UNITED STATESSECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K(Mark One)

È ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

For the fiscal year ended June 30, 2005

‘ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE 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 of incorporation) (I.R.S. Employer Identification No.)

4150 Network Circle (650) 960-1300Santa Clara, CA 95054 (Registrant’s telephone number, including area code)

(Address of principal executive offices, http://www.sun.com/aboutsun/investorincluding zip code) (Registrant’s url)

Securities registered pursuant to Section 12(b) of the Act: NoneSecurities registered pursuant to Section 12(g) of the Act:

* Common Stock* Share Purchase Rights

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. È

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the SecuritiesExchange Act of 1934). YES È No ‘

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct). YES ‘ No È

The aggregate market value of the voting stock (Common Stock) held by non-affiliates of the registrant, as ofDecember 23, 2004 (the last business day of registrant’s second quarter of fiscal 2005), was approximately $18.0billion based upon the last sale price reported for such date on The Nasdaq National Market. For purposes of thisdisclosure, shares of Common Stock held by persons who hold more than 5% of the outstanding shares of CommonStock and shares held by officers and directors of the Registrant have been excluded because such persons may bedeemed to be affiliates. This determination is not necessarily conclusive.

The number of shares of the registrant’s Common Stock (par value $0.00067) outstanding as of September 6, 2005was 3,410,044,325.

DOCUMENTS INCORPORATED BY REFERENCE

Parts of the Proxy Statement for the 2005 Annual Meeting of Stockholders are incorporated by reference into Items 10,11, 12, 13 and 14 hereof.

INDEX

Restatement—Explanatory Note 3

PART IItem 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

PART IIItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of

Equity Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations . . . . . 22

Item 7A. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

Consolidated Statements of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

Consolidated Balance Sheets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

Consolidated Statements of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64

Consolidated Statements of Stockholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . . . 108

Item 9A. Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108

Item 9B. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109

PART IIIItem 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related StockholderMatters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

Item 14. Principal Accountant Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

PART IVItem 15. Exhibits and Financial Statement Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114

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Restatement—Explanatory Note

Sun Microsystems, Inc. has restated its consolidated financial statements for fiscal 2004 and 2003, quarterly financialdata for each of the quarters within fiscal 2005 and 2004, and selected financial data for fiscal 2004 and 2003 (theRestatement). The determination to restate these financial statements and selected financial data was made by ourmanagement in consultation with the Audit Committee on September 12, 2005, as a result of our identification oferrors related to the accounting for deferred taxes in certain foreign jurisdictions, as well as the aggregate effect ofcorrections to provisions for State and foreign tax returns and withholding taxes. In addition, the determination torestate our quarterly financial statements within fiscal 2005 was the result of evaluating the impact of certain pre-taxaccounting adjustments recorded throughout the year. Our Audit Committee discussed these matters with ourindependent registered public accounting firm. These errors were largely identified through the operation of ourinternal controls over financial reporting. Although we believe such errors were immaterial to our consolidatedfinancial statements and selected financial information for fiscal 2004 and 2003, under relevant Securities andExchange Commission accounting interpretations, a restatement of the consolidated financial statements of such priorperiods to correct immaterial misstatements therein is required if the aggregate correcting adjustment related to sucherrors would be material to the financial statements of the current period.

The Restatement reduces the benefit from income taxes for fiscal 2005 by $45 million and decreases the provision forincome taxes for fiscal 2004 and 2003 by zero and $45 million, respectively.

The Restatement has an immaterial effect on our consolidated balance sheets at the end of each of the restated periodsand has no net effect on revenues or operating cashflows for those periods. Although there is no pre-tax impact as aresult of these adjustments to the consolidated financial statements for fiscal 2005, the pre-tax accounting adjustmentsthroughout the year would be considered material to the previously reported quarters of fiscal 2005. Accordingly, thefiscal 2005 quarters have been restated. The following tables set forth the effects of the Restatement on our previouslyreported financial statements of operations for fiscal 2004 and 2003 and the affected quarters of fiscal 2005 and 2004(in millions, except per share amounts):

Fiscal YearsEnded June 30,

2004 2003

(Restated)

Impact of adjustments to provision for (benefit from) income taxes . . . . . . . . . . . . . . . . . . . . . . . . . $ — $ (45)

Net loss—as previously reported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (388) $(3,429)Impact of restatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 45

Net loss—as restated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (388) $(3,384)

Net loss per share—basic and diluted—as previously reported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(0.12) $ (1.07)Impact of restatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 0.01

Net loss per share—basic and diluted—as restated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(0.12) $ (1.06)

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Fiscal 2005

FirstQuarter

SecondQuarter

ThirdQuarter

FourthQuarter

Year endedJune 30, 2005

(Restated) (Restated) (Restated)

Impact of pre-tax adjustments to income (loss) beforetaxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 14 $ (14) $ (3) $ 3 $ —

Impact of tax adjustments to provision for (benefit from)income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — 22 23 45

Net impact of adjustments to net income (loss) . . . . . . . . . . . . $ 14 $ (14) $ (25) $ (20) $ (45)

Net income (loss)—as previously reported/announced . . . . . . $ (147) $ 18 $ (3) $ 70(*) $ (62)(*)Impact of restatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 (14) (25) (20) (45)

Net income (loss)—as restated . . . . . . . . . . . . . . . . . . . . . . . . . $ (133) $ 4 $ (28) $ 50 $ (107)

Net income (loss) per share—basic and diluted—aspreviously reported/announced . . . . . . . . . . . . . . . . . . . . . . . $(0.04) $ 0.01 $(0.00) $ 0.02(*) $(0.02)(*)

Impact of restatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — (0.01) (0.01) (0.01) $(0.01)

Net income (loss) per share—basic and diluted, as restated . . . $(0.04) $ 0.00 $(0.01) $ 0.01 $(0.03)

(*) Amount reflects the impact of certain adjustments made to our reported results subsequent to the date of ourearnings announcement. See Item 7. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations for further information.

Fiscal 2004

FirstQuarter

SecondQuarter

ThirdQuarter

FourthQuarter

Year endedJune 30, 2004

(Restated) (Restated) (Restated) (Restated)

Impact of adjustments to provision for (benefit from)income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2 $ 1 $ (6) $ 3 $ —

Net income (loss)—as previously reported . . . . . . . . . . . . . . $ (286) $ (125) $ (760) $ 783 $ (388)Impact of restatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2) (1) 6 (3) —

Net income (loss)—as restated . . . . . . . . . . . . . . . . . . . . . . . . $ (288) $ (126) $ (754) $ 780 $ (388)

Net income (loss) per share—basic—as previouslyreported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(0.09) $(0.04) $(0.23) $ 0.24 $(0.12)

Impact of restatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — (0.01) —

Net income (loss) per share—basic—as restated . . . . . . . . . . $(0.09) $(0.04) $(0.23) $ 0.23 $(0.12)

Net income (loss) per share—diluted—as previouslyreported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(0.09) $(0.04) $(0.23) $ 0.23 $(0.12)

Impact of restatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — —

Net income (loss) per share—diluted—as restated . . . . . . . . $(0.09) $(0.04) $(0.23) $ 0.23 $(0.12)

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PART I

ITEM 1. BUSINESS

GENERAL

Sun’s business is singularly focused on providing network computing products and services. Network computing hasbeen at the core of our offerings for the 23 years of our existence and is based on the premise that the power of a singlecomputer system can be increased dramatically when interconnected with other computer systems for the purposes ofcommunication and sharing of computing power. Interoperability, long-term investment protection and value-addedinnovation across many different computing platforms and devices remain fundamental elements of our approach andare unique parts of what makes our offerings valuable to customers. Customers value us for our thought leadership, ourability to create and nurture large communities of developers around innovation and the value that the resultingsolutions create for their own businesses.

Core beliefs like invention, openness, community, sharing, freedom and collaboration are a fundamental part of ourculture and DNA. With these beliefs as our foundation, together with our partner community, we provide networkcomputing infrastructure solutions that comprise Computer Systems (hardware and software), Network StorageSystems (hardware and software), Support Services, and Client solutions and Educational services (formerly known asProfessional and Knowledge services). Core brand franchises include the Solaris™ operating system (Solaris OS), theJava™ technology platform and products and the UltraSPARC® processor technology.

Our customers use our products and services to build mission-critical network computing environments to operateessential elements of their businesses. Our network computing infrastructure solutions are used in a wide range oftechnical, 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. Typical applications which customers operate on our infrastructure solutions range, forexample, from webserving to high-performance technical computing to enterprise-wide Resource Planning andCustomer Relationship Management.

For the fiscal year ended June 30, 2005, we had net revenues of $11.1 billion, employed approximately 31,000employees and conducted business in over 100 countries. We were incorporated in California in February 1982 andreincorporated in Delaware in July 1987.

Our Internet address is http://www.sun.com. Our most recent annual report on Form 10-K and certain of our otherfilings with the Securities and Exchange Commission (SEC) are available in PDF format through our InvestorRelations website at http://www.sun.com/aboutsun/investor. Our annual reports on Form 10-K, quarterly reports onForm 10-Q, current reports on Form 8-K and amendments to those reports are also available on the SEC website athttp://www.sec.gov, which can be reached from our Investor Relations website. The contents of these websites are notintended to be incorporated by reference into this report or in any other report or document we file, and our referencesto these websites are intended to be inactive textual references only.

BUSINESS STRATEGY

Our business strategy is built around our singular focus on network computing infrastructure and the community that itenables. Our Computer Systems (hardware and software), Network Storage Systems (hardware and software), SupportServices, as well as our Client solutions and Educational services are designed to enable network solutions that attackcost and complexity, accelerate network service deployment and enable mobility with security. The core elements ofour business strategy include:

• On-going innovation in systems design, networking integration, microprocessor architecture, operating systems andsoftware to ensure continuing technology leadership and resulting price-performance advantage;

• An end-to-end architecture that extends our common Java™ technology-based programming environment across ourSPARC® (Scalable Processor Architecture) technology implementation and our line of x64-based products. Ourproducts provide exceptional price-performance, flexibility, scalability and choice for devices as small as smartcards and cell phones up through large, multi-million dollar systems;

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• A commitment to interoperability and open source development as the key to building stronger communities, highervalue solutions for our customers and opening up new market opportunities;

• Our emphasis on customers’ infrastructure investment protection as demonstrated through legacy applicationsupport, our binary compatibility guarantee and the ability to selectively upgrade single processor boards within thesame system;

• A solutions-based selling model which emphasizes our end-to-end network computing architecture platform tointegrate our products and services to address customers’ strategic business challenges and information technologyneeds;

• Innovative business opportunities which make customers more active participants in how we innovate and offerthem new ways of acquiring and deploying IT solutions. These business models are augmenting the types ofproducts and services we offer, as well as how we assemble them into customer solutions;

• Expansion of our Network Computing vision to include data storage technology which enables us to help customerstightly integrate advanced data management technologies to acquire, use and distribute knowledge, as well as store,manage and retrieve it; and

• A robust partner community, including independent software vendors (ISVs), system integrators, resellers andoriginal equipment manufacturers (OEMs), whose members collaborate in building new and innovative solutionsbased on our products and services while extending our reach and expertise.

Innovation

In order to be a leading developer of enterprise and network computing products and technologies, we must continue toinvest and innovate. As indicated by our research and development investments of approximately 16-17% of annualrevenues during each of the last three fiscal years, we continue to focus on technological innovation. Over the past fewyears, we have also made significant investments in several product and services technology acquisitions. Ourinvestments in research and development and acquisitions include:

• The highly reliable and scalable Solaris Operating System (Solaris OS) and our most recent release, Solaris 10,which debuted several major advancements in availability, performance and security to help customers proactivelymanage their computing resources. These innovations are now available through the OpenSolaris™ project, which isintended to drive a deeper understanding of Solaris and expand adoption in the ISV community;

• The highly scalable UltraSPARC processor and systems architecture. Our latest processor technology incorporateschip multithreading at the processor level as part of our throughput computing initiative. We are driving towardssignificant gains in performance for the same footprint and power consumption, leveraging technology acquiredthrough our purchase of Afara Websystems, Inc. (fiscal 2003);

• The fast growing x64 systems offering based on AMD’s Opteron™ processor, which has won 32 world recordbenchmarks and is creating new opportunities for Sun in a variety of customer and industry environments. includinggrid computing environments for high-performance technical computing;

• The x64 system architecture and advanced systems technology acquired with our purchase of Kealia, Inc. (fiscal2004). These developments bring to the market our next generation of x64 rack-optimized servers and further ourstrategy of horizontal scalability on our AMD Opteron-based systems;

• Mission-critical clustering, messaging, identity management, directory and web services infrastructure softwareknown as Java Enterprise System and an industry-leading business model based on per employee pricing, whichmakes “middleware” substantially more affordable compared to the traditional model by being priced on a peremployee basis;

• The cross-platform Java software development environment, spanning smart cards, cellular handsets, set top boxes,desktop computers and servers, used by our customers and ISV partners;

• Virtualization, provisioning and monitoring software architecture for network computing resource optimization andsystems management simplification;

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• Enterprise desktop technologies, Java Desktop System, StarOffice™, including technologies acquired throughTarantella, Inc.’s (fiscal 2006) Secure Global Desktop family of products which, combined with SunRay thin clientcan provide seamless access to virtually any application environment;

• Network-based storage systems and software, including our acquisition of Procom Technology, Inc.’s (fiscal 2005)network attached storage (NAS) intellectual property assets and engineering expertise, which will better enable us tobuild our next generation of NAS and file-based storage system; and

• Remote and proactive managed services offerings delivered through a secure connection to Sun. Our new servicestechnology provides remote diagnostics and preventive services for our customers, now enhanced to include multi-platform support, through our acquisition of managed service provider SevenSpace, Inc. (fiscal 2005). The SunConnection is the first of many such products which deepen our relationships with customers and allow us to deliverongoing value to them.

Many of these technologies provide us with a competitive advantage and differentiation in the marketplace. Byinvesting in research and development, as well as product and services technology acquisitions, we believe we are ableto develop and deliver more valuable systems technology and better address the complex issues our customers face.We intend to continue our investments into new computing technologies and are focused on the development anddelivery of leading-edge network computing products based upon our innovations.

End-to-End Architecture

Developing and deploying services over the network requires an infrastructure platform that is enterprise-ready,developer-rich and economically compelling. This means that we are focused on providing the optimal combination ofsoftware, hardware and services that will give the customer the best value through lower annual administrative costs,lower developer training costs and lower downtime costs, which, in turn, will decrease the customers’ total cost ofownership.

