qualify for Retirement. Your resignation will not be considered Retirement if you work in the same or similar profession during the six-month period following your termination of employment. You will be considered to have retired if you perform services for a nonprofit organization following your termination of employment. Sun shall make the determination of whether you have retired in its sole discretion.

“Mutual Agreement” for purposes of this Plan means that both you and Sun agree that your employment should terminate.

“Involuntary Termination” for purposes of this Plan means termination of your employment for any reason by Sun except for Cause.

Conditions Under Which You Will Not Receive Plan Benefits

Even if you are an Eligible Employee, you will not receive Plan benefits if any of the following apply:

• You are terminated for Cause. “Cause” means (i) misconduct as described in Sun’s Misconduct Policy (HR503) or (ii) documented unsatisfactory job performance. Sun shall make this determination in its sole discretion.

• You voluntarily terminate employment (including as a result of disability) even if you claim “constructive termination,” prior to your termination date as set forth in your Termination Letter.

• You decline a written offer of a “Comparable Job” at Sun for which, in Sun’s judgment, you are reasonably qualified. A “Comparable Job” is a job within 50 miles of your current job location at the same or higher salary/job grade as the current job and with at least the same total target cash compensation opportunity. A Comparable Job need not involve the same duties and responsibilities as your current job.

• You accept another regular job at Sun before your employment at Sun terminates(i.e., a job other than a Temporary Job Assignment, defined below).

• You are on an unpaid personal non-FMLA, non-Military Leave of Absence on the date of the Termination Letter.

• You begin working for another employer (whether regular or temporary) before your employment at Sun terminates. You are required to immediately notify Sun in writing if you begin another job prior to your termination date.

• Your job is re-leveled for any reason, for example, to reflect your current job duties and responsibilities or to reflect any changes in your job duties and responsibilities. A job re-leveling is not a Workforce Reduction unless Sun determines, in its sole discretion, that you have experienced a Material Job Change as defined above.

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• For Severance Benefits only, you do not timely sign a Release and Waiver Agreement or you timely sign a Release and Waiver Agreement but you revoke it within the seven calendar day revocation period.

Temporary Job Assignments

For purposes of this Plan, a “Temporary Job Assignment” is a job as a Sun employee that is not expected to last more than two years at the time it is offered to you and which is offered to you after you receive a Termination Letter but prior to your employment termination. If you accept a job which, at the time it is offered to you, is expected to last more than two years, you will be treated as a regular Sun employee and will not receive Plan benefits in connection with the Workforce Reduction, Retirement, Mutual Agreement or Involuntary Termination that occurred immediately prior to your acceptance of your new job at Sun.

While you are on a Temporary Job Assignment you will not receive Plan benefits. However, at the end of the Temporary Job Assignment, provided you meet the conditions of the Plan, you will receive Plan benefits in accordance with the terms of the Plan in effect as of the date of the Termination Letter.

If you accept a Temporary Job Assignment and it has not ended after two years, you will be treated as if you are in a regular position and will not be eligible for Plan benefits unless and until the new job is part of a Workforce Reduction or you terminate employment as a result of Retirement, Mutual Agreement or Involuntary Termination. In other words, you will not receive Plan benefits in connection with the Workforce Reduction, Retirement, Mutual Agreement or Involuntary Termination that occurred immediately prior to your acceptance of your new job at Sun.

Outsourcing Situations

Additional eligibility requirements apply if your job is eliminated due to outsourcing. Outsourcing is the transfer of work, a function, a group or an organization at Sun to a vendor The vendor (the “Outsourcing Service Provider”) may seek to hire Sun employees who were previously performing that function or who were members of the group being outsourced.

If your position is outsourced, you will be able to receive Plan benefits, but only if all the following apply:

• You are an Eligible Employee (described above).

• You do not receive an offer of a Comparable Outsource Job, which is Regular Employment. A “Comparable Outsource Job” is a job at the Outsourcing Service Provider for which you are qualified, providing the same level of base pay

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or higher as your Sun job, and which is not anticipated, pursuant to the outsourcing agreement between Sun and the Outsourcing Service Provider, to require you to relocate to a job location more than 50 miles away from your Sun job location within the first 12 months of your employment with the Outsourcing Service Provider. For purposes of the Plan, if you participate in the iWork program, Sun job location means your home if you are a home assigned employee or the location of your mailstop if you are a flexible employee. If you work from home or a flexible office based on any arrangement outside of the iWork program, your Sun mailstop is your job location. For purposes of the Plan, “Regular Employment” is employment with the Outsourcing Service Provider that is on the same terms and conditions as those provided to their other employees and that is anticipated to be ongoing for an indefinite period. If you are currently working part-time for Sun and you are offered a full-time job by the Outsourcing Service Provider or you are offered a job by the Outsourcing Service Provider that is outside the outsourcing agreement between the Outsourcing Service Provider and Sun (i.e., your job would not support Sun), you will not be considered to have received an offer of a Comparable Outsource Job, which is Regular Employment.

• You fulfill all the regular duties of your Sun job from the date of the outsourcing notice until your last day of work (which may be prior to your termination date) as set forth in the Termination Letter. For purposes of the Plan, outsourcing notice is a written notice of termination due to outsourcing, which does not contain the date your employment will terminate.

• You meet all the Conditions For Receiving Plan Benefits (described above).

You will be ineligible to receive Plan benefits if:

• You receive an offer of a Comparable Outsource Job, which is Regular Employment,

• You accept an offer of a Comparable Outsource Job, which is Short-Term Employment (for purposes of the Plan, Short-Term Employment is employment with the Outsourcing Service Provider that is anticipated, at the time of the job offer, to last less than 12 months), with the Outsourcing Service Provider and the outsourcing agreement between the Outsourcing Service Provider and Sun provides that severance benefits equivalent to the severance benefits under this Plan will be paid by the Outsourcing Service Provider, or

• You meet any of the Conditions Under Which You Will Not Receive Plan Benefits (described above).

Notification Benefits

You need not sign a Release and Waiver Agreement in order to be eligible for Notification Benefits.

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If you are an Eligible Employee and you receive a written Termination Letter that your employment will terminate, you will receive the following Notification Benefits:

• Notification Pay. You will remain employed for sixteen (16) weeks following the date of your Termination Letter. During this sixteen (16) week period, you will receive your regularly bi-weekly Pay (defined below under Severance Benefits) and your Sun Flex benefits will continue, but you are not required to work during this time.

• Employment Transition Services (career service assistance) for ten (10) months. The period of Employment Transition services available to you begins running on the date of your Termination Letter.

Severance Benefits

When you receive a Termination Letter, you may choose to sign a Release and Waiver Agreement in order to also receive Severance Benefits. You will have at least 45 calendar days after your employment termination date to sign the Agreement. If you do not sign and return to Sun a Release and Waiver Agreement within a reasonable period of time (as determined by Sun in its sole discretion) after your employment termination date or you subsequently revoke the Agreement during the seven (7) calendar day revocation period, you will not be eligible to receive the Severance Payment and the Severance COBRA Payment described below. You may not sign the Release and Waiver Agreement prior to your employment termination date.

You will receive the following benefits as soon as administratively practical after Sun receives your signed Release and Waiver Agreement and the revocation period has ended:

• Severance Payment. This is a lump sum payment equal to four (4) weeks Pay (defined below) for each Year of Service (defined below), up to a maximum determined by your Position (defined below) plus sixteen (16) or thirty-two (32) weeks Pay determined by your Position, and

• COBRA Premiums. Your existing coverage under Sun’s group health plan (and, if applicable, the existing group health coverage for your eligible dependents) will end on the date on which your employment terminates. You and your eligible dependents may then be eligible to elect temporary continuation coverage under Sun’s group health plan in accordance with the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended (“COBRA”). If you are eligible for a Severance Payment and elect COBRA continuation coverage, Sun will pay your COBRA Premiums (defined below) for a period equal to the number of weeks of Pay you will receive as a Severance Payment. After such period of Sun-paid coverage, you (and, if applicable, your eligible dependents) may continue COBRA coverage at your own expense in accordance with COBRA. No provision of the Plan will affect the continuation coverage rules under COBRA. Therefore, the period during which you must elect to continue Sun’s group health plan coverage under COBRA, the length of time during which COBRA coverage will be made available to you, and all your other rights and obligations under COBRA will be applied in the same manner that such rules would apply in the absence of the Plan.

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Notwithstanding the foregoing, if your employment terminates because of Retirement, the Severance Payment and will be paid and the payment of COBRA Premiums will begin no earlier than six (6) months after your employment termination date. The Severance Payment will be paid no later than the later of (i) March 15 following the calendar year in which such payments are no longer subject to a substantial risk of forfeiture or (ii) September 15 following Sun’s fiscal year in which such payments are no longer subject to a substantial risk of forfeiture. Notwithstanding any other provision of the Plan to the contrary, if the Plan is considered a nonqualified deferred compensation plan under Section 409A(d) of the Internal Revenue Code and the regulations thereunder and you are a “key employee” as defined under Section 409A(a)(2)(B)(i) of the Internal Revenue Code (in general, one of Sun’s top 50 officers based on compensation), your Severance Payment may not be made for 6 months following your employment termination date.

“Year of Service” for purposes of this Plan means a full or partial year of service with Sun prior to your employment termination date. If you are a rehired employee, prior service at Sun will be counted as Year of Service provided that the prior service period exceeded the period when you were not employed by Sun. Years of Service includes up to seven (7) (ten (10) for former employees of Procom Technology, Inc.) years of service credit for service with a predecessor employer that was acquire by Sun; however, the service credit limit will not apply to former employees of Storage Technology Corporation and SeeBeyond Technology Corporation. A partial year of service will be treated as a full year of service.

“COBRA Premiums” for purposes of this Plan are the COBRA premiums that you would have to pay to continue for a certain period of time, the medical, dental, and/or vision coverage you had immediately prior to terminating employment.

“Pay” for purposes of this Plan (other than for sales-related incentive based positions) means your base pay as of the date of the Termination Letter, which does not include car allowance, draws, spifs, bonuses or any non-base compensation. “Pay” for sales-related incentive based positions is based on the On-Target Earnings rate (OTE) effective on the date of the Termination Letter.

“Position” for purposes of this Plan means your position as either a member of the EMG or a Vice President who is not a member of the EMG on the date of the Termination Letter as recorded in Sun’s HR Database.

Example of Calculation of Severance Payment

Assume you are a Vice President with eight years of service. The calculation of your Severance Payment is as follows:

16 weeks Pay based on the Pay you would have received had you worked for those 16 weeks, plus 20 weeks Pay*, for a total of 36 weeks of Pay.

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• 4 weeks Pay per Year of Service x 8 years = 32 weeks but the maximum allowed payment based on Years of Service is 20 weeks Pay. The 16 weeks of Pay is not included in calculating the maximum payment based on Years of Service.

Stock Options

If your employment terminates because of Retirement and you are eligible to receive benefits under the Plan, your stock options will continue to vest for fifteen (15) months after your employment termination date. Except as provided in the previous sentence, all other terms and conditions of your option agreements remain the same.

Sales-Related Incentive Based Positions

If you are in a sales-related incentive based position, commission earnings end effective the date of your Termination Letter. Base pay will be used to determine the payment of unused, accrued vacation in your final paycheck.