In fiscal 2005, we upgraded a number of current products supporting our strategy as an end-to-end infrastructureplatform company. We improved the performance of our dual-thread UltraSPARC IV processor across our mid andhigh-end server lines. Targeted for mission-critical enterprises, the UltraSPARC IV processor is fully binarycompatible with our previous generation processor, so customers can run existing applications without the time andexpense of rewriting, retesting or re-certifying applications. This provides unique advantages for us over ourcompetitors.

We also strengthened our x64 low-end server product line and now provide customers the choice of either the Linux orSolaris™ Operating System on x64. We introduced a new version of our Solaris OS, which brings significant benefitsto customers by reducing system downtime and upgrade costs. Solaris 10, like all our past versions of the Solaris OS,comes with our binary compatibility guarantee that every release is designed to run existing applications currentlyrunning on previous Solaris OS releases.

Our software consists of Sun’s powerful and scalable Solaris OS, Sun Java Enterprise System, Java Desktop System,N1™ Grid Engine System and the Java Studio development environment. Our software builds upon our well-established Java technology to meet the needs of developers, CIOs and operators to provide information, data andapplications anywhere, anytime and on any device, using open application programming interfaces that work with awide array of operating systems and applications.

Interoperability

From our inception, we have focused on developing products and technologies based upon open standards. We believethe real power in computing lies in the ability to freely access and share information over the network, whileunconstrained by proprietary software and hardware standards. We pioneered this approach with the invention ofNetwork File System technology in 1985 and since then have focused on optimizing the interoperability of differentsystems on different networks.

For our customers, interoperability means the freedom to build heterogeneous networks and to choose best-of-breedhardware and software solutions for their IT environments. Interoperability, and the simplicity and flexibility that it

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provides, constitute an important element of our value proposition to customers. With the advent of webservices, theJava platform has proven itself as a key enabler of an entire generation of new applications and dynamic content in theform of new consumer services for phones, PCs and other devices. The thought leadership displayed by Sun is valuedby customers because the window it provides them into critical developments in the industry is relevant to the successof their business infrastructures.

In May 2005, Sun and Microsoft Corporation (Microsoft) reaffirmed a commitment to joint collaboration based on a10-year intellectual property licensing and technology collaboration agreement. Since then, we have taken a number ofsteps to further our joint goal of interoperability. Sun and Microsoft announced joint authorship and commitment to thesystem management specification, Web Services-Management, which, when implemented, is expected to enable fullsystem management across our Solaris OS and Microsoft Windows environments. A number of other collaborationprojects are also underway to improve compatibility and close integration between our respective products.

Investment Protection

Our customers have made significant investments in hardware and software assets for their companies. To help ourcustomers maximize the return on their investments, we make Investment Protection a priority in all our products. Weguarantee that customer applications running on earlier versions of Solaris will run on our newest version, Solaris 10,without the need to recompile, thus avoiding cost and risk. As the Solaris OS runs on both our UltraSPARC-based datacenter servers as well as our x64 systems, customers are able to leverage the same application environment and skillsets thereby lowering their cost of operations. Our hardware also supports heterogeneous environments so thatcustomers not only have the choice but also have the flexibility to change operating systems as their needs change. Ourcustomers can purchase our x64 servers and storage and deploy them with the Solaris OS, Linux, or MicrosoftWindows. They can then redeploy as needed the very same hardware using a different operating system choice withoutthe daunting task of purchasing and porting to a new hardware platform. On our data center servers, we also providethe ability to selectively upgrade single processor boards within the same system, meaning customers have the abilityto gradually adopt faster processors without having to buy completely new hardware. This extends the lifecycle of acustomer’s investment. By building investment protection into our product offerings, we make it easier for customersto manage change, complexity and costs in their IT infrastructure.

Solutions-Based Selling Model

With our solutions-based selling model, we offer an integrated and consistent set of end-to-end networking architecturesolutions and methodologies to the marketplace. This set of solutions and methodologies brings together a combinationof servers, software, storage and services to help customers address their most complex problems, including businesscompliance, reducing costs, providing secure global access and designing next-generation data centers. We haveorganized our resources, technical understanding and business expertise into the following six competencies:

• Data Center: Focused on enabling enterprises to leverage our systems products, architectures and best practices atthe heart of next-generation, service-oriented data centers;

• Storage and Data Management: Focused on information life cycle management, and the products and processesnecessary to manage business continuity, legislative compliance, storage consolidation, and content repositories atthe heart of the global storage industry;

• Desktop and Mobility: Focused on leveraging open-source products to drive cost savings in desktop deploymentswith SunRay, Java Desktop System, and StarOffice;

• Identity Management: Focused on securing the enterprise, and automating the provisioning processes associatedwith granting and denying access to users, systems and enterprise resources;

• Enterprise Web Services: Focused on enabling enterprises to leverage Java 2 Enterprise Edition (J2EE) webservices platform, and evolving service oriented architectures (SOAs) and service delivery platforms (SDPs); and

• Manageability Services: Focused on our global service offerings, enabling increased system service levels, datacenter operational efficiency and effectiveness, as well as next-generation automation technologies to providepredictive, preemptive and proactive service to heterogeneous infrastructures.

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These competencies line up directly with the three key strategies we present to our customers as part of our vision —attacking cost and complexity, accelerating network service deployment and enabling mobility with security. Webelieve our solution-based selling approach allows us to engage with our customers over the entire lifecycle of theirkey infrastructure projects, improving the delivery of sustainable value from the products and services we produce.

Innovative Business Opportunities

As a company, we are continually exploring new ways of doing business and collaborating with our partners andcustomers to deliver greater value.

OpenSolaris: A community is built through the sharing of ideas, technologies and markets. Accordingly, in June2005, we released OpenSolaris, an initiative to make the source code for Solaris 10 available under the Open SourceInitiative (OSI) approved Common Development and Distribution License (CDDL). Consistent with our heritage ofopen source and open standards-based software, our intention in making Solaris 10 free is to help foster the innovationand collaboration needed to provide for new opportunities for developers, customers and partners. Making Solarissource code an open environment encourages a deeper understanding of Solaris and its innovations by providing adirect channel of feedback from the engineering community, thus helping to drive the cycle of innovation even furtherand even faster.

Subscription Model: We continue to use our subscription model to greatly simplify the pricing, licensing, deliveryand maintenance of our product and service offerings for our customers. We combine our software and services into anintegrated package to facilitate quick deployment and reduce cost, complexity and risks to our customers over thelifetime of the subscription. Customers receive new products and upgrades automatically over the term of thesubscription. The subscription model offers customers a simple, predictable and affordable way to buy our softwareand services.

Utility Computing: We have developed a number of hardware and software products, service offerings, solutionarchitectures and business models aligned with our vision of utility computing. In fiscal 2005, we introduced productssuch as Sun Storage Grid Utility and Sun Storage Grid Rack. Our N1 Grid Engine is the software that enables all theindividual components of the grid to act together as one system. We have built service offerings specifically to helpcustomers build their own “private” grid or buy into our “public” grid utility. Our subscription business model makesall this easy and predictable to purchase; some offerings are as easy as $1 per-employee per year or $1 per GB ofstorage per hour. As customers come to realize the potential for cost savings and significant reductions in complexity,we expect utility computing to become an important element of our product and services strategy.

Remote Services Delivery: Sun Connection, introduced in fiscal 2005, is an integrated, secured service connectionthat links customers, partners, developers and Sun in a dynamic and collaborative network-based community. OurCustomer Networked Services group, which is driving the Remote Services Delivery effort, is an internal partnershipbetween our Services and Software organizations to deliver advanced Support and Educational Services throughsoftware innovation. Sun Management Connection, which incorporates the remote managed services technology fromour recent SevenSpace Inc. acquisition, allows us to deliver scalable, 24x7x365 remote management of heterogeneousIT environments over the Internet without customer investment in IT infrastructure.

Data Storage Technology

Recently, data retention requirements on companies have been multiplying with stricter regulations from such sourcesas the Sarbanes-Oxley Act, the U.S. Food and Drug Administration and the Securities and Exchange Commission. Wesee an opportunity and need to expand our network computing infrastructure to include data archival technology andInformation Lifecycle Management (ILM). We anticipate that our ILM strategy, and its focus on data storage,retention, retrieval and appropriate destruction, will become an important part of our end-to-end solutions.Accordingly, in August 2005, we acquired Storage Technology Corporation (StorageTek) to support our efforts. As aresult of this acquisition, we expect to broaden our storage product portfolio, expand our storage channel network, andstrengthen our sales and service forces in line with our expanded vision.

Alliances and Partner Community

Revolutionary solutions come from the meeting of many different minds. We seek out partners with whom we sharecommon interest and cause. In fiscal 2005, we continued to form relationships with significant partners to extend our

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customer solutions. We also continue to partner with Advanced Micro Devices, Inc. (AMD) to expand our entry-levelline of Opteron processor-based x64 systems, giving customers greater platform choice with maximum priceperformance. We also maintain a strategic alliance with Fujitsu to collaborate on the development, delivery and supportof a future generation of SPARC-based systems. This alliance is intended to enlarge the Solaris footprint, driveincreased market share for our enterprise-class systems and allow us to dedicate additional resources to our throughputcomputing initiative and our next generation of processor products. In addition, we continued our relationship withHitachi Data Systems to provide high-end storage solutions and extend our storage offering into enterpriseenvironments.

Our partner community is essential to our success. While our product and service offerings are very broad, werecognize that no single supplier of computing solutions can meet all of the needs of all of its customers. We haveestablished relationships with leading ISVs, value-added resellers (VARs), OEMs, channel development providers,independent distributors, computer systems integrators and SDPs to deliver solutions that our customers demand.Through these relationships, our goal is to optimize our ability to be the technology of choice, the platform of choice,the partner of choice and to provide the end-to-end solutions that customers require to compete.

SALES, MARKETING AND DISTRIBUTION

Our Global Sales Organization manages and has primary responsibility for our field sales, relationships with ourselling partners, technical sales support, sales operations and delivery of professional services covering our sixcompetency areas. We sell end-to-end networking architecture platform solutions, including products and services, inmost major markets globally through a combination of direct and indirect channels. We also offer component products,such as central processor unit (CPU) chips and embedded boards, on an OEM basis to other hardware manufacturersand supply after-market and peripheral products to their end-user installed base, both directly and through independentdistributors and VARs. In addition, our strategic alliance with Fujitsu provides expanded distribution of bothcompanies’ existing SPARC product lines.

Our sales force serves the telecommunications, government, financial services, manufacturing, education, retail, lifesciences, media and entertainment, transportation, energy/utilities and healthcare industries. We have organized oursales coverage within 15 geographically established markets (GEMs) around the world. We have approximately 78sales and service offices in the United States and an additional 145 sales and service offices in 47 other countries. Weemploy independent distributors in over 100 countries. In general, our sales coverage model calls for independentdistributors to be deployed in partnership with our direct sales force. However, in some smaller markets, independentdistributors may be our sole means of sales, marketing and distribution.

Our relationships with channel partners are very important to our future revenues and profitability. Channelrelationships accounted for more than 67%, 63% and 61% of our total net revenues in fiscal 2005, 2004 and 2003,respectively. Our channel partners include:

• Systems integrators, both government and commercial, who serve the market for large commercial projects requiringsubstantial analysis, design, development, implementation and support of custom solutions;

• Channel development providers who supply our products and provide product marketing and technical supportservices to our smaller resellers;

• VARs who provide added value in the form of software packages, proprietary software development, high-endnetworking integration, vertical integration, vertical industry expertise, training, installation and support;

• OEMs who integrate our products with their hardware and software; and

• Independent distributors who primarily serve foreign markets where we do not have a direct presence.

Additionally, ISV partners help us maximize our technology footprint by integrating their software products with ourplatforms and technologies. SDPs, such as Internet Service Providers (ISPs) and Application Service Providers (ASPs),allow us to expand our service coverage without new large-scale investments.

We have a wide range of marketing activities. Our Worldwide Marketing Organization oversees our marketingplanning, determines product and pricing strategy, coordinates advertising, demand creation and public relationsactivities, maintains strategic partnerships with major ISVs and performs competitive analyses.

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Although our sales and other operating results can be influenced by a number of factors, and historical results are notnecessarily indicative of future results, our sequential quarterly operating results generally fluctuate downward in thefirst and third quarters of each fiscal year when compared with the immediately preceding quarter.

Revenues from outside the United States (U.S.) were approximately 60% of our total net revenues in fiscal 2005 and57% and 56% of our total net revenues in fiscal 2004 and 2003, respectively. Direct sales we make outside of the U.S.are generally priced in local currencies and can be subject to currency exchange fluctuations. The net foreign currencyimpact on our total net revenues and operating results is difficult to precisely measure. However, because of the generalweakening of the U.S. dollar, our best estimate of the foreign exchange benefit approximated 3% of total net revenuesfor fiscal 2005.

The countries primarily contributing to our international sales are the United Kingdom (U.K.), Germany and Japan.The U.K. represented approximately 9%, 8% and 7% of our total net revenues in fiscal 2005, 2004 and 2003,respectively. Germany represented approximately 8%, 7% and 8% of our total net revenues in fiscal 2005, 2004 and2003, respectively. Japan represented approximately 7%, 7% and 8% of our total net revenues in fiscal 2005, 2004 and2003, respectively. For information about sales to unaffiliated customers and revenues by geographic areas, refer toNote 16 to the Consolidated Financial Statements — Industry Segment, Geographic, and Customer Information andItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results ofOperations.

Some of our sales to international customers are made under export licenses that must be obtained from the U.S.Department of Commerce. In addition, all of our export transactions are subject to U.S. export control laws, and certaintransactions could require prior approval of the U.S. Department of Commerce. Protectionist trade legislation in eitherthe U.S. or other countries, such as a change in the current tariff structures, export compliance laws or other tradepolicies, could adversely affect our ability to sell or to manufacture in international markets. Furthermore, revenuesfrom outside the U.S. are subject to inherent risks, including the general economic and political conditions in eachcountry. See Note 16 to the Consolidated Financial Statements for additional information concerning sales tointernational customers and business segments.

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 total net revenues, respectively. More than 80% of the revenue attributed toGE was generated through GE subsidiaries acting as either a reseller or financier of our products. The vast majority ofthe revenue included in the amounts above is from sales through a single GE subsidiary, having comprised 13%, 11%and 9% of total net revenues in fiscal 2005, 2004 and 2003, respectively. This GE subsidiary acts as a distributor of ourproducts to resellers who in turn sell those products to end-users. Our business could be adversely affected if GE oranother significant customer terminated its business relationship with us or significantly reduced the amount ofbusiness it did with us.