Obligation to Repay Sun

If you are reemployed by Sun (in any capacity) before the end of the number of weeks used to determine your Severance Benefits, you must repay to Sun the portion of your Severance Payment for the period that you have been reemployed.

For example, if you are a Vice President with eight years of service, you would have received 36 weeks of Pay. If you were then reemployed by Sun 4 weeks following your employment termination date, you would be required to repay to Sun an amount calculated as follows:

36 weeks of Severance Payment paid minus 4 weeks of actual unemployment equals 32 weeks of Severance Payment to be repaid to Sun.

Reduction of Other Benefits

Any Notification Pay received under this Plan will reduce the amount of any short term and long term disability benefits you are entitled to receive under the Sun Microsystems, Inc. Comprehensive Welfare Plan.

Taxes and Other Deductions

Sun will withhold all appropriate federal, state, local, income and employment taxes from your Plan benefit payments. Contributions to Sun’s 401(k) plan and employee stock purchase plan will not be deducted from your Severance Payment or any Notification Pay paid after your employment termination date.

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Bonus Programs

The Plan does not change the terms of any bonus program for which you may have been eligible at the time of your termination with Sun.

Accordingly, if you are eligible for a bonus payment under a program operated on a quarterly or fiscal year basis (such as SMI Bonus) and terminate employment prior to the last day of a quarter or fiscal year, you will not be eligible to receive the bonus for the quarter or fiscal year in which you terminate employment, except to the extent the bonus program provides otherwise. Unless the bonus program provides otherwise, bonus program payments will not be prorated for a partial quarter’s or year’s participation.

Disability Prior to Employment Termination

If you become disabled after receiving a Termination Letter but before you terminate employment, your employment termination date will not change. You should contact SunDial to discuss the employment disability benefits for which you may be eligible.

Death Prior to Employment Termination

If you die after receiving a Termination Letter but before you sign the Release and Waiver Agreement, neither you nor your estate will be entitled to any further Plan benefits.

Leaves of Absence

If you are on a full-time Medical, FMLA, State Family Care Leave or Military Leave and your job is part of a Workforce Reduction, you may, in Sun’s sole discretion, be given your Termination Letter either during your leave or at the end of your leave. If you receive the Termination Letter at the end of your leave of absence, you will receive the Plan benefits for which you are eligible and your employment will be terminated sixteen (16) weeks after your leave of absence ends. If you receive the Termination Letter while on leave, you may choose to (i) end your leave early and terminate your employment after sixteen (16) weeks (you will receive the Plan benefits for which you are eligible) or (ii) continue your leave (at the end of your leave, you will receive the Plan benefits for which you are eligible and your employment will be terminated sixteen (16) weeks after your leave of absence ends). In no event will your employment termination date extend beyond 24 months after your Medical Leave began. If you are on an intermittent Medical, FMLA or State Family Care Leave, the provisions of this section will not apply to you and your employment will be terminated on the employment termination date indicated on the Termination Letter.

Employees on leaves of absence who are eligible to receive Plan benefits at the end of their leave, will be covered by the terms of the Plan in effect as of the date their positions were designated by Sun to be part of a Workforce Reduction.

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SUN MICROSYSTEMS, INC.

U.S. VICE PRESIDENT SEVERANCE PLAN

SUMMARY OF PLAN BENEFITS

To receive the Severance Payment and Payment of COBRA Premiums,

the Release and Waiver Agreement must be signed and not revoked.

See Important Notes at the end of Summary.

SALARY/JOB GRADE	NOTIFICATION PAY	EMPLOYMENT TRANSITION SERVICES	SEVERANCE PAYMENT	PAYMENT OF COBRA PREMIUMS
Vice President	16 weeks of Pay	10 months career service assistance	16 weeks Pay plus 4 weeks Pay per Year of Service up to 20 weeks	16 weeks of COBRA premiums plus 4 weeks of COBRA premiums per Year of Service up to 20 weeks
Executive Management Group	16 weeks of Pay	10 months career service assistance	32 weeks Pay plus 4 weeks Pay per Year of Service up to 32 weeks	32 weeks of COBRA premiums plus 4 weeks of COBRA premiums per Year of Service up to 32 weeks

IMPORTANT NOTES TO SUMMARY OF PLAN BENEFITS

NOTIFICATION PAYMENT	EMPLOYMENT TRANSITION SERVICES	SEVERANCE PAYMENT	PAYMENT OF COBRA PREMIUMS
1. A Signed Release and Waiver Agreement is not required. 2. Calculated as number of days Pay (base pay or OTE, as applicable). “Pay” has the same meaning as used for Severance Payment.	1. Career assistance will be provided by an agency designated by Sun. 2. The period of Employment Transition Services begins running on the date of the Termination Letter. 3. A signed Release and Waiver Agreement is not required. 4. Instructions on initiating Employment Transition Services is provided with the Termination Letter.	1. Lump sum Severance Payment paid after Sun receives signed Release and Waiver Agreement and period for revoking Agreement has ended. 2. “Pay” (other than for sales-related incentive based positions) means base pay and does not include any non-base compensation. 3. “Pay” for sales-related incentive based positions is based on on-target earnings (OTE) effective on the date of the Termination Letter. 4. “Years of Service” for calculating benefits means each full or partial year of service with Sun prior to your employment termination date. 5. The 16 weeks/32 weeks additional payment is not included for purpose of calculating the maximum payment based on Years of Service.	1. If you elect COBRA coverage, your COBRA premiums will be paid after Sun receives signed Release and Waiver Agreement and period for revoking Agreement has ended. 2. “Years of Service” for calculating benefits means each full or partial year of service with Sun prior to your employment termination date. 3. The 16 weeks/32 weeks additional period for payment of COBRA premiums is not included for purpose of calculating the maximum period for payment of COBRA premiums based on Years of Service.

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Plan Operation, Administration and General Provisions

Other Benefit Plans/Agreements

Your rights and participation in any other Sun benefit plan at termination of employment are governed solely by the terms of those other plans. Amounts you receive under the Plan will be reduced by any pay in lieu of notice you receive under the Worker Adjustment and Retraining Notice Act (“WARN”), if any, and by any other type of severance (or similar) payment you receive under any plan or agreement (including any change of control agreement), if any (including any payments pursuant to a Sun foreign subsidiary’s or an acquired company’s plan or agreement) or as required by law.

Amendment and Termination

Sun reserves the right to modify, suspend or terminate the Plan at any time and for any reason. Any action amending or terminating the Plan shall be in writing and shall be approved by the Leadership and Development Compensation Committee of the Board of Directors of Sun.

Unfunded Plan

All Plan benefits are paid from Sun’s general funds, and each participant is an unsecured general creditor of Sun. Nothing contained in the Plan creates a trust fund of any kind for your benefit or creates any fiduciary relationship between you and Sun with respect to any of Sun’s assets. Sun is under no obligation to fund the benefits provided under the Plan prior to payment.

Plan Benefits Cannot Be Assigned

The rights of any person to any benefit under the Plan may not be made subject to option or assignment, either by voluntary or involuntary assignment or by operation of law, including bankruptcy, garnishment, attachment or other creditor’s process. Any act in violation of this rule shall be void.

No Employment Rights

Nothing in the Plan may be deemed to give any individual a right to remain employed by Sun or affect Sun’s right to terminate an individual’s employment at any time, with or without cause.

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Legal Construction

The Plan is subject to the provisions of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), and, to the extent not preempted by ERISA, California law. If any provision of the Plan is held by a court of competent jurisdiction to be invalid or unenforceable, the remaining provisions of the Plan shall continue to be fully effective.

Plan Administrator

Sun is the “Plan Administrator” of the Plan as that term is used in ERISA. Sun has full discretionary authority to administer and interpret the Plan, including the exclusive right to adopt rules and procedures to implement the Plan, to interpret in its sole discretion, provisions of the Plan, to decide any questions in connection with the administration of the Plan, or relating to any claim for Plan benefits, including, whether an individual is eligible for Plan benefits and the amount of Plan benefits. Sun may delegate its responsibilities to other persons, which includes delegation of discretion. Subject to the claims and appeal procedures, the decisions of Sun and its delegatees relating to the Plan are final and binding on all persons.

Claims and Appeal Procedures

If you disagree with Sun’s determination of the amount of your benefits or with any other decision Sun may have made regarding your interest in the Plan, you may file a claim with Sun. You must send your claim in writing to: Director, Executive Compensation – U.S. Vice President Severance Plan, Sun Microsystems, Inc., 4230 Network Circle, M/S USCA23-106, Santa Clara, CA 95054. You should file the claim as soon as possible, but no later than one (1) year after the determination /decision.

In the event that your claim for benefits is denied in whole or in part, Sun must provide you written or electronic notification of the denial of the claim, and of your right to appeal the denial. The notice of denial will be set forth in a manner designed to be understood by you, and will include (i) the specific reason or reasons for the denial, (ii) reference to the specific Plan provisions upon which the denial is based, (iii) a description of any information or material that Sun needs to complete the review and an explanation of why such information or material is necessary, and (iv) an explanation of the Plan’s appeal procedures and the time limits applicable to such procedures, including a statement of your right to bring a civil action under Section 502(a) of ERISA following a denial on appeal. This notice will be given to you within 90 calendar days after Sun receives the claim, unless special circumstances require an extension of time – in which case Sun has up to an additional 90 calendar days for processing the claim. If an extension of time for processing is required, notice of the extension will be furnished to you before the end of the initial 90-day period. This notice of extension will describe the special circumstances necessitating the additional time and the date by which Sun expects to render its decision on the claim.

Effective Date November 1, 2005 Page 12 of 15 Execution Copy

If your claim for benefits is denied, in whole or in part, you (or your authorized representative) may appeal the denial by submitting a written appeal to the Appeal Committee within 60 calendar days after you receive the denial. If you fail to appeal a denial within the 60-day period, Sun’s determination will be final and binding. If you appeal to the Appeal Committee, you (or your authorized representative) may submit comments, documents, records and other information relating to your claim for benefits. You may request (free of charge) reasonable access to, and copies of, all documents, records, and other information relevant to your claim.

The Appeal Committee will make a decision on each appeal no later than 60 calendar days following receipt of the appeal. If special circumstances require an extension of time for processing the appeal, the Appeal Committee will make a decision on the appeal no later than 120 calendar days following receipt of the appeal. If an extension for review is required, notice of the extension will be furnished to you before the extension begins. The extension notice will indicate the special circumstances requiring an extension and the date by which the Appeal Committee expects to render a decision. The Appeal Committee will give written or electronic notice of its decision to you after its decision is made. In the event that the Appeal Committee confirms the denial of the claim for benefits in whole or in part, the notice will outline, in a manner calculated to be understood by you, (i) the specific reason or reasons for the decision, (ii) reference to the specific Plan provisions upon which the decision is based, (iii) a statement that you may request (free of charge) reasonable access to, and copies of, all documents, records, and all other information relevant to your claim, and (iv) a statement of your right to bring an action under Section 502(a) of ERISA.