Our product order backlog at June 30, 2005 was $805 million, as compared with $834 million at June 30, 2004. Ourproduct backlog includes orders for which customer-requested delivery is scheduled within six months and orders thathave been specified by the customer for which products have been shipped but revenue has been deferred. In eithercase, sufficient evidence of an arrangement exists and final delivery has yet to be completed. Backlog levels vary withdemand, product availability, product revenue recognition treatment, and our delivery lead times and are subject tosignificant decreases as a result of, among other things, customer order delays, changes or cancellations. As such,backlog levels may not be a reliable indicator of future operating results. However, backlog orders are supported byevidence of a customer arrangement (typically a customer purchase order), or customer pre-payment (wherebycustomer delivery occurs over a period of time or through specific milestones). Although actual customer delivery canoccur over several periods, product backlog can be used to identify potential revenue coverage for pending periods.The larger the percentage coverage of targeted pending revenue, the lower the potential risk of non-achievement. Aswe explore new ways of doing business and collaborate with our partners and customers to deliver greater value, ourbacklog metric may evolve to better identify potential revenue coverage for pending periods.

WORLDWIDE OPERATIONS

Our Worldwide Operations organization manages company-wide purchasing of materials used in producing ourproducts, assists in product design enhancements, oversees our own manufacturing operations and those of our

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manufacturing partners and coordinates logistics operations. Our manufacturing operations consist primarily of finalassembly, test and quality control of enterprise and data center systems. For all other systems, we rely on externalmanufacturing partners. We manufacture primarily in Oregon and Scotland and distribute much of our hardwareproducts from our facilities and our partner facilities located in California, the Netherlands and Japan. We areexpanding our direct ship capabilities, using a customer fulfillment architecture which enables us to ship some productsdirectly from our suppliers to our customers, reducing cost, risk and complexity in the supply chain. We havecontinued efforts to simplify the manufacturing process by reducing the diversity of system configurations offered andincreasing the standardization of components across product types. In addition, we have continued to increase ourfocus on quality and processes that are intended to proactively identify and solve quality issues. The early identificationof products containing defects in engineering, design and manufacturing processes, as well as defects in third-partycomponents included in our products, could result in delays of product shipments.

We depend on many suppliers for the necessary parts and components to manufacture our products. There are anumber of vendors producing the parts and components that we need. However, there are some components that canonly be purchased from a single vendor due to price, quality, or technology reasons. For example, we depend on TexasInstruments for our SPARC® microprocessors and several other companies for custom integrated circuits. If we wereunable to purchase the necessary parts and components on acceptable terms from a particular vendor and we had tofind a new supplier for such parts and components, our new and existing product shipments could be delayed,adversely affecting our business and operating results. Similarly, our ability to purchase components in sufficientquantities to meet customer demand could impact our future operating results. Further, we also face the risk of orderingtoo many components, or conversely, not enough components, because orders are generally based on forecasts ofcustomer orders rather than actual orders, which subjects us to inventory risk.

RESEARCH AND DEVELOPMENT

Our research and product development programs are intended to sustain and enhance our competitive position byincorporating the latest global advances in hardware, software, graphics, networking, data communications and storagetechnologies. In addition, we have extended our product offerings and intellectual property through acquisitions ofbusinesses or technologies or other arrangements with our partners. Our product development continues to focus onenhancing the performance, scalability, reliability, availability and serviceability of our existing systems and thedevelopment of new technology standards. Additionally, we remain focused on system software platforms for Internetand intranet applications, telecommunications and next-generation service provider networks, developing advancedworkstation, server and storage architectures and advanced service offerings. We devote substantial resources tosoftware development as we believe it provides and will continue to provide significant competitive differentiation.

We conduct research and development principally in the U.S., U.K., France, Ireland, Germany, Japan, Norway andIndia. Research and development (R&D) expenses were $1,785 million, $1,926 million and $1,837 million in fiscal2005, 2004 and 2003, respectively.

PRODUCTS

Our products consist of Computer Systems and Network Storage systems, a variety of software and services related toboth systems and storage. For information about external revenue for similar classes of products and services, refer toNote 16 to the Consolidated Financial Statements- Industry Segment, Geographic, and Customer Information and Item7 Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations.

COMPUTER SYSTEMS

Our Computer Systems products and technologies, including our full line of scalable workgroup and enterprise servers,our UltraSPARC microprocessors and our software, are designed, developed and produced as integrated systems fornetwork computing environments.

Servers. We offer a full range of servers from our data center/high-performance computing servers through our entryservers and blade systems.

Data Center servers. Our data center servers, including the Sun Fire™ E25K and Sun Fire E20K, are designed tooffer greater performance and lower total cost of ownership than mainframe systems and are used for serverconsolidations, application migrations, data mining and warehousing, custom applications, on-line transaction support,

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enterprise resource planning, high performance technical computing and databases. The Sun Fire E25K server is one ofthe most scalable UNIX® platform-based systems in the marketplace and incorporates our UltraSPARC IVmicroprocessor, bringing dual-threaded capability to the data center.

Enterprise servers. Our enterprise servers, including Sun Fire E6900, Sun Fire E4900, Sun Fire E2900 and Sun FireV1280 servers, provide reliability, availability and scalability to address the needs of data centers and enterprise-scalenetwork computing at a moderate cost. These servers are available with various options in processor and memoryexpandability, hardware redundancy and component accessibility and run on the Solaris OS. In fiscal 2005, weintroduced the Sun Fire E2900, Sun Fire E4900 and Sun Fire E6900 servers, which use the UltraSPARC IV processorand are built to deliver dual-threaded capability and fault management technology into our family of mid-range SunFire servers.

Entry server systems. We also offer an expansive line of entry server systems differentiated by their size, theirprocessor architecture (SPARC or x64), their form factor (rackable or stand-alone systems) and the environment forwhich they are targeted (general purpose or specialized systems).

Entry SPARC-based systems include our Sun Fire V240, Sun Fire V210 and Sun Fire V440 servers, which delivernetwork computing in a compact, low-cost package. In fiscal 2005, we introduced the Sun Fire V890 and the Sun FireV490 servers, which use the new UltraSPARC IV processor and Solaris 10 OS.

During the latter half of fiscal 2005, we upgraded our Sun Fire V20z server and Compute Grid Rack System, as well asthe new Sun Fire V40z server, with the new industry-standard, dual-core AMD Opteron processors. We also enhancedour x64 server line in fiscal 2005 with the new dual-core AMD Opteron processors. These processors, which integratefour microprocessors with two complete cores, have improved processing performance without the need to increasepower consumption or rack/floor space.

We offer an additional line of products aimed at the unique needs of OEMs and Network Equipment Providers (NEPs).Rack-optimized systems, such as our Blade product offerings, combine high-density hardware architecture and systemmanagement software that OEMs find particularly useful in building their own solution architectures. Our NEP-certified and ruggedized Netra™ systems are designed to meet the specialized needs of NEPs.

Desktops and Workstations. Our desktops and workstations provide powerful solutions for a wide range of businessand technical activities such as software development, mechanical design, financial analysis and education. Ourproduct line includes high-performance 64-bit workstations, graphics accelerator boards, x64-based workstations andthin Sun Ray™ Ultra-Thin Client products. The Sun Blade™ 2500 and 1500 workstations are designed to meet theneeds of demanding graphics, visualization and compute applications. The Sun Blade W1100z and Sun Blade W2200zare AMD Opteron-based workstations that support Linux (Red Hat and SuSe, 32-Bit and 64-Bit) and the Solaris OS(32-Bit and 64-Bit) and are Microsoft certified.

Processor and Network Products. In fiscal 2005, the UltraSPARC processor lines were reoriented to reflect the twomain types of workloads our customers experience. Our data-intensive processor line includes the UltraSPARC IV,with dual-core processors, which furthers our throughput computing initiative. Our multi-core technology enablescustomers to experience real performance improvements in their workloads. For network-intensive workloads whichrequire more horizontal scaling, we offer the UltraSPARC IIIi+ processors, which are mainly used on our entry andworkgroup servers.

In fiscal 2005, we also began offering our first application switching network system, the Sun N2000 Series SecureApplication switch, a productization of technology from our acquisition of Nauticus Networks, Inc. (January 2004).The N2000 Series reduces cost and complexity in network computing through improved resource utilization, serviceconsolidation and leading price-to-performance ratio.

Software. Our software offerings consist primarily of enterprise infrastructure software systems, software desktopsystems, developer software and infrastructure management software.

Solaris Operating System (OS). The Solaris OS is a high-performance, highly reliable, scalable and secure operatingenvironment for SPARC and x64 platforms that is easy to install and use, is optimized for the Java platform andsupports more than 8,000 applications. It is optimized for enterprise computing, Internet and intranet businessrequirements, powerful databases and high performance technical computing environments.

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With our newest version of Solaris OS, Solaris 10, customers now have access to our latest technical innovations suchas Solaris Containers, Predictive Self-healing and Solaris Dynamic Tracing (DTrace) capability, all while maintainingbinary compatibility with previous Solaris versions. Solaris Containers is an advanced approach to systemvirtualization with multiple software partitions per single instance of the Solaris OS, making consolidation simple, safeand secure. Predictive Self-Healing delivers improved service availability with on-line error detection and autorecovery. Dynamic Tracing (DTrace) equips users with a tool for analyzing and diagnosing elusive bottlenecks in real-time. The Solaris 10 source code was recently made available through the OSI as a project called OpenSolaris.OpenSolaris is helping to drive even more innovation into our Solaris OS and has fostered a deeper understanding ofSolaris features in the ISV community.

Our Trusted Solaris™ OS provides a high level of privacy and reduces the risk of security violations on a commercial-grade OS. Our current version, Trusted Solaris 8 OS is available for both SPARC and x64 platforms.

Java technology. Our Java platform application environment allows development of application softwareindependent of the underlying operating system or microprocessor based on open standards. Java technology allows adeveloper to write applications once for a wide range of platforms and devices. Our Java platforms are based on acommon core architecture and include the Java 2 Platform, Standard Edition (J2SE™) technology used on personalcomputers and workstation clients and available on Solaris OS, Linux, HP-UX, AIX, Tru64 Unix, Windows, MacOS Xand other platforms; Java 2 Platform, Enterprise Edition (J2EE™) technology used to develop and deploy web serviceswhich enable secure, robust and interoperable business applications; Java 2 Platform, Micro Edition (J2ME™)technology, which extends Java technology to consumer and embedded devices such as mobile phones, personal digitalassistants (PDAs), digital set top boxes and residential gateways; and Java Card™ smart card technology.

Sun Java Enterprise System. Our Sun Java Enterprise System (Java ES) software enables enterprises to utilize theirinformation and applications into services offered on intranets and the Internet. The Java ES business model drove amarket transformation by making enterprise software more simple, affordable and predictable through a newsubscription acquisition model. In fiscal 2005, we began offering a new release of Java ES along with more targetedJava Suites covering Identity management, Application platform services, System availability, Web infrastructure andEnterprise communications.

Sun Java Studio Developer tools. We develop and market software development tools designed to aid in applicationdevelopment and integration. The Java 2 Software Development Kit enables developers to create and run both applets(miniature applications written in the Java programming language) that run inside a web browser and applications thatrun outside of a browser. Our Sun Java Studio Developer Platform provides a desktop-to-mainframe development andtest environment for programming in C, C++ and Java programming languages.

Sun Java Desktop System. Our desktop software includes all the key components of a user’s environment, rangingfrom the user interface and desktop utilities to a browser, multimedia capabilities and the StarOffice personalproductivity suite. The StarOffice office productivity suite has a fully integrated set of applications including wordprocessing, spreadsheet, graphic design, presentations, database access, HTML editor, mail/news reader, event plannerand formula editor tools. It runs on most major operating environments and platforms, including the Solaris OS,Microsoft Windows, Linux, OS/2 and Java platforms.

Sun N1 Grid Engine. N1 Grid Engine software is our vision and architectural blueprint for reducing the cost andcomplexity of managing enterprise data centers by allowing a data center to work like a single system by combining anenterprise’s IT resources (e.g. servers, storage and network devices) with virtualization, provisioning, policy andautomation, and monitoring.

NETWORK STORAGE

Our Network Storage systems integrate storage, storage components and software to complete our end-to-end datamanagement solutions across heterogeneous environments.

Storage Systems. Our high-end data storage systems provide a platform for direct attach storage or storage areanetwork (SAN) solutions. They are designed for extreme availability, performance, scalability, connectivity andmanageability required for the Data Center. Our high-end data storage systems, including the Sun StorEdge™ 9980, SunStorEdge 9970 and the new Sun StorEdge 9990, combine Hitachi Data Systems’ (HDS) high-end storage hardware withour resource management and file management software under an OEM agreement with HDS first signed in fiscal 2002.

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We offer a wide range of flexible, scalable mid-range storage systems, including the Sun StorEdge 6320, Sun StorEdge6120, Sun StorEdge 6130 and Sun StorEdge A5200 Array, which support high-performance computing and enterpriseSAN implementations, as well as storage virtualization technology. In fiscal 2005, we announced several significantenhancements to the Sun StorEdge 6920 system, including heterogeneous storage virtualization, which will allowcustomers to integrate multivendor storage assets into a single modular system and simplify storage management andimprove resource utilization.

Our Sun StorEdge products for workgroup applications, including the Sun StorEdge 3510 and StorEdge 3511 Arraysand the Sun StorEdge 3310 Array, offer a flexible, compact, cost-effective approach for growing storage demands.Their building-block architecture is designed to allow users to expand and customize as needed, offering performanceand flexibility at low cost for a variety of environments enabling increased return on investment.

Storage Software. Our Java StorEdge software is an integral part of our complete storage solutions. Our JavaStorEdge software is based on the Java ES architecture and comprises an open, integrated and automated storagemanagement software family. The Sun StorEdge software suites are focused on availability, utilization, performanceand storage resource management. In fiscal 2005, we introduced Sun Java StorEdge Software (Java SS) and Suites,which allow customers to acquire and deploy our comprehensive suite of storage and data management software andservices in-house on an annual per-employee or capacity basis. Our targeted Java SS Suites cover StorEdgeConsolidation, StorEdge Continuity, StorEdge Content and StorEdge Compliance.

We also announced our new Sun Grid Storage Utility as part of our vision for a standardized, open, grid-basedcomputing infrastructure available to customers as a utility, pay-as-you-go model. This new offering includes fullyintegrated hardware, software and services, provided, managed and serviced by us on a 24x7x365 basis.

SERVICES

Our services team provides expertise in helping our customers deploy network computing environments through abroad range of services comprised of support services for hardware and software and Client solutions and Educationalservices. Sun Services assists customers globally, provides support services to nearly 850,000 units under contracts inmore than 100 countries, trains approximately 400,000 students annually and provides consulting, integration andoperations assistance to IT organizations globally.

SUPPORT AND MANAGED SERVICES

The SunSpectrumSM Support services product offerings allow customers the power and flexibility to customize theirsupport services contracts. Customers can choose from four levels of support that range from mission critical to self-support. This service is sold separately or packaged with hardware, software and peripherals as a single-price supportservice. Each contract type is specifically designed to enable high availability and continuous operation for ourcustomers. Our resources in the field for services delivery are complemented by third-party service providers whoprimarily deliver hardware support services such as spares inventories and manpower. Investments by these third-partyservice providers help us expand our geographic coverage without additional fixed cost investments on our part.Software support is primarily delivered by our software support engineers. In fiscal 2005, we announced a newintegrated, secure network services connection called Sun Connection intended to simplify and standardize IT as aservice. Customers who pay the annual subscription fee can turn on a secure connection to allow us to automaticallyand systematically manage their security updates, systems monitoring and predictive diagnostic tests over thatconnection, thereby reducing management costs and increasing system availability.

CLIENT SOLUTIONS AND EDUCATIONAL SERVICES

Our Client solutions organization brings together more than 10,000 experts across Sun, focused on our sixcompetencies: Data Center, Storage and Data Management, Desktop and Mobility, Identity Management, EnterpriseWeb Services and Manageability Services. Our highly trained Client solutions teams specialize in providing customerswith advanced systems, software, storage and network architecture design consulting, platform integration, enterprisesystems management and operation such as network security and identity management, wireless network-basedsystems and advanced Sun Java System software integration solutions. We provide people, processes and technologyand we partner with third-party systems integrators, to deliver solutions tailored to meet our customers’ needs. Ourtechnical and project management experts help design IT architectures and plan migrations from legacy systems to

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network computing or help customers upgrade existing network computing environments. Additionally, to keepcustomer computing environments operating at peak performance, operations experts help customers manage thecomplexity of heterogeneous systems and networks.

Our Educational Services organization develops and delivers integrated learning solutions for enterprises, ITorganizations and individual IT professionals. These solutions help ensure that the necessary talent is available andproperly aligned to meet our clients’ network computing needs, as well as business objectives. Our learning solutionsinclude education consulting services, learning management technologies, multi-mode learning content andprofessional certifications.

COMPETITION

We compete in the computer hardware, software and services markets. These markets are intensely competitive. Ourcompetitors are some of the largest, most successful companies in the world. They include International BusinessMachines Corporation (IBM), Dell, Inc. (Dell), Hewlett-Packard Company (HP), EMC Corporation (EMC) and FujitsuLimited (Fujitsu). We also compete with systems manufacturers and resellers of systems based on microprocessorsmanufactured by Intel Corporation (Intel) and the Windows family of operating systems software from Microsoft.

Customers make buying decisions based on many factors, including new product and service offerings and features;product performance and quality; availability and quality of support and other services; price; platform; interoperabilitywith hardware and software of other vendors; quality; reliability; security features and availability of products; breadthof 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. Webelieve competition will be at least as intense in the next fiscal year as it was over the last fiscal year. In thisenvironment, each factor on which we compete is critical and the lack of competitive advantage with respect to one ormore 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. For more information about the competitiverisks we face, refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations— Risk Factors.

We have encouraged the use of SPARC technology as a standard in the computer marketplace by licensing much of thetechnology and promoting open interfaces to the Solaris OS, as well as by offering microprocessors and enablingtechnologies to third party customers. As a result, several licensees, including Fujitsu and the Fujitsu-Siemens jointventure company, also offer products based on the Solaris OS and the SPARC architecture that compete directly withour products. We have also worked to make our Java programming language a standard for complex networks. Wedevelop applications, tools and systems platforms, as well as work with third parties to create products andtechnologies, in order to continue to enhance the Java platform’s capabilities. As part of this effort, we license Javatechnology which widely encourages our competitors to also develop products competing with these applications, toolsand platforms. If we are unable to compete effectively, our business could be harmed.

PATENTS, TRADEMARKS AND INTELLECTUAL PROPERTY LICENSES

We have used, registered or applied to register certain trademarks and service marks to distinguish genuine Sunproducts, technologies and services from those of our competitors in the U.S. and in foreign countries and jurisdictions.We enforce our trademark, service mark and trade name rights in the U.S. and abroad.

We hold a number of U.S. and foreign patents relating to various aspects of our products and technology. While webelieve that patent protection is important, we believe that factors such as innovative skills and technological expertiseprovide even greater competitive differentiators. From time to time we have been notified that we may be infringingcertain patents or other intellectual property rights of others. Several pending claims are in various stages of evaluation.With the exception of the matters further disclosed at Item 3. Legal Proceedings of this Form 10-K, we believe nomaterial litigation has arisen from these claims. We are evaluating the desirability of entering into licensing agreementsin certain of these cases. Based on industry practice, we believe that any necessary licenses or other rights could beobtained on commercially reasonable terms. However, no assurance can be given that licenses can be obtained onacceptable terms or that litigation will not occur. The failure to obtain necessary licenses or other rights, or litigationarising out of such claims, could adversely affect our business.

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ENVIRONMENT

We are committed to developing and shipping products that are environmentally responsible. We are a leader in energyefficient computing technologies and commitment to reductions in factors contributing to global climate changethrough what we call “sustainable computing.” We create technologies that will enable, at least, three significant shiftsin the computing industry, changes which hold enormous potential for positive environmental impact: 1) transition tothin client computing from traditional desktop PCs thereby increasing overall energy efficiency and reducing materialwaste; 2) increases in computing resource utilization with throughput computing technology and N1 Grid virtualizationtechnology across data centers; and 3) transition to increased teleworking allowing large employers to unleash thesocial, environmental and economic benefits of mobility with security.

We are further committed to reducing regulated chemicals from our products and operations. In January 2003, theEuropean Union (EU) issued a directive called the Reduction of Hazardous Substances (RoHS) stating that all EUmember states must ensure that after July 1, 2006, no new electrical and electronics equipment containing lead andother hazardous substances be sold into the EU. Currently, a number of our products contain such substances above theset regulatory level. Given the potentially large impact to our customers and to our sales and the fact that othergovernment entities are also considering enacting similar legislation, we understand the critical necessity to ensure thatall our products are environmentally safe and RoHS compliant. Our efforts to ensure RoHS compliance across ourentire product line are progressing, and we intend to meet or exceed all requirements and similar environmentallegislation, although there can be no assurance of this.

The EU issued another environmental directive in January 2003, known as the Directive on Waste Electrical andElectronic Equipment (the WEEE Directive). The WEEE Directive requires that a producer of electronic equipment beresponsible for financing and managing waste from its products placed on the EU market after August 13, 2005. OurWEEE compliance program is progressing as planned, and we intend to meet all requirements of the Directive in atimely manner. On August 13, 2005, we implemented a product collection and waste management program thataddresses the labeling, take back, treatment, recovery, reuse and disposal of covered electronic products sold orimported into the EU.

EMPLOYEES

As of June 30, 2005, we had approximately 31,000 employees. We expect our headcount to increase by approximately8,500 employees as a result of our acquisitions of SeeBeyond and StorageTek in the first quarter of fiscal 2006. Wedepend on key employees and face competition in hiring and retaining qualified employees. Our employees are vital toour success, and our key management, engineering and other employees are difficult to replace. Although we haveentered into a limited number of employment contracts with certain current and former executive officers, we generallydo not have employment contracts with our key employees. Further, we do not maintain key person life insurance onany of our employees. As our stock price has decreased and because we offer equity-based incentive compensation, ourability to continue to offer competitive compensation packages to current employees has been negatively impacted.Consequently, these pressures have affected our ability to attract and retain highly qualified personnel. If these adverseconditions continue, we may not be able to retain highly qualified employees in the future and this could harm ourbusiness.

EXECUTIVE OFFICERS OF THE REGISTRANT

The following sets forth certain information regarding our Executive Officers as of September 6, 2005.Name Age Position

Scott G. McNealy . . . . . . 50 Chairman of the Board of Directors and Chief Executive OfficerJonathan I. Schwartz . . . . 39 President and Chief Operating OfficerCrawford W. Beveridge . . 59 Executive Vice President, People and Places, and Chief Human Resources OfficerRobyn M. Denholm . . . . . 41 Senior Vice President, FinanceMichael A. Dillon . . . . . . 46 Senior Vice President, General Counsel and SecretaryStephen T. McGowan . . . 57 Chief Financial Officer and Executive Vice President, Corporate ResourcesGregory M. Papadopoulos 47 Executive Vice President and Chief Technology OfficerBret C. Schaefer . . . . . . . 48 Vice President, Finance and Corporate Controller

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Mr. McNealy is a Founder of Sun and has served as Chairman of the Board of Directors and Chief Executive Officersince April 2004, as Chairman of the Board of Directors, President and Chief Executive Officer from June 2002 toApril 2004, as Chairman of the Board of Directors and Chief Executive Officer from April 1999 to June 2002, asChairman of the Board of Directors, President and Chief Executive Officer from December 1984 to April 1999, asPresident and Chief Operating Officer from February 1984 to December 1984 and as Vice President of Operationsfrom February 1982 to February 1984. Mr. McNealy has served as a director of the Company since the incorporation ofthe Company in February 1982.

Mr. Schwartz has served as President and Chief Operating Officer of Sun since April 2004, as Executive VicePresident, Software of Sun from July 2002 to April 2004, as Senior Vice President, Corporate Strategy and Planningfrom July 2000 to July 2002, as Vice President, Ventures Fund from October 1999 to July 2000, as Vice President,Internet and Application Products from May 1999 to October 1999, as Vice President, Enterprise Products Group fromJuly 1998 to May 1999 and as Director, Product Marketing, Javasoft, from July 1997 to July 1998.

Mr. Beveridge has served as Executive Vice President, People and Places, and Chief Human Resources Officer of Sunsince March 2000 and as Vice President, Corporate Resources from March 1985 to December 1990. From January1991 to February 2000, Mr. Beveridge served as Chief Executive, Scottish Enterprise, a Scottish quasi-autonomousnon-governmental organization involved in economic development in Scotland. Mr. Beveridge serves on the Board ofDirectors of Autodesk, Inc., a digital design and content company.

Ms. Denholm has served as Senior Vice President, Finance since August 2005, as Vice President and CorporateController from August 2003 to August 2005, as Vice President and Acting Corporate Controller from June 2003through August 2003, as Vice President, Finance, Services and Finance Systems and Processes from August 2001through June 2003, as Director, Asia Pacific Shared Financial Services from April 1998 through August 2001 and asAustralasian Financial Controller, Computer Systems from January 1996 through April 1998.

Mr. Dillon has served as Senior Vice President, General Counsel and Secretary of Sun since April 2004, and previouslyheld the position of Vice President, Products Law Group, from July 2002 to March 2004. From October 1999 untilJune 2002, he served as Vice President, General Counsel and Corporate Secretary of ONI Systems Corp, an opticalnetworking company. Mr. Dillon initially joined Sun in 1993 and thereafter held successive management positions inseveral legal support groups until October 1999.

Mr. McGowan has served as Chief Financial Officer and Executive Vice President, Corporate Resources of Sun sinceJuly 2002, as Vice President, Finance, Global Sales Operations from July 2001 to June 2002, as Vice President, StaffOperations, Global Sales Operations from June 2000 to June 2001, as Vice President, Finance, Computer Systems,Network Storage and Network Service Providers from February 1998 to June 2000, as Vice President, Finance,Worldwide Financial Operations of Sun Microsystems Computer Corporation (SMCC), a wholly-owned subsidiary ofSun, from July 1994 to February 1998 and as Vice President, Finance, North America and Australia Field Operationsof SMCC from October 1992 to July 1994.

Mr. Papadopoulos has served as Executive Vice President and Chief Technology Officer of Sun since December 2002,as Senior Vice President and Chief Technology Officer from July 2000 to December 2002 and as Vice President andChief Technology Officer from April 1998 to July 2000. He served as Vice President and Chief Technology Officer ofSun Microsystems Computer Corporation (SMCC), a wholly-owned subsidiary of Sun from March 1996 to April 1998,as Chief Technology Officer of SMCC from December 1995 to March 1996 and as Chief Scientist, Server SystemsEngineering from September 1994 to December 1995. Mr. Papadopoulos had a part-time, non-compensatedappointment as a Visiting Professor of Electrical Engineering and Computer Science at the Massachusetts Institute ofTechnology from September 2002 to August 2003.

Mr. Schaefer has served as Vice President, Finance and Corporate Controller since August 2005. He served as VicePresident, Finance Global Sales Operations from May 2003 to August 2005, as Vice President, Finance WorldwideOperations from July 2002 to May 2003, and as Senior Finance Director, Global Sales Operation from August 2000 toJuly 2002. Prior to August 2000 and from the time he joined Sun in July 1991, Mr. Schaefer held successivemanagement positions in Sun’s finance organization.

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ITEM 2. PROPERTIES

At June 30, 2005, Sun’s worldwide facilities represented aggregate floor space of 13.9 million square feet both in theU.S. and in 47 other countries. In square feet, our properties consisted of (in millions):

U.S.Rest of the

World Total

Owned facilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.8 0.8 5.6Leased facilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.5 3.8 8.3

Total facilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.3 4.6 13.9

At June 30, 2005, our owned properties consisted of:

Location

SquareFootage of

Facility

Bagshot, England . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,995Broomfield, Colorado . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 916,045Burlington, Massachusetts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 693,846Farnborough (Guillemount Park), England . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 320,000Linlithgow, Scotland . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 423,070Menlo Park, California . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,022,008Newark, California . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,404,309Santa Clara, California . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 816,240

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,621,513

At June 30, 2005, we had no offices under construction, however we have approximately 1.2 million square feet offacilities available for future construction. We continually evaluate our facility requirements in light of our businessneeds and stage the future construction accordingly. In addition, we own approximately 38 acres of undeveloped landin Austin, Texas.