No legal action for benefits under the Plan may be brought until you (i) have submitted a written claim for benefits in accordance with the procedures described above, have been notified by Sun that the claim is denied, have filed a written appeal in accordance with the appeal procedures described above, and have been notified that the Appeal Committee has denied the appeal, or (ii) Sun or the Appeal Committee fail to follow these procedures. No legal action may be commenced or maintained against the Plan, Sun or the Appeal Committee more than two (2) years after the Appeal Committee denies your appeal or Sun or the Appeal Committee fail to follow these procedures.

If you wish to take legal action after exhausting the appeal procedures, you may serve process on Sun at the address indicated in the section below entitled “Plan Information.”

Plan Information

Plan Governed by ERISA

The Plan is an employee welfare benefit plan subject to ERISA. The Plan is subject to most of the provisions of Title I of ERISA. However, it is not subject to Title IV of ERISA, which includes the plan termination insurance provisions.

Effective Date November 1, 2005 Page 13 of 15 Execution Copy

Address of Sun

The principal executive office of Sun Microsystems, Inc. is 4150 Network Circle, Santa Clara, California 95054. Its telephone number is (650) 960-1300.

Identification Numbers

Sun’s Employer Identification Number (EIN) is 94-2805249. The Plan Number assigned to the Plan is 540.

Type of Plan

The Plan is a welfare benefit plan providing special severance benefits to eligible employees. All benefits under the Plan are paid directly by Sun to participants.

Plan Year

The Plan’s year ends on December 31.

Service of Process

The Plan’s agent for service of legal process is:

General Counsel

Legal Department

Sun Microsystems, Inc.

4120 Network Circle, MS USCA 12-202

Santa Clara, CA 95054

Statement of ERISA Rights and Protections

As a participant in the Sun Microsystems, Inc. U.S. Vice President Severance Plan, you are entitled to certain rights and protections under ERISA. ERISA provides that all plan participants are entitled to:

Receive Information About your Plan and Benefits

Examine, without charge, at the plan administrator’s office - and at other specified locations - all documents governing the Plan and a copy of the latest annual report (Form 5500 Series) filed by the Plan with the U.S. Department of Labor and available at the Public Disclosure Room of the Employee Benefits Security Administration.

Obtain, upon written request to the plan administrator, copies of documents governing the operation of the plan, copies of the latest annual report (Form 5500 Series) and updated summary plan description (there may be a reasonable charge for the copies).

Prudent Actions by Plan Fiduciaries

In addition to creating rights for plan participants, ERISA imposes obligations on those responsible for the operation of the Plan. The people who operate the Plan, called “fiduciaries” of the Plan, have a duty to do so prudently and in the interest of you and other plan participants and beneficiaries. No one, including Sun or any other individual, may fire you or otherwise discriminate against you in any way to prevent you from obtaining a benefit or exercising your rights under ERISA.

Effective Date November 1, 2005 Page 14 of 15 Execution Copy

Enforce Your Rights

If your claim for a benefit is denied or ignored, in whole or in part, you have a right to know why this was done, to obtain copies of documents relating to the decision without charge, and to appeal any denial, all within certain time schedules.

Under ERISA, there are steps you can take to enforce the above rights. For instance, if you request a copy of plan documents or the latest annual report from the plan administrator and do not receive them within 30 days, you may file suit in a Federal court. In such a case, the court may require the plan administrator to provide the materials and pay you up to $110 a day until you receive them, unless the materials were not sent because of reasons beyond the administrator’s control. If your claim for benefits is denied or ignored, in whole or in part, and you have been through the Plan’s appeal procedures, you may sue in a state or Federal court. If it should happen that plan fiduciaries misuse the Plan’s money, or if you are discriminated against for asserting your rights, you may seek assistance from the U.S. Department of Labor, or you may file suit in a Federal court. The court will decide who should pay court costs and legal fees. If you are successful, the court may order the person you sued to pay these legal costs and fees. If you lose, the court may order you to pay these costs and fees (for example, if it finds your claim is frivolous).

Assistance With Your Questions

If you have questions about the Plan, you should contact the plan administrator. If you have questions about this statement or your rights under ERISA, or if you need assistance in obtaining documents from the plan administrator, you should contact the nearest office of the Employee Benefits Security Administration, U.S. Department of Labor, listed in your telephone directory or the Division of Technical Assistance and Inquiries, Employee Benefits Security Administration, U.S. Department of Labor, 200 Constitution Ave. N.W., Washington, D.C., 20210. You may also obtain certain publications about your rights and responsibilities under ERISA by calling the publications hotline of the Employee Benefits Security Administration.

Execution

To record the amendment and restatement of the Plan effective November 1, 2005 as set forth herein, Sun Microsystems, Inc. has caused its authorized representative to sign this document the 27th day of October, 2005.

Sun Microsystems, Inc.
By:	/s/ William N. MacGowan
Printed Name:	William N. MacGowan
Title:	Senior Vice President, Human Resources

Effective Date November 1, 2005 Page 15 of 15 Execution Copy

EX-10.5

Exhibit 10.5

Amended FY06 Quarterly SMI Bonus Plan

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

Revised as of December 26, 2006

Plan Objective

The Quarterly SMI Bonus Plan (the “Plan”) is designed to reward eligible employees (“Participants”) for their contribution to the Company’s success through the achievement of specific SMI financial goals in each fiscal quarter during the Company’s fiscal year 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.

Capitalized terms not defined within the text below are defined in the section of the Plan entitled “Glossary.”

Plan Year/Performance Periods

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

Eligibility

To be eligible, participants 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

Additionally, participants must also be in a Plan-eligible position and on Company Payroll through the following dates, reflecting the last day of each fiscal quarter, respectively:

• September 25^th, 2005 to participate in the FY06 Q1 Bonus

• December 25^th, 2005 to participate in the FY06 Q2 Bonus

• March 26^th, 2006 to participate in the FY06 Q3 Bonus

• June 30^th, 2006 to participate in the FY06 Q4 Bonus

In the U.S., only Regular Full-Time Employees and Regular Eligible Part-Time Employees are eligible to participate in the Plan. Outside the U.S., eligibility is determined by job grade and local legislation.