Starting in fiscal 2001, we began to vacate properties in the U.S. and internationally. Of the properties that werevacated under all facility exit plans, 3.3 million square feet remain vacant or sub-leased of which 1.2 million squarefeet are under sub-lease to non-Sun businesses and 2.1 million square feet are vacant.

Substantially all of our facilities are used jointly by our Product groups, Sun Services group, Global Sales Organizationand other functions. Our manufacturing facilities are located in Linlithgow (Scotland) and Beaverton (Oregon).

ITEM 3. LEGAL PROCEEDINGS

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

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

No matters were submitted to a vote of stockholders of Sun during the fourth quarter of fiscal 2005.

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PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDERMATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock trades on The Nasdaq National Market under the symbol “SUNW”. As of September 6, 2005, therewere approximately 22,503 stockholders of record and the closing price of Sun’s common stock was $3.84 per share asreported by The Nasdaq National Market.

The following table sets forth for the fiscal periods indicated the high and low sale prices for our common stock asreported by The Nasdaq National Market:

Fiscal 2005 Fiscal 2004

High Low High Low

First Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $4.33 $3.29 $5.18 $3.39Second Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.62 3.93 4.59 3.14Third Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.65 3.87 5.93 3.87Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.16 3.42 5.12 3.64

No cash dividends were declared or paid in fiscal 2005 or 2004. We anticipate retaining available funds to financefuture growth and have no present intention to pay cash dividends.

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ITEM 6. SELECTED FINANCIAL DATA(1)

The following information has been restated to reflect adjustments that are further discussed in the “Restatement—Explanatory Note” in the forepart of this Form 10-K and in Note 2 “Restatement of Financial Statements” to ourConsolidated Financial Statements included in Part II, Item 8. “Financial Statements and Supplementary Data” of thisForm 10-K.

The following selected financial data should be read in conjunction with “Item 7. Management’s Discussion andAnalysis of Financial Condition and Results of Operations” and our restated Consolidated Financial Statementsincluded in “Item 8. Financial Statements and Supplementary Data.”

Fiscal Years Ended June 30,

2005 2004 2003 2002 2001

Dollars % Dollars % Dollars % Dollars % Dollars %

(Restated)(In millions, except per share amounts)

Net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,070 100.0 $11,185 100.0 $11,434 100.0 $12,496 100.0 $18,250 100.0Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,481 58.5 6,669 59.6 6,492 56.8 7,580 60.7 10,040 55.0

Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,589 41.5 4,516 40.4 4,942 43.2 4,916 39.3 8,210 45.0Operating expenses:

Research and development . . . . . . . . . . . . . . 1,785 16.1 1,926 17.2 1,837 16.1 1,832 14.7 2,016 11.0Selling, general and administrative . . . . . . . . 2,919 26.4 3,317 29.7 3,329 29.1 3,806 30.5 4,445 24.4Restructuring charges . . . . . . . . . . . . . . . . . . 262 2.4 344 3.1 371 3.2 517 4.1 75 0.4Impairment of goodwill and other intangible

assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — 49 0.4 2,125 18.6 6 — 1 —Goodwill amortization . . . . . . . . . . . . . . . . . . — — — — — — — — 285 1.6Purchased in-process research and

development . . . . . . . . . . . . . . . . . . . . . . . . — — 70 0.6 4 — 3 — 77 0.4

Total operating expenses . . . . . . . . . . . . . . . . . . 4,966 44.9 5,706 51.0 7,666 67.0 6,164 49.3 6,899 37.8

Operating income (loss) . . . . . . . . . . . . . . . . . . . (377) (3.4) (1,190) (10.6) (2,724) (23.8) (1,248) (10.0) 1,311 7.2Gain (loss) on equity investments, net . . . . . . . . 6 — (64) (0.6) (84) (0.7) (99) (0.8) (90) (0.5)Interest and other income, net . . . . . . . . . . . . . . 133 1.2 94 0.8 155 1.3 299 2.4 363 2.0Settlement income . . . . . . . . . . . . . . . . . . . . . . . 54 0.5 1,597 14.3 — — — — — —

Income (loss) before taxes . . . . . . . . . . . . . . . . . (184) (1.7) 437 3.9 (2,653) (23.2) (1,048) (8.4) 1,584 8.7Provision (benefit) for income taxes . . . . . . . . . (77) (0.7) 825 7.4 731 6.4 (461) (3.7) 603 3.3Cumulative effect of change in accounting

principle, net . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — — — (54) (0.3)

Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . $ (107) (1.0) $ (388) (3.5) $ (3,384) (29.6) $ (587) (4.7) $ 927 5.1

Net income (loss) per common share—basic . . $ (0.03) $ (0.12) $ (1.06) $ (0.18) $ 0.28Net income (loss) per common share—

diluted(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.03) $ (0.12) $ (1.06) $ (0.18) $ 0.27Shares used in the calculation of net income

(loss) per common share—basic . . . . . . . . . . 3,368 3,277 3,190 3,242 3,234Shares used in the calculation of net income

(loss) per common share—diluted(1) . . . . . . . 3,368 3,277 3,190 3,242 3,417

As of June 30,

2005 2004 2003 2002 2001

(Restated) (Restated)

Cash, cash equivalents and marketable debt securities . . . . . . . . . . . . . . . . . . . $ 7,524 $ 7,608 $ 5,741 $ 5,864 $ 6,171Total assets(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $14,190 $14,805 $13,295 $16,522 $18,181Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,123 $ 1,432(3) $ 1,531 $ 1,654(3) $ 1,565Other non-current obligations(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,083(4) $ 1,460(4) $ 642(4) $ 202(4) $ 884(4)

(1) Share and per share amounts for all periods presented have been adjusted to reflect stock splits through June 30, 2005.(2) Certain amounts from prior years, relating to deferred income taxes, have been changed to conform to the current year

presentation.(3) Includes approximately $257 million and $205 million classified as current portion of long-term debt as of June 30, 2004 and

2002, respectively.(4) Includes deferred settlement income from Microsoft as of June 30, 2005 and 2004, long-term tax liabilities as of June 30, 2005,

2004 and 2001 and long-term restructuring liabilities for all periods presented.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS

Changes to Previously Announced Fiscal 2005 Fourth Quarter and Annual Results

Subsequent to the July 26, 2005 announcement of our preliminary fourth quarter and full fiscal year results for 2005,we have made certain adjustments to our reported results. These adjustments resulted in a reduction in fourth quarternet income and an increase in full fiscal year net loss for 2005 of $51 million. These adjustments principally related toan increase in our tax provision of $33 million to correct computational errors that were identified through a controlprocedure that was performed subsequent to the date of our earnings release and an increase in our commission andother accruals of $18 million due in part to the receipt of more accurate information.

In addition, having fully reviewed the impact of accounting adjustments recorded in fiscal 2005, we have restated ourconsolidated financial statements for fiscal 2004 and 2003, and the quarters of fiscal 2005 with respect to errors relatedto, our accounting for deferred taxes in certain foreign jurisdictions as well as the aggregate effect of corrections toprovisions for State and foreign tax returns and withholding taxes. The adjustments associated with these corrections inour accounting for taxes decreased our previously announced net income for the fourth quarter for fiscal 2005 by $23million, offset by the correction of $3 million of pretax inter-quarter accounting adjustments. These adjustments furtherincreased our previously announced net loss for fiscal year 2005 by $45 million.

Set forth below is a reconciliation of the July 26, 2005 announcement of our preliminary results press release toamounts reported in this Annual Report on Form 10-K which reflects the above mentioned adjustments (in millions,except per share amounts):

Three Months Ended June 30, 2005 Year Ended June 30, 2005

PreviouslyAnnounced

NetChange

Reported inAnnual

Report onForm 10-K

PreviouslyAnnounced

NetChange

Reported inAnnual

Report onForm 10-K

Operating loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(100) $(15) $(115) $ (359) $(18) $ (377)Loss before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . (69) (15) (84) (166) (18) (184)Benefit from income taxes . . . . . . . . . . . . . . . . . . . . (190) (56) (134) (155) (78) (77)Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 (71) 50 (11) (96) (107)Net income (loss) per common share—basic and

diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $0.04 $0.01 $(0.00) $(0.03)

Restatement of Financial Statements

We have restated our historical fiscal 2004 and 2003 consolidated financial statements for the cumulative impact oferrors in accounting for deferred taxes in certain foreign jurisdictions totaling $41 million and for corrections toprovisions for State and foreign tax returns and withholding taxes of $4 million. These errors were identified in thethird and fourth quarters of fiscal 2005. In addition, as a result of evaluating certain pre-tax accounting adjustmentsrecorded throughout fiscal year 2005, we restated the previously reported quarters of fiscal 2005.

The determination to restate these consolidated financial statements was made as a result of our assessment that thesetax items, although immaterial to the consolidated financial statements for fiscal 2004 and 2003, would be consideredmaterial to the consolidated financial statements for the full fiscal year and previously reported quarters of 2005.

The adjustments associated with the above corrections in our accounting for taxes reduced our net loss by $45 millionor net loss per share by $0.01 in fiscal 2003 and had no net impact on the previously reported annual net loss for fiscal2004, but did result in restatements to our previously filed quarterly financial information for fiscal 2004.

The information included in this Form 10-K sets forth the effects of the Restatement on the previously reportedfinancial statements of operations for fiscal 2004 and 2003 and the affected quarters of 2005 and 2004.

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Further information on the nature and impact of these adjustments to fiscal year 2004 and 2003 as well as the impact toour quarterly financial information for fiscal 2005 and 2004 is provided in Note 2, “Restatement of FinancialStatements,” to our consolidated financial statements. The impact of the restatement on the results of operations forfiscal years 2004 and 2003 is shown in the table below (in millions, except per share amounts):

Fiscal Years EndedJune 30,

2004 2003

(Restated)

Impact of adjustments to provision for (benefit from) income taxes . . . . . . . . . . . . . . . . $ — $ (45)

Net loss—as previously reported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (388) $(3,429)Impact of restatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 45

Net loss—as restated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (388) $(3,384)

Net loss per share—basic and diluted—as previously reported . . . . . . . . . . . . . . . . . . . . $(0.12) $ (1.07)Impact of restatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 0.01

Net loss per share—basic and diluted—as restated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(0.12) $ (1.06)

Executive Overview

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

During the fourth quarter of fiscal 2005, we experienced a year over year decrease in total net revenues ofapproximately $136 million or 4.4%, which included a favorable foreign currency impact of approximately 2%. For thefull fiscal year 2005, as compared with fiscal 2004, we experienced a decrease in total net revenues of approximately$115 million or 1.0%. Our Products net revenue for the fourth quarter and full fiscal year 2005 was unfavorablyimpacted by competition and a continuing market shift in overall computer system demand away from our data centerservers towards the use of entry-level servers. This decrease was partially offset by an increase in Client solutions andEducational services revenue.

During the fourth quarter of fiscal 2005, we experienced a year over year increase in gross margin of approximately $7million or 2.0 percentage points. For the full fiscal year 2005, as compared with fiscal 2004, we experienced an overallincrease in gross margin of approximately $73 million or 1.1 percentage points. Our Products gross margin during thefourth quarter of fiscal 2005 increased 1.3 percentage points, primarily due to manufacturing and component costreductions partially offset by the unfavorable impact of discounting and pricing actions. Our Products gross marginduring the full fiscal year 2005 decreased by $113 million or 0.3 percentage points, primarily due to planned list pricereductions, sales discounting actions and the impact of our patent related settlement with Kodak, partially offset bysupply chain restructuring and component cost reductions. Our Services gross margin during the fourth quarter of fiscal2005 increased by $38 million or 3.6 percentage points and during the full fiscal year 2005 increased $186 million or3.6 percentage points, primarily due to the favorable impact of our improved utilization, cost reductions andproductivity measures. This increase was partially offset by a fourth quarter adjustment associated with spares andfixed asset amortization of $20 million.

During fiscal 2005, as compared with fiscal 2004, our research and development expenses decreased $141 million andour sales, general and administrative expenses decreased $398 million, primarily due to our on-going cost reduction

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and productivity improvement initiatives. In fiscal 2005, we continued to reduce our on-going cost structure byreducing our global workforce, consolidating our global property portfolio and taking other expense reductionmeasures. Our fiscal 2005 results included $262 million of restructuring charges related to these activities and weexpect to record additional charges over the next several quarters.

During fiscal 2005, we recorded a net tax benefit of $77 million. This benefit included a $213 million tax benefitarising from adjustments to our income tax reserves resulting from the conclusion of both a U.S. income tax audit and aforeign income tax audit and a benefit of $69 million related to the impact of a change in the U.S.-Dutch withholdingtax treaty. This was offset by a tax expense of $205 million on income generated in certain foreign jurisdictions andadjustments for the differences between estimated amounts recorded and actual liabilities resulting from the filing ofprior periods’ tax returns.

During fiscal 2005, our operating activities provided cash flows of $369 million. Our focus on cash managementremains a top priority and we plan to continue to drive improvement in our cash conversion cycle. We ended the fourthquarter of fiscal 2005 with a cash conversion cycle of 30 days, an improvement of 10 days from June 30, 2004. At June30, 2005 we had a total cash, cash equivalents and marketable debt securities balance of approximately $7.5 billion,which will be impacted by our first quarter of fiscal 2006 acquisitions of Storage Technology Corporation(StorageTek) and SeeBeyond Technology Corporation (SeeBeyond). See Note 18 to the Consolidated FinancialStatements.

Critical Accounting Policies and Estimates

The accompanying discussion and analysis of our financial condition and results of operations are based upon ourconsolidated financial statements, which have been prepared in accordance with generally accepted accountingprinciples in the United States (U.S. GAAP). The preparation of these financial statements requires us to makeestimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and relateddisclosure of contingent assets and liabilities. These estimates form the basis for making judgments about the carryingvalues of assets and liabilities that are not readily apparent from other sources. We base our estimates and judgmentson historical experience and on various other assumptions that we believe are reasonable under the circumstances.However, future events are subject to change and the best estimates and judgments routinely require adjustment. Weare required to make estimates and judgments in many areas, including those related to fair value of derivativefinancial instruments, recording of various accruals, bad debt and inventory reserves, the useful lives of long-livedassets such as property and equipment, warranty obligations and potential losses from contingencies and litigation. Webelieve the policies discussed below are the most critical to our financial statements because their application placesthe 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. Our critical accountingpolicies are described in the following paragraphs.

Revenue Recognition

As discussed in Note 3 to our Consolidated Financial Statements, we enter into agreements to sell hardware, software,services and multiple deliverable arrangements that include combinations of products and/or services. Additionally,while the majority of our sales transactions contain standard business terms and conditions, there are some transactionsthat contain non-standard business terms and conditions. As a result, significant contract interpretation is sometimesrequired to determine the appropriate accounting including: (1) whether an arrangement exists; (2) how thearrangement consideration should be allocated among the deliverables if there are multiple deliverables; (3) when torecognize revenue on the deliverables; and (4) whether undelivered elements are essential to the functionality ofdelivered elements. In addition, our revenue recognition policy requires an assessment as to whether collectibility isprobable, which requires us to evaluate the creditworthiness of our customers. Changes in judgments on theseassumptions and estimates could materially impact the timing of revenue recognition.

We recognize revenue as work progresses on fixed price professional services contracts when we can reliably evaluateprogress to completion. We perform periodic analyses of these contracts in order to determine if the applicableestimates regarding total revenue, total cost and the extent of progress toward completion require revision. For fixedprice professional services contracts, when the current estimates of total contract revenue and contract cost indicate a

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loss, the estimated loss is recognized in the period the loss becomes evident. Changes in assumptions underlying theseestimates and costs could materially impact the timing of revenue recognition and loss recognition.

Channel Partners selling our high-volume products generally carry Sun products as inventory, if our revenuerecognition criteria are met, we recognize revenue when we sell to the Channel Partners. Channel Partners selling ourhigh-end products generally purchase our products at the time an end-user is identified. The revenue we recognizeassociated with channel sales transactions requires us to make estimates in several areas including: (1) creditworthinessof the Channel Partner; (2) the amount of credits we will give for subsequent changes in our price list (i.e., priceprotection); (3) the amount of credits we will give for additional discounts in certain competitive transactions (i.e.,margin protection); (4) the amount of stock rotation; and (5) the likelihood of returns. We reduce revenue in these areasusing assumptions that are based on our historical experience. Changes in these assumptions could require us to makesignificant revisions to our estimates that could materially impact the amount of net revenue recognized.

Goodwill

We review goodwill for impairment on an annual basis and whenever events or changes in circumstances indicate thecarrying value of goodwill may not be recoverable. In testing for a potential impairment of goodwill, we: (1) allocategoodwill to the various Sun businesses to which the acquired goodwill relates; (2) estimate the fair value of those Sunbusinesses to which goodwill relates based on future expected discounted cash flows; and (3) determine the carryingvalue (book value) of those businesses, as some of the assets and liabilities related to those businesses, such as propertyand equipment and accounts receivable, are not held by those businesses but by functional departments (for example,our Global Sales Organization and Worldwide Operations organization). Prior to this allocation of the assets to thereporting units, we are required to assess long-lived assets for impairment in accordance with Statement of FinancialAccounting Standard (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS144). Furthermore, if the estimated fair value is less than the carrying value for a particular business, then we arerequired to estimate the fair value of all identifiable assets and liabilities of the business, in a manner similar to apurchase price allocation for an acquired business. This can require independent valuations of certain internallygenerated and unrecognized intangible assets such as in-process research and development and developed technology.Only after this process is completed is the amount of any goodwill impairment determined.

The process of evaluating the potential impairment of goodwill is subjective and requires significant judgment at manypoints during the analysis. In estimating the fair value of the businesses with recognized goodwill for the purposes ofour annual or periodic analyses, we make estimates and judgments about the future cash flows of these businesses.Although our cash flow forecasts are based on assumptions that are consistent with the plans and estimates we areusing to manage the underlying businesses, there is significant judgment in determining the cash flows attributable tothese businesses over their estimated remaining useful lives. In addition, we make certain judgments about allocatingshared assets such as accounts receivable and property and equipment to the balance sheet for those businesses. Wealso consider our market capitalization (adjusted for unallocated monetary assets such as cash, marketable debtsecurities and debt) on the date we perform the analysis.

We performed our fiscal 2005 annual goodwill impairment analysis in the fourth quarter of fiscal 2005. Based on ourestimates of forecasted discounted cash flows as well as our market capitalization, at that time, we concluded that ourgoodwill was not impaired. At June 30, 2005, our remaining goodwill had a net book value of $441 million.

We may incur charges for impairment of goodwill in the future if the net book value of our operating reporting unitsexceeds the estimated fair value. If we incur future impairments to our goodwill, it would have an adverse impact onour future earnings.

Other Intangible Assets

SFAS 144 is the authoritative standard on the accounting for the impairment of other intangible assets. In accordancewith SFAS 144 and our internal accounting policy, we perform tests for impairment of intangible assets other thangoodwill (Other Intangible Assets) semi-annually and whenever events or circumstances suggest that Other IntangibleAssets may be impaired. In fiscal 2005, we performed our impairment analysis, and determined that no impairmentcharges were necessary.

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At June 30, 2005, we had Other Intangible Assets with a carrying value of approximately $141 million. These OtherIntangible Assets consist primarily of $113 million in acquisition-related intangible assets and $28 million in intangibleassets primarily associated with patent licenses acquired through our settlement with Kodak. To evaluate potentialimpairment, SFAS 144 requires us to assess whether the future cash flows related to these assets will be greater thantheir carrying value at the time of the test. Accordingly, while our cash flow assumptions are consistent with the plansand estimates we are using to manage the underlying businesses, there is significant judgment in determining the cashflows attributable to our Other Intangible Assets over their respective estimated useful lives. For example, if wereduced the estimated useful life of all intangible assets as of June 30, 2005, by one year or reduced the projected cashflows by 20%, up to $36 million of our Other Intangible Assets would be considered to be impaired and we would berequired to recognize an impairment based on the difference between the fair value of these Other Intangible Assetsand their carrying value.

We are required to periodically evaluate our Other Intangible Assets balances for impairments. If we incur impairmentsto our Other Intangible Assets, it would have an adverse impact on our future earnings.

Restructuring

We have engaged and may continue to engage in restructuring actions and activities associated with productivityimprovement initiatives and expense reduction measures, which require us to make significant estimates in severalareas including: 1) realizable values of assets made redundant, obsolete or excess; 2) expenses for severance and otheremployee separation costs; 3) the ability to generate sublease income, as well as our ability to terminate leaseobligations at the amounts we have estimated; and 4) other costs. The amounts we have accrued represent our bestestimate of the obligations we expect to incur in connection with these actions, but could be subject to change due tovarious factors including market conditions and the outcome of negotiations with third parties. Should the actualamounts differ from our estimates, the amount of the restructuring charges could be materially impacted. For a fulldescription of our restructuring actions, refer to our discussion of restructuring charges and workforce rebalancingefforts in the Results of Operations section. Any additional restructuring actions could have an adverse impact on ouroperating results in the period in which any such action is taken.

Equity Investments in Privately-Held Companies

Our investments in privately-held companies are made as part of Sun’s strategic equity investment strategy. Ourstrategy is to invest up to certain authorized amounts in companies developing products, markets and services that arestrategic to Sun’s business and technology. These equity investments are generally made in connection with a round offinancing with other third-party investors. At June 30, 2005, we had approximately $26 million of equity investmentsin privately-held companies. As our equity investments generally do not permit us to exert significant influence orcontrol over the entity in which we are investing, these amounts generally represent our cost of the investment, less anyadjustments we make when we determine that an investment’s net realizable is other than temporarily impaired asdefined by SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (SFAS 115).

The process of assessing whether a particular equity investment is other than temporarily impaired requires asignificant amount of judgment. In making this judgment, we carefully consider the investee’s cash position, projectedcash flows (both short and long-term), financing needs, recent financing rounds, most recent valuation data, the currentinvesting environment, management/ownership changes, and competition. This valuation process is based primarily oninformation that we request from these privately-held companies. This information is not subject to the same disclosureand audit requirements as the reports required of U.S. public companies, and as such, the reliability and accuracy of thedata may vary. Based on our evaluation, we recorded net impairment charges, which are reflected in gain (loss) onequity investments, net in the accompanying Consolidated Statements of Operations, related to our investments inprivately-held companies of $15 million, $67 million and $72 million in fiscal years 2005, 2004 and 2003, respectively.

Estimating whether our investments in privately-held, early-stage technology companies are other than temporarilyimpaired is inherently subjective and may contribute to significant volatility in our reported results of operations. If weincur additional other than temporary impairments to our equity investments in privately-held companies, it could havean adverse impact on our future earnings.

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Income Taxes

Estimates and judgments are required in the calculation of certain tax liabilities and in the determination of therecoverability of certain of the deferred tax assets, which arise from net operating losses, tax carryforwards andtemporary differences between the tax and financial statement recognition of revenue and expense. SFAS No. 109,“Accounting for Income Taxes” (SFAS 109), also requires that the deferred tax assets be reduced by a valuationallowance, if based on the weight of available evidence, it is more likely than not that some portion or all of therecorded 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 andnegative evidence including our past operating results, the existence of cumulative losses in the most recent fiscal yearsand our forecast of future taxable income on a jurisdiction by jurisdiction basis. In determining future taxable income,we are responsible for assumptions utilized including the amount of state, federal and international pre-tax operatingincome, 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 theplans and estimates we are using to manage the underlying businesses. Cumulative losses incurred in the U.S. andcertain foreign jurisdictions in recent years represented sufficient negative evidence to require valuation allowances inthese jurisdictions, which we intend to maintain until sufficient positive evidence exists to support reversal of thevaluation allowance. Future reversals or increases to our valuation allowance could have a significant impact on ourfuture earnings.

In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex taxregulations in a multitude of jurisdictions. We recognize potential liabilities for anticipated tax audit issues in the U.S.and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes and interest willbe due. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of theliabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longernecessary. If our estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expensewould result.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123 (revised 2004), “Share-BasedPayment” (SFAS 123R). SFAS 123R requires measurement of all employee stock-based compensation awards using afair-value method and the recording of such expense in the consolidated financial statements. In addition, the adoptionof SFAS 123R will require additional accounting related to the income tax effects and disclosure regarding the cashflow effects resulting from share-based payment arrangements. In January 2005, the U.S. Securities and ExchangeCommission (SEC) issued Staff Accounting Bulletin No. 107, which provides supplemental implementation guidancefor SFAS 123R. SFAS 123R is effective for our first quarter of fiscal 2006. We have selected the Black-Scholesoption-pricing model as the most appropriate fair-value method for our awards and will recognize compensation coston a straight-line basis over our awards’ vesting periods. We expect that the adoption of SFAS 123R will have amaterial impact on our results of operations. However, uncertainties, including our future stock-based compensationstrategy, stock price volatility, estimated forfeitures and employee stock option exercise behavior, make it difficult todetermine whether the stock-based compensation expense that we will incur in future periods will be similar to theSFAS 123 pro forma expense disclosed in Note 3 to the Consolidated Financial Statements. In addition, the amount ofstock-based compensation expense to be incurred in future periods will be reduced by our acceleration of certainunvested and “out-of-the-money” stock options in fiscal 2005 as disclosed in Note 15 to the Consolidated FinancialStatements.

See Note 3 to the Consolidated Financial Statements for a description of certain other recent accountingpronouncements including the expected dates of adoption and effects on our results of operations and financialcondition.

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RESULTS OF OPERATIONS

Net RevenuesFor the fiscal year ended June 30,(dollars in millions, except revenue per employee dollars in thousands)

2005 Change 2004 Change 2003

Computer Systems products . . . . . . . . . . . . . . . . . . . $ 5,826 (0.5)% $ 5,854 (6.2)% $ 6,243Network Storage products . . . . . . . . . . . . . . . . . . . . . 1,300 (13.4)% 1,501 (3.2)% 1,550

Products net revenue . . . . . . . . . . . . . . . . . . . . . . . $ 7,126 (3.1)% $ 7,355 (5.6)% $ 7,793Percentage of total net revenues . . . . . . . . . . . . 64.4% (1.4) pts 65.8% (2.4) pts 68.2%

Support services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,031 1.1% $ 2,999 5.5% $ 2,844Client solutions and Educational services . . . . . . . . . 913 9.9% 831 4.3% 797

Services net revenue . . . . . . . . . . . . . . . . . . . . . . . $ 3,944 3.0% $ 3,830 5.2% $ 3,641Percentage of total net revenues . . . . . . . . . . . . 35.6% 1.4 pts 34.2% 2.4 pts 31.8%

Total net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,070 (1.0)% $11,185 (2.2)% $11,434

Services contract penetration rate(1) . . . . . . . . . . . . . . 52.7% 8.4 pts 44.3% 8.2 pts 36.1%

Revenue per employee(2) . . . . . . . . . . . . . . . . . . . . . . $ 342 9.3% $ 313 2.0% $ 307

(1) The services contract penetration rate is calculated by dividing the number of Computer Systems and NetworkStorage products under a Support service contract by the installed base. Systems under a Support service contractrepresents the total number of systems under an active Support service contract as of the last day of a fiscalquarter. Installed base is defined as the total number of units in active use, which is calculated by measuring thenumber of units shipped against our estimate of the product’s useful life. These estimates range between three andfive years, varying by product, and are a function of system type, product complexity, degree of self-supportattributes, the level of criticality to a customer and the average selling price. By its nature, the Services contractpenetration rate is an approximation. We use this metric to assess the performance of the Support servicesbusiness as it measures, through an estimation process, our ability to capture an ongoing revenue stream from theproducts we sell.

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

Due to the generally weakened U.S. dollar during fiscal 2005 and 2004, our total net revenues were favorably impactedby foreign currency exchange rates as compared with fiscal 2004 and 2003, respectively. The net foreign currencyimpact to our total net revenues is difficult to precisely measure. However, our best estimate of the foreign exchangerate impact in fiscal 2005 as compared with fiscal 2004, approximated a benefit of 2% of Products net revenue and abenefit of 4% of Services net revenue. Our best estimate of the foreign exchange benefit in fiscal 2004 as comparedwith fiscal 2003, approximated a benefit of 3% of Products net revenue and a benefit of 6% of Services net revenue.

Products Net Revenue

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

During fiscal 2005, as compared with fiscal 2004, Computer Systems revenue decreased, primarily due to reducedsales of our data center servers resulting from intense competition and a continuing market shift in overall computersystem demand towards the usage of our lower-priced entry level servers. The decrease in Computer Systems revenuewas partially offset by increased unit sales of our entry level servers, which included servers running on our SPARCand AMD’s Opteron processors. During fiscal 2005, as compared with fiscal 2004, Network Storage revenue decreaseddue to intense competition and reduced sales of our entry level and data center storage systems and low-end storagecomponents, which were only partially offset by increased unit sales of our mid-range storage systems.