Employees at the Director WW Job Level who are eligible for Incentive Bonus Plans are also eligible to participate in the Plan on separate terms as set forth herein.

Outsourced Employees are eligible to participate in the Plan on separate terms as set forth herein.

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

• Ineligible Part-Time Employees (as defined in the Glossary)

• Service Providers.

• Ineligible Outsourced Employees (as defined in the Glossary)

• Employees at the Principal WW Job Level and below who are eligible for Incentive Bonus Plans.

• Employees who are eligible for any other plan that serves as a substitute for, or replacement of, the Plan, as determined the Company, in its sole discretion.

Page 1 of 9 December 23, 2005

Amended FY06 Quarterly SMI Bonus Plan

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

Revised as of December 26, 2006

• Legacy StorageTek and SeeBeyond Employees are not eligible to participate in the Plan with respect to FY06 Q1 and Q2 Bonuses. These employees, when in Plan-eligible positions, will be eligible to participate in the Plan with respect to FY06 Q3 and Q4 Bonuses; however, such participation will be on separate terms, as set forth herein.

• Employees who received a “3” rating for the Company’s fiscal year 2005 are not eligible to participate in the Plan with respect to FY06 Q1- Q3 Bonuses. Employees who receive a “3” rating for the Company’s fiscal year 2006 are not eligible to participate in the Plan with respect to the FY06 Q4 Bonus.

• Non- U.S employees at the Staff level (WW Job Level “E”) and below.

Bonus Target Percentage

A Participant’s bonus target percentage under the Plan (“Bonus Target Percentage”) is determined based upon his or her WW Job Level and location:

Location	WW Job Level	U.S. Salary Grade	Bonus Target Percentages
Worldwide	Director – Non-IB	E13 – E15	25%
	Director – IB	E00	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	E/S/Z-7 to 9	8%
	Staff Associate – Non-IB	E/S/Z-4 to 6	8%
	Associate/Clerical – Non-IB	E/S/Z-1-3 and N	3%

The Participant’s Bonus Target Percentage is divided between the four quarters as follows: Q1: 10%; Q2: 25%; Q3: 25%; Q4: 40%, which results in quarterly bonus target percentages (“Quarterly Bonus Target Percentages”), as provided in the table below:

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%

Company Performance Measures

The Plan is based on Company performance against the following measures (the “Company Performance Measures”):

1. FY06 Q1- quarterly Operating Income;

Page 2 of 9 December 23, 2005

Amended FY06 Quarterly SMI Bonus Plan

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

Revised as of December 26, 2006

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: For purposes of calculating the bonus accrual under the Plan, “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

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 of the Board of Directors (the “LDCC”) . Significant changes to operations may result in changes to the Plan at LDCC discretion.

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

• Restructuring Activity

• Real Estate Transactions

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 LDCC. Significant changes to operations may result in changes to the Plan at LDCC discretion.

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

Bonus Plan Funding Percentage

The Company uses a schedule (the “Quarterly Bonus Funding Schedule”), which provides percentages based upon the Company’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 FY06 Q1-Q3 : By referring to the Quarterly Bonus Funding Schedule, which provides a percentage based on the Company’s actual performance against its goal with respect to quarterly Operating Income.

2. With respect to FY06 Q4 for Participants other than Legacy StorageTek and SeeBeyond Employees and new hires in FY06 Q3 and Q4: By referral to the Quarterly Bonus Funding Schedule, which provides percentages based on the Company’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”.

Page 3 of 9 December 23, 2005

Amended FY06 Quarterly SMI Bonus Plan

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

Revised as of December 26, 2006

3. With respect to FY06 Q4 for Participants who are Legacy StorageTek and SeeBeyond Employees or new hires in FY06 Q3 or Q4: By referral to the Quarterly Bonus Funding Schedule, which provides percentages based on the Company’s actual performance against its goals with respect to quarterly Operating Income (“Operating Income Percentage”), annual Free Cash Flow (“Free Cash Flow Percentage”) and annual Revenue (“Revenue Percentage”)

Individual Performance

A percentage will be applied to a Participant’s FY06 Q4 bonus calculation ranging from 0%-200% based upon the Participant’s annual performance (the “Individual Performance Percentage”).

Eligible Wages

For Participants who are classified by the Company as exempt or salaried non-exempt, Quarterly Eligible Wages are generally calculated by dividing the number of calendar days of a Participant’s active employment by the Company in a fiscal quarter by the number of calendar days in that quarter and multiplying the resulting percentage by the Participant’s annual base salary on the last day of that fiscal quarter. For Participants who are paid hourly, in lieu of the annual base salary figure, an annual wage figure (the “annual wage”) is determined for purposes of this calculation based upon the Participant’s hourly rate and the schedule of hours worked. For U.S. non-exempt and non-exempt salaried Participants, the annual salary or annual wage figure includes overtime pay (e.g. Shift-differential, Standby/Call-out pay) earned during the Plan year.

An exception applies in determination of eligible wages for FY06 Q4 with regard to Participants hired by the Company on or after the start of FY06 Q3 and for Legacy StorageTek and SeeBeyond Employees who otherwise meet eligibility criteria on or after the start of FY06 Q3. For this population, two eligible wages are calculated: (1) Quarterly Eligible Wages; and ( 2) annual eligible wages, which are calculated by dividing the number of days the Participant is in the Company eligible position in FY06 Q3 and Q4 by the number of calendar days in the fiscal year and multiplying the resulting percentage by the Participant’s annual base salary on the last day of that quarter (or annual wage, as applicable) (“Annual Eligible Wages”).