During fiscal 2004, as compared with fiscal 2003, our Computer Systems and Network Storage products net revenuedecreased, primarily as a result of an intensely competitive environment. While our unit shipments for both Computer

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Systems and Network Storage systems increased as compared with fiscal 2003, we responded to competitive pressuresfor both product groups with price reductions, which negatively impacted our revenue. Network Storage productsrevenue was impacted to a lesser degree than Computer Systems products revenue during fiscal 2004, as NetworkStorage products revenue benefited from our focus on including storage products as an element of our solution-basedselling strategy.

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 thecontract period and represents approximately 77%, 78% and 78% of services net revenue in fiscal 2005, 2004 and2003, respectively. During fiscal 2005, as compared with fiscal 2004, Support services net revenue increased due to thebenefit of foreign exchange and an increase in the number of systems under a Support services contract. Theseincreases were substantially offset by competitive pricing pressures. The increase in the number of systems under aSupport services contract is primarily due to our continuing emphasis on our solution-based selling strategy, whichincludes Support services as an essential element of a sale. The 8.4 percentage point increase in the services contractpenetration rate is due to a continued increase in the systems under contract and a decrease in the estimate of thenumber of active systems that comprise the installed base.

During fiscal 2004, as compared with fiscal 2003, excluding the benefit of foreign currency exchange rates, theincrease in Support Services net revenue was primarily due to renewing contracts with existing customers and enteringinto a higher percentage of Support services contracts with new products sales. The impact of the increase in thenumber of systems under an active Support service contract was substantially offset by competitive pricing pressures, achange in the mix towards maintenance contracts sold or renewed with reduced service levels and a shift in productsales mix to a greater proportion of low-end products, which are typically sold with reduced levels of services.

Client solutions and Educational services revenue consists primarily of revenue generated from professional servicessuch as technical consulting that helps our customers plan, implement, and manage distributed network computingenvironments. The overall increase in Client solutions and Educational services revenues during fiscal 2005, ascompared with fiscal 2004, was largely due to revenue recognized on a significant solution sale in the United Kingdomand our solution-based selling strategy internationally, particularly in EMEA.

During fiscal 2004, as compared with fiscal 2003, excluding the benefit of foreign currency exchange rates, the factorscontributing to the overall increase in Client solutions and Educational services revenue included a combination ofhigher Client solutions services revenues, resulting primarily from the success of our solution-based selling strategy incertain countries within EMEA in the fiscal year, partially offset by a reduction in customers’ discretionary spendingrelated to Educational services and, to a lesser extent, the decline in new product revenues.

Net Revenues by Geographic AreaFor the fiscal year ended June 30,(dollars in millions)

2005 Change 2004 Change 2003

U.S. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,392 (7.9)% $ 4,768 (5.5)% $ 5,048Percentage of net revenues . . . . . . . . . . . . . . . . . . 39.7% (2.9) pts 42.6% (1.5) pts 44.1%

Americas — Other (Canada and Latin America) . . . $ 590 5.0% $ 562 3.5% $ 543Percentage of net revenues . . . . . . . . . . . . . . . . . . 5.3% 0.3 pts 5.0% 0.2 pts 4.8%

EMEA (Europe, Middle East and Africa) . . . . . . . . . $ 4,152 5.3% $ 3,942 4.2% $ 3,783Percentage of net revenues . . . . . . . . . . . . . . . . . . 37.5% 2.2 pts 35.3% 2.2 pts 33.1%

APAC (Asia, Australia and New Zealand) . . . . . . . . $ 1,936 1.2% $ 1,913 (7.1)% $ 2,060Percentage of net revenues . . . . . . . . . . . . . . . . . . 17.5% 0.4 pts 17.1% (0.9) pts 18.0%

International revenues . . . . . . . . . . . . . . . . . . . . . . . . $ 6,678 4.1% $ 6,417 0.5% $ 6,386Percentage of net revenues . . . . . . . . . . . . . . . . . . 60.3% 2.9 pts 57.4% 1.5 pts 55.9%

Total net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,070 (1.0)% $11,185 (2.2)% $11,434

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United States (U.S.)

During fiscal 2005, as compared with fiscal 2004, net revenues in the U.S. declined primarily due to a decrease inproducts net revenue. In the U.S., our sales mix has traditionally included a higher proportion of product sales, whichhas contributed to the challenge in growing revenue in this geographic market as we continue to experience intensecompetitive pressures, especially in selling our high-end server products in certain key sectors. In the government andtelecommunications sector, we continue to experience intense competition and reduced spending in certain areas whichhave traditionally been sources of relative competitive strength. During fiscal 2005, increased merger and acquisitionactivity in the telecommunication sector correlated to reduced customer spending in key accounts. Partially offsettingthe decline in net revenue from the government and telecommunications sectors during fiscal 2005, was year over yeargrowth in sales to our Wall Street financial services customer base.

During fiscal 2004, as compared with fiscal 2003, our net revenues in the U.S. declined primarily as the result of anintensely competitive environment. Although difficult to accurately quantify, our fiscal 2004 product transition fromUltraSPARC III to UltraSPARC IV may have impacted revenue in the U.S. to a greater extent than other regions as themix of products sold in the U.S. product market included a higher proportion of products undergoing the transition toUltraSPARC IV.

The following table sets forth net revenues in geographic markets contributing significantly to changes in internationalnet revenues during the last three fiscal years ended June 30:

(dollars in millions)

2005 Change 2004 Change 2003

United Kingdom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,000 5.8% $945 11.3% $849Germany(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 877 5.9% $828 (6.7)% $887Japan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 730 (4.2)% $762 (18.6)% $936Central and North EMEA(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 708 4.9% $675 2.3% $660

(1) Beginning in fiscal 2005, all periods presented have been adjusted to exclude Austria from the Germanygeographic market.

(2) CNE consists primarily of Finland, Norway, Sweden, the Netherlands, Belgium, Luxembourg and Switzerland. Inprior quarterly and annual reports we included an international area called “Northern Europe” that consisted ofFinland, Norway, Sweden, the Netherlands, Belgium, Luxembourg, Eastern European countries and Russia. Theresults for Eastern European countries and Russia have moved to another geographic market. This change to CNEreflects the manner in which we manage our international operations.

United Kingdom (U.K.)

During fiscal 2005, as compared with fiscal 2004, net revenues in the U.K. increased due to our solution-based sellingapproach as well as overall growth in the U.K. economy and the benefit of foreign currency exchange rates. Theseincreases were offset by a continuing market shift in overall computer system demand towards the use of entry-levelservers. Our revenue mix in the U.K. included a higher proportion of services revenues when compared to othergeographic markets such as the U.S. and Japan, which contributed to our overall revenue growth in this geographicmarket for the fiscal year. The government sector primarily contributed to the increase in revenue during fiscal 2005, ascompared with fiscal 2004, and included $62 million of revenue recognized in the first quarter of fiscal 2005, related tothe first phase of a multi-year, solution-based sale to a health care services provider.

During fiscal 2004, as compared with fiscal 2003, total net revenues in the majority of our products and servicecategories continued to grow in the U.K., primarily due to the benefit of foreign currency exchange rates and overallgrowth in the U.K. economy, which resulted in increased sales activity in certain key vertical markets such as financialservices.

Germany

During fiscal 2005, as compared with fiscal 2004, net revenues in Germany increased due to the benefit of foreigncurrency exchange rates and the benefits arising from certain elements of our strategic alliance with Fujitsu. These

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increases were partially offset by intense competition, the weak demand for our data center servers and a challengingmacroeconomic environment. Despite these challenges, the government sector remained a source of overall revenuestrength during fiscal 2005.

During fiscal 2004, as compared with fiscal 2003, we experienced lower revenues in Germany, primarily due to adecreased number of major infrastructure solution deals during fiscal 2004, an increase in the length of sales cycles andintense product competition in a challenging economic environment.

Japan

During fiscal 2005, as compared with fiscal 2004, net revenues in Japan decreased, primarily due to a decrease inProducts net revenue, partially offset by a slight increase in Support services and Client solutions revenues and thebenefit of foreign currency exchange rates. The decrease in Products net revenue in Japan is primarily a result of theimplementation of certain elements of our broad-based strategic alliance with Fujitsu. As noted above, the revenueimpact of this alliance in Japan was offset by other financial benefits received. Irrespective of the impact of the Fujitsualliance in Japan, the actions we initiated in fiscal 2004 to adjust to the intense competitive business environment havecontributed towards stabilization of this geographic market’s revenue.

During fiscal 2004, as compared with fiscal 2003, we experienced a decline in revenue in Japan due to intensecompetitive pressures in a challenging Japanese economic environment. This negatively impacted our overall share ofthe server market and in particular sales of our high-end server products. In Japan we took certain actions in fiscal2004, which included a change in management and implementation of a plan to reduce our future costs, to adjust to theintensely competitive business environment.

Central and Northern Europe (CNE)

During fiscal 2005, as compared with fiscal 2004, net revenues in CNE increased primarily due to increases in bothProducts and Client solutions revenues. The increase in net revenue occurred in a variety of sectors and across themajority of products and services categories that, in part, can be attributed to the success of our solution-based salesapproach in this geographic market.

In CNE, the increase in our total net revenues in fiscal 2004, as compared to fiscal 2003, was primarily a result of thefavorable foreign currency impact and an improving CNE telecommunications sector.

Gross MarginFor the fiscal year ended June 30,(dollars in millions)

2005 Change 2004 Change 2003

Products gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,952 (3.7)% $3,065 (11.2)% $3,451Percentage of products net revenue . . . . . . . . . . . . . . . . . 41.4% (0.3) pts 41.7% (2.6) pts 44.3%

Services gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,637 12.8% $1,451 (2.7)% $1,491Percentage of services net revenue . . . . . . . . . . . . . . . . . 41.5% 3.6 pts 37.9% (3.1) pts 41.0%

Total gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $4,589 1.6% $4,516 (8.6)% $4,942Percentage of net revenues . . . . . . . . . . . . . . . . . . . . . . . 41.5% 1.1 pts 40.4% (2.8) pts 43.2%

Products Gross Margin

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

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During fiscal 2005, as compared with fiscal 2004, our products gross margin percentage decreased by 0.3 percentagepoints due to planned list price reductions and sales discounting actions of approximately 5 percentage points, changesin product mix to a greater proportion of lower-margin products of approximately 1 percentage point and the impact ofour settlement with Kodak of approximately 1 percentage point. Offsetting these decreases were cost reductions due tosupply chain restructuring, product cost engineering and continued use of dynamic bidding events, which collectivelybenefited gross margin by approximately 6 percentage points.

During fiscal 2004, as compared with fiscal 2003, the 2.6 percentage points decrease in our products gross marginpercentage was primarily due to planned list-price reductions and sales discounting actions of approximately 7percentage points and changes in product mix to a greater proportion of lower-margin products of approximately 1percentage point. These decreases were partially offset by manufacturing and component cost reductions benefitingproducts gross margin of approximately 6 percentage points, which primarily consisted of reductions in platformspecific costs and lower costs of certain commodities including CPU boards, drives and removables.

Services Gross Margin

Our services gross margin percentage is influenced by numerous factors including services mix, pricing, geographicmix, foreign currency exchange rates, resource requirements and third-party costs. Many of these factors influence, orare 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 anestimate only.

During fiscal 2005, as compared with fiscal 2004, our services gross margin increased by 3.6 percentage points due torevenue volume efficiencies of approximately 3 percentage points and costs savings associated with renegotiatedcontracts with our partners and our workforce reductions of approximately 2 percentage points. These increases werepartially offset by the negative impact of increased costs associated with a change in services mix to a higherproportion of Client solutions with lower margins of approximately 1 percentage point.

During fiscal 2004, as compared with fiscal 2003, the 3.1 percentage point decrease in our services gross marginreflected the negative impact of competitive pricing pressures of approximately 3 percentage points and increased costsassociated with specific solution-based sales of approximately 1 percentage point. These decreases were partially offsetby efficiencies realized from increased sales volume over a fixed cost base of approximately 1 percentage point.

Operating ExpensesFor the fiscal year ended June 30,(dollars in millions)

2005 Change 2004 Change 2003

Research and development . . . . . . . . . . . . . . . . . . . . . . $1,785 (7.3)% $1,926 4.8% $1,837Percentage of net revenues . . . . . . . . . . . . . . . . . . . . 16.1% (1.1) pts 17.2% 1.1 pts 16.1%

Selling, general and administrative . . . . . . . . . . . . . . . . $2,919 (12.0)% $3,317 (0.4)% $3,329Percentage of net revenues . . . . . . . . . . . . . . . . . . . . 26.4% (3.3) pts 29.7% 0.6 pts 29.1%

Restructuring charges . . . . . . . . . . . . . . . . . . . . . . . . . . $ 262 (23.8)% $ 344 (7.3)% $ 371Percentage of net revenues . . . . . . . . . . . . . . . . . . . . 2.4% (0.7) pts 3.1% (0.1) pts 3.2%

Impairment of goodwill and other intangible assets . . . $ — (100)% $ 49 (97.7)% $2,125Percentage of net revenues . . . . . . . . . . . . . . . . . . . . —% (0.4) pts 0.4% (18.2) pts 18.6%

Purchased in-process research and development . . . . . $ — (100)% $ 70 N/M $ 4Percentage of net revenues . . . . . . . . . . . . . . . . . . . . —% (0.6) pts 0.6% 0.6 pts —%

Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . $4,966 (13.0)% $5,706 (25.6)% $7,666N/M — Not meaningful

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Research and Development (R&D) Expenses

During fiscal 2005, as compared with fiscal 2004, R&D expenses decreased by $141 million, primarily due to $125million in cost savings associated with workforce reductions, $50 million in cost savings associated with discretionaryand outside services spending and an $18 million decrease in depreciation and amortization. These decreases werepartially offset by a $38 million increase in compensation costs associated with salaries and bonuses and a $10 millionincrease in prototype expenses associated with new product introductions.

During fiscal 2004, as compared with fiscal 2003, R&D expenses increased by $89 million primarily due to a $77million increase in compensation costs associated with acquisitions and annual salary adjustments in effect since thethird quarter of fiscal 2003 and a $29 million increase in variable compensation costs. These increases were partiallyoffset by a decrease of $15 million in depreciation and amortization.

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

Selling, General and Administrative (SG&A) Expenses

During fiscal 2005, as compared with fiscal 2004, SG&A expenses decreased by $398 million primarily due to $263million in cost savings associated with workforce reductions, $107 million in occupancy cost savings associated withfacilities exit actions, $56 million in reductions in legal costs, a $48 million decrease in depreciation and amortizationand $22 million in reductions in marketing costs. These decreases were partially offset by a $66 million increase incompensation costs associated with salaries and bonuses.