Quarterly Eligible Wages and Annual Eligible Wages for all Participants exclude relocation allowances, expense reimbursements, tuition reimbursement, car/transportation allowances, expatriate allowances, long-term disability payments, retention bonuses or other retention premium payments, as well as other commissions and bonuses paid during the Plan year. Quarterly Eligible Wages and Annual Eligible Wages are calculated at On-Target Earnings for SMI bonus plan participants who are on Incentive Bonus Plans. For countries outside of the U.S., the eligible wage calculation(s) are subject to local regulations and practices.

The Company reserves the right to pro-rate Plan bonus amounts, in the manner it deems appropriate, based upon any material change (as determined by the Company) in the Participant’s position or annual compensation. In the event the Participant experiences a Status Change during a fiscal quarter, the Company reserves the right to pro-rate a Participant’s Eligible Wages, as determined in its sole discretion. The methods for determining Quarterly Eligible Wages and Annual Eligible Wages in the most common Status Change situations will use the above formulas, as modified below:

For Participants who move from one target award level to another, the Company will utilize separate calculations for each level, using the last annual base salary (or annual wage, as applicable) for each applicable level.

For Participants who retire, become disabled, or die during a quarter within the fiscal year (who may receive a prorated bonus for that quarter, at the Company’s discretion) the Company will utilize their last annual base salary (or annual wage, as applicable) of record in the eligible position.

Page 4 of 9 December 23, 2005

Amended FY06 Quarterly SMI Bonus Plan

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

Revised as of December 26, 2006

For a Participant on a paid leave of absence during any quarter of the Plan year, the Company will utilize the the last annual base salary (or annual wage, as applicable) of record for the time the Participant was both actively working and designated on a paid leave status and shall consider the period the Participant is designated as active and the period the Participant is designated as on “Paid Leave” for purposes of determining the “active” days in the quarter . “Paid leave status” will not include any period of time in which the Participant receives earnings from short-term and/or long-term disability except, as required by law.

For Outsourced Employees, the Company will utilize the last annual base salary (or annual wage, as applicable) of record in the Plan-eligible position at the Company and the number of days in the Plan-eligible position during the relevant period. In order to be eligible, those employees must have been employed by the Company in a Plan- eligible position during the quarter in which they transfer. Exceptions to this policy may exist outside of the U.S. based upon local laws and regulations.

For Participants who change from a Plan-ineligible position to a Plan-eligible position (or vice versa), the Company will utilize the last annual base salary (or annual wage, as applicable) in the Plan-eligible position and consider the number of days the Participant is in the Plan-eligible position.

For Participants who experience a change in scheduled hours of work per week, the Company will utilize separate calculations for each Plan-eligible work schedule, using the last annual base salary (or annual wage, as applicable) for each Plan-eligible work schedule within the fiscal quarter and considering the number of days the Participant is in each Plan-eligible position.

Bonus Calculation

FY06 Q1-Q3 – All Participants

A Participant’s quarterly bonus payment for FY06 Q1-Q3 will be calculated as follows:

   Quarterly Bonus Target Percentage

x Bonus Plan Funding Percentage

x Quarterly Eligible Wages

= Actual Quarterly Bonus Payment*

Example: In FY06 Q2, if the Company achieves 100% of its Operating Income goal, the actual quarterly bonus payment of a Staff Associate who is irregular Full-Time Employee with Quarterly Eligible Wages of $50,000 will be calculated as follows:

Quarterly Bonus Target Percentage			2	%
Bonus Plan Funding Percentage	X		100	%
Quarterly Eligible Wages	X	$	50,000
Actual Quarterly Bonus Payment for FY06 Q2*		$	1,000

FY06 Q4 – All Participants Except Legacy StorageTek and SeeBeyond Employees and New Hires in FY06 Q3 and Q4

A Participant’s (other than a Participant who is a Legacy StorageTek or SeeBeyond Employee or a new hire during FY06 Q3 or Q4) quarterly bonus payment for FY06 Q4 will be calculated as follows:

   Quarterly Bonus Target Percentage

x Bonus Plan Funding Percentage

x Individual Performance Percentage

x Quarterly Eligible Wages

= Actual Quarterly Bonus Payment*

Page 5 of 9 December 23, 2005

Amended FY06 Quarterly SMI Bonus Plan

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

Revised as of December 26, 2006

Example: In FY06 Q4, if the Company achieves 100% of its quarterly Operating Income goal, 70% of its annual Free Cash Flow goal, and 90% of its annual Revenue goal, the actual quarterly bonus payment of a Staff Associate who is a Regular Full-Time Employee with Quarterly Eligible Wages of $50,000 and an Individual Performance Percentage of 125% 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	%

Step Two – Determine actual quarterly bonus payment:

Quarterly Bonus Target Percentage			3.20	%
Bonus Plan Funding Percentage	X		90	%
Individual Performance Percentage	X		125	%
Quarterly Eligible Wages	X	$	50,000
Actual Quarterly Bonus Payment for FY06 Q4*		$	1,800

FY06 Q4 – Legacy StorageTek and SeeBeyond Employees and New Hires in FY06 Q3 and Q4

The quarterly bonus payment for FY06 Q4 of a Participant who is a Legacy StorageTek or SeeBeyond Employee or a new hire in FY06 Q3 or Q4, with the same assumptions used in the prior example above (with regard to financial performances on key measures and individual performance Percentage), would be determined as follows:

Step One – Determine Annual Eligible Wages

Salary on Last Day of FY06 Q4		$	50,000
Number of days in eligible position in FY06 Q3 and Q4 divided by the number of days in fiscal year	X		40	%
Annual Eligible Wages		$	20,000

Page 6 of 9 December 23, 2005

Amended FY06 Quarterly SMI Bonus Plan

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

Revised as of December 26, 2006

Step Two – Determine Operating Income Factor (Using Quarterly Eligible Wages):

Quarterly Eligible Wages		$	50,000
Operating Income Percentage (With 50% Weighting: 100% x 0.50= 50%)	X		50	%
Quarterly Bonus Target	X		3.2	%
Operating Income Factor		$	1,600

Step Three – Determine Free Cash Flow Factor (Using Annual Eligible Wages):

Annual Eligible Wages		$	20,000
Free Cash Flow Percentage (With 25% Weighting: 70% x 0.25= 17.5%)	X		17.5	%
Quarterly Bonus Target	X		3.2	%
Free Cash Flow Factor		$	112

Step Four – Determine Revenue Factor (Using Annual Eligible Wages):

Annual Eligible Wages		$	20,000
Revenue Percentage (With 25% Weighting: 90% x 0.25= 22.5% )	X		22.5	%
Quarterly Bonus Target	X		3.2	%
Revenue Factor		$	576

Step Five – Determine Company Performance Factor

Operating Income Factor		$	800
Free Cash Flow Factor	+	$	112
Revenue Factor	+	$	144
Company Performance Factor		$	1,056

Step Six – Determine FY06 Q4 Bonus:

Company Performance Factor		$	1,056
Individual Performance Percentage	X		125	%
Actual Quarterly Bonus Payment for FY06 Q4*		$	1,320

* Before applicable taxes and other withholdings, if any.

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.

Page 7 of 9 December 23, 2005

Amended FY06 Quarterly SMI Bonus Plan

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

Revised as of December 26, 2006

Communication of Results

With respect to any particular fiscal quarter during fiscal year 2006, results will be communicated as soon as possible after the Company’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

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

Company: The Company and its subsidiaries.

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.

Incentive Bonus Plan: A variable sales compensation plan in the form of a bonus based on the achievement of financial metrics such as revenue or contribution, or other performance measures.

Ineligible Outsourced Employees: Employees who are hired by an Outsourcing Service Provider to do work which is not part of a Business Process Outsourcing and employees whose jobs are outsourced but do not transition to the Outsourcing Service Provider.

Ineligible Part-time Employee: A regular employee, as internally designated by the Company in its sole discretion, who is paid directly through the Company’s payroll who is scheduled to work fewer than 20 hours per week. If the Company has not classified an individual as an employee on the date his or her service with the Company is terminated and, for that reason, has not withheld employment taxes with respect that individual, and the individual is later determined retroactively to have been a common-law employee of the Company, whether by the Company, a governmental agency or a court, the individual will nevertheless be ineligible to receive Plan benefits.

Legacy StorageTek or SeeBeyond Employee: A former StorageTek or SeeBeyond employee who was hired by the Company as a result of the 2005 acquisitions of StorageTek or SeeBeyond, respectively.

On-Target Earnings: For employees on an Incentive Bonus Plan, the sum of the annual base salary and the target annual incentive bonus.

Page 8 of 9 December 23, 2005

Amended FY06 Quarterly SMI Bonus Plan

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

Revised as of December 26, 2006

Outsourced Employees: Regular Full-Time Employees and Regular Eligible Part-Time Employees who, during a fiscal quarter, transition to an Outsourcing Service Provider in order to provide services as part of a Business Process Outsourcing, as determined by GBS in its sole discretion.

Outsourcing Service Provider: The third party vendor with whom the Company has contracted for the Business Process Outsourcing.

Regular Eligible Part-Time Employee: A regular employee, as designated by the Company in its sole discretion, who is paid directly through the Company’s 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, partner, or contractor.

Regular Full-time Employee: A regular employee, as internally designated by the Company in its sole discretion, who is paid directly through the Company’s payroll who is scheduled to work 40 hours per week and is not an intern, visiting professor, vendor, consultant, partner, or contractor. If the Company has not classified an individual as an employee on the date his or her service with the Company is terminated and, for that reason, has not withheld employment taxes with respect that individual, and the individual is later determined retroactively to have been a common-law employee of the Company, whether by the Company, a governmental agency or a court, the individual will nevertheless be ineligible to receive Plan benefits.

SeeBeyond: SeeBeyond Technology Corporation.

Service Providers: Temporary workers, contractors, vendors, partners, interns, visiting professors and all other workers who are not Regular Full-Time Employees or Regular Eligible Part-Time Employees, as determined by the Company, in its sole discretion.

Status Change: Participants who transition from one Bonus Target Percentage to another during a fiscal quarter, Participants who experience an unpaid leave of absence, Participants who transition from a Plan-eligible position to a Plan-ineligible position (or vice versa), a change in scheduled hours of work, Outsourced Employees, Participant’s who are hired after the beginning of a fiscal quarter, a Participant who retires, [becomes disabled] or [who dies] during a fiscal quarter.

StorageTek: StorageTek Technology Corporation.

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 9 of 9 December 23, 2005

EX-15.1

EXHIBIT 15.1

January 30, 2006

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 No. 333-81101) of Sun Microsystems, Inc. of our report dated November 2, 2005 and January 20, 2006 relating to the unaudited condensed consolidated interim financial statements of Sun Microsystems, Inc. that are included in its Form 10-Q for the quarters ended September 25, 2005 and December 25, 2005.

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: February 3, 2006

/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: February 3, 2006

/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 December 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: February 3, 2006	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 December 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: February 3, 2006	By:	/s/  STEPHEN T. McGOWAN
		Name: Stephen T. McGowan
		Title:   Chief Financial Officer