During fiscal 2004, as compared with fiscal 2003, SG&A expenses decreased by $12 million primarily due to an $82million decrease in depreciation and capital related costs, a $79 million reduction in discretionary spending in areassuch as information technology and marketing, and $32 million in savings associated with facilities exits. Thesedecreases were partially offset by a $61 million increase in legal costs associated with settlements as well as variouson-going legal proceedings, a $52 million increase in variable compensation, including commissions and bonuses, $38million in workforce rebalancing efforts and $24 million in compensation costs, which includes the impact of exchangerates and annual salary adjustments in effect since the third quarter of fiscal 2003, offset by workforce reductionactions.

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

Restructuring Charges and Workforce Rebalancing Efforts

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) or, for actions prior to December 31,2002, EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring),” we recognized a total of $262 million, $344 millionand $371 million in restructuring charges in fiscal 2005, 2004 and 2003, respectively.

We estimated the cost of exiting and terminating our facilities leases by referring to the contractual terms of theagreements and by evaluating the current real estate market conditions. In addition, we have estimated sublease incomeby evaluating the current real estate market conditions or, where applicable, by referring to amounts being negotiated.As of June 30, 2005, our estimated sublease income to be generated from sublease contracts not yet negotiatedapproximated $85 million. Our ability to generate this amount of sublease income, as well as our ability to terminatelease obligations at the amounts we have estimated, is highly dependent upon the commercial real estate marketconditions in certain geographies at the time we perform our evaluations or negotiate the lease termination andsublease arrangements with third parties. The amounts we have accrued represent our best estimate of the obligationswe expect to incur and could be subject to adjustment as market conditions change.

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The following describes restructuring actions we have initiated over the past five fiscal years:

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, weplan to reduce our workforce by approximately 1,000 employees across certain employee levels, business functions,operating units, and geographic regions. In addition, we plan to eliminate excess facility capacity in light of revisedfacility requirements. In fiscal 2005, we recognized a total of $44 million in charges associated with Restructuring PlanV, which consisted solely of workforce reduction charges. We anticipate recording additional charges related to ourworkforce and facilities reductions over the next several quarters, the timing of which will depend upon the timing ofnotification 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 andexpense reduction measures. The total amount and timing of these charges will depend upon the nature, timing, andextent 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 ourworkforce, 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 workforceby approximately 4,150 employees under this plan. This plan also included eliminating excess facility capacity in lightof revised facility requirements and other actions. In fiscal 2004, we recognized $343 million in total charges,consisting of $215 million in workforce reduction charges and $128 million in excess facility charges. During fiscal2004, the charge relating to the consolidation of excess facilities included:

• $95 million of estimated future obligations for non-cancelable lease payments (net of estimated sublease income of$35 million) and/or termination fees resulting from exiting excess rental facilities; and

• $33 million for the impairment of property and equipment (primarily leasehold improvements) for which there areinsufficient cash flows to support the carrying cost. The property and equipment impairment was determined basedon the difference between the assets’ estimated fair value and their carrying value.

Under this plan to date, we have recognized $551 million in charges, consisting of $290 million in workforce reductioncharges and $261 million in excess facility charges.

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

As of June 30, 2005, substantially all employees to be terminated as a result of the restructuring had been notified.While most of the severance and related fringe benefits have been paid, in accordance with local employment laws, weexpect to pay the remaining restructuring accrual related to severance over the next few quarters.

Restructuring Plan III

In October 2002, we implemented a workforce reduction and facility exit plan (Restructuring Plan III). The goal of thisplan was to reduce costs and improve operating efficiencies. We implemented the plan by reducing our workforce byapproximately 3,200 employees across all employee levels, business functions, operating units, and geographic regionsand eliminating excess facility capacity in light of revised facility requirements. During fiscal 2003, we recognized$308 million in total charges, consisting of $176 million in workforce reduction and $132 million in excess facilitycharges. During fiscal 2003, the charge relating to the consolidation of excess facilities included:

• $114 million of estimated future obligations for non-cancelable lease payments and/or termination fees resultingfrom exiting excess rental facilities; and

• $18 million for the impairment of property and equipment (primarily leasehold improvements) for which there areinsufficient cash flows to support the carrying cost. The property and equipment impairment was determined basedon the difference between the assets’ estimated fair value and their carrying value.

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Under this plan to date, we have recognized $302 million in restructuring charges, consisting of $169 million inworkforce reduction charges and $133 million in excess facility charges.

All facilities relating to the amounts accrued under this restructuring plan were exited by June 30, 2004.

Restructuring Plan II

In the second quarter of fiscal 2002, we implemented a workforce reduction and facility exit plan (Restructuring PlanII). The goal of the restructuring was to reduce costs and improve operating efficiencies. Specifically, we reduced ourworkforce by approximately 9% (or 3,400 employees and 500 contractors) across all employee levels, businessfunctions, operating units, and geographic regions and eliminated excess facilities in light of revised facilityrequirements. During fiscal 2002, we recognized $511 million in total charges, consisting of $146 million in workforcereduction and $365 million in excess facility charges.

Under this plan to date, we have recognized $533 million in restructuring charges, consisting of $144 million inworkforce reduction charges and $389 million in excess facility charges.

All facilities relating to the amounts accrued under the restructuring were exited by December 31, 2002.

Facility Exit Plan I

In the fourth quarter of fiscal 2001, we elected to exit certain building leases and discontinue certain building projects.We incurred approximately $75 million in facility exit costs associated with this decision. As a result of the continueddeterioration of certain commercial real estate markets, we reduced our sublease income assumptions and, accordingly,recorded additional charges of $33 million and $26 million in fiscal 2003 and fiscal 2002, respectively, to reflect thesechanges in our estimates.

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The following table sets forth an analysis of the restructuring accrual activity for the fiscal years ended June 30, 2005,2004 and 2003 (in millions):

RestructuringPlan V

RestructuringPlan IV

RestructuringPlan III

RestructuringPlan II

FacilityExit Plan I

Total

Severanceand

Benefits

Severanceand

Benefits

FacilitiesRelated

and Other

Severanceand

BenefitsFacilitiesRelated

Severanceand

BenefitsFacilitiesRelated

FacilitiesRelated

Balance as of June 30, 2002 . . . . . . $— $ — $ — $ — $ — $ 19 $169 $ 53 $ 241Severance and benefits . . . . . . . . — — — 176 — — — — 176Accrued lease costs . . . . . . . . . . . — — — — 114 — — — 114Property and equipment

impairment . . . . . . . . . . . . . . . . — — — — 18 — — — 18Provision adjustments . . . . . . . . . — — — (4) (4) (2) 40 33 63

Total restructuring charges . . . — — — 172 128 (2) 40 33 371Cash paid . . . . . . . . . . . . . . . . . . . . . — — — (148) (5) (17) (31) (26) (227)Non-cash . . . . . . . . . . . . . . . . . . . . . — — — — (13) — 3 — (10)

Balance as of June 30, 2003 . . . . . . — — — 24 110 — 181 60 375Severance and benefits . . . . . . . . — 215 — — — — — — 215Accrued lease costs and other . . . — — 95 — — — — — 95Property and equipment

impairment . . . . . . . . . . . . . . . . — — 33 — — — — — 33Provision adjustments . . . . . . . . . — — — (3) (3) — — 7 1

Total restructuring charges . . . — 215 128 (3) (3) — — 7 344Cash paid . . . . . . . . . . . . . . . . . . . . . — (49) (6) (21) (19) — (28) (23) (146)Non-cash . . . . . . . . . . . . . . . . . . . . . — — (34) 1 2 — — 1 (30)

Balance as of June 30, 2004 . . . . . . — 166 88 1 90 — 153 45 543Severance and benefits . . . . . . . . 44 83 — — — — — — 127Accrued lease costs . . . . . . . . . . . — — 111 — — — — — 111Property and equipment

impairment . . . . . . . . . . . . . . . . — — 16 — — — — — 16Provision adjustments . . . . . . . . . — (8) 6 — 8 — 4 (2) 8

Total restructuring charges . . . 44 75 133 — 8 — 4 (2) 262Cash paid . . . . . . . . . . . . . . . . . . . . . — (204) (47) (1) (20) — (28) (17) (317)Non-cash . . . . . . . . . . . . . . . . . . . . . — — (17) — (1) — — — (18)

Balance as of June 30, 2005 . . . . . . $44 $ 37 $157 $ — $ 77 $ — $129 $ 26 $ 470

The remaining cash expenditures relating to workforce reductions are expected to be paid over the next few quarters.Our accrual as of June 30, 2005 for facility-related leases (net of anticipated sublease income) will be paid over theirrespective lease terms through fiscal 2023. As of June 30, 2005, $178 million of the total $470 million accrual forworkforce reductions and facility-related leases was classified as current accrued liabilities and other and the remaining$292 million was classified as other non-current obligations.

The above restructuring charges are based on estimates that are subject to change. Changes to the previous estimateshave been reflected as “Provision adjustments” on the above table in the period the changes in estimates were made.

Workforce Rebalancing Efforts

Prior to the initiation of our Restructuring Plan IV, we had initiated certain workforce rebalancing efforts during thefirst six months of fiscal 2004. As a result, we incurred $55 million of separation costs during this period.Approximately $3 million, $14 million and $38 million of these separation costs were included in cost of sales,

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research and development and selling, general and administrative expenses, respectively. During fiscal 2005 and fiscal2004, we paid $1 million and $54 million in cash, respectively.

Impairment of Goodwill and Other Intangible Assets

Impairment of Goodwill

We performed our annual goodwill impairment analyses in the fourth quarter of each of fiscal 2005, 2004 and 2003. Inaddition, in October 2002, based on a combination of factors, particularly: (1) our then current and projected operatingresults; (2) our decision to reduce our workforce and eliminate excess facility space; and (3) our then current marketcapitalization, we concluded there were sufficient indicators to require us to assess whether any portion of our recordedgoodwill balance was impaired. Based on our estimates of forecasted discounted cash flows as well as our marketcapitalization, at each of these dates, we concluded that goodwill impairment charges of none, $49 million and $2,027million were necessary in fiscal 2005, 2004 and 2003, respectively.

Impairment charges taken during fiscal 2004 related to the goodwill in our Educational services reporting unit. Thelower discounted cash flows attributable to our Educational services reporting unit in fiscal 2004 were primarily due toa decrease in revenue and gross margin, mostly resulting from the end-of-life of new enterprise learning platformlicensing and hosting agreements, as well as reduced expectations for other products. Educational services revenuesdeclined in fiscal 2004 by approximately 16% as compared to fiscal 2003. In measuring the amount of goodwillimpairment, we estimated the fair value of the reporting unit based on our estimates of forecasted discounted cashflows as well as our market capitalization and concluded it was negative. Any allocation of such negative fair valuewould have resulted in no implied value of the existing goodwill. As a result, we concluded that all of the recordedgoodwill in the Educational services reporting unit was impaired and needed to be expensed as a non-cash charge tocontinuing operations during the fourth quarter of 2004. The resulting impairment charge of $49 million primarilyrelated to goodwill acquired from our acquisitions of ISOPIA, Inc. of $39 million and Ed Learning Systems, Inc. of $7million.

Impairment charges taken during fiscal 2003 related to the goodwill in our then Volume Systems and Network Storagereporting units, which were primarily related to goodwill acquired from our acquisition of Cobalt, Inc. When weperformed our analysis in October 2002, the estimated fair value of our reporting units had decreased because our thencurrent forecasted discounted cash flows and market capitalization were lower than at the time of our previous analysis.As required by SFAS 142, in measuring the amount of goodwill impairment, we made a hypothetical allocation of theestimated fair value of the reporting units to the tangible and intangible assets (other than goodwill) within thesereporting units. Based on this allocation, we concluded that all of the recorded goodwill in the Volume Systemsreporting unit ($1,566 million) and the Network Storage reporting unit ($461 million) was impaired and needed to beexpensed as a non-cash charge to continuing operations during the second quarter of fiscal 2003. When we conductedour fiscal 2003 annual analysis in the fourth quarter of fiscal 2003, we concluded at that time that we did not have anyimpairment of goodwill based on our then forecasted discounted cash flows as well as our market capitalization.

We perform our goodwill impairment analysis at one level below the operating segment level as defined in SFAS 142.See Note 16 to the Consolidated Financial Statements for further detail. This analysis requires management to make aseries of critical assumptions to: (1) evaluate whether any impairment exists; and (2) measure the amount of impairment.SFAS 142 requires that we estimate the fair value of our reporting units as compared with their estimated book value. Ifthe estimated fair value of a reporting unit is less than the estimated book value, then an impairment is deemed to haveoccurred. In estimating the fair value of our reporting units, we primarily use the income approach (which utilizesforecasted discounted cash flows to estimate the fair value of the reporting unit) and the market approach (whichestimates fair value based on market prices for comparable companies). We also consider Sun’s total marketcapitalization as of each date on which we conclude an analysis is required, and our average market capitalization for aperiod of time prior to and subsequent to each date on which we conclude an analysis is required, to adequately considerthe impact of volatility on our market capitalization on that day. As required by SFAS 142, prior to conducting ourgoodwill impairment analysis, we assess long-lived assets for impairment in accordance with SFAS 144.

Impairment of Other Intangible Assets

SFAS 144 is the authoritative standard on the accounting for the impairment of Other Intangible Assets. This analysisdiffers from our goodwill analysis in that an impairment is only deemed to have occurred if the sum of the forecasted

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undiscounted future cash flows related to the asset are less than the carrying value of the intangible asset we are testingfor impairment. If the forecasted cash flows are less than the carrying value, then we must write down the carryingvalue to its estimated fair value.

In accordance with SFAS 144 and our internal accounting policy, we performed semi-annual other intangible assetsimpairment analyses in the second and fourth quarters of each of our past three fiscal years. In addition, based on thesame considerations outlined in the above discussion on goodwill, in October 2002, we concluded there were sufficientindicators to require us to assess whether a portion of our Other Intangible Assets was impaired. Based on ourestimates of forecasted undiscounted cash flows at each of these dates, we concluded that other acquisition-relatedintangible asset impairment expenses of none were needed in fiscal 2005 and 2004 and $42 million in our then ProductGroup segment was necessary during fiscal 2003, to reduce our other acquisition-related intangible assets balance to itsestimated fair value.

In-process Research and Development (IPRD)

IPRD expense of none, $70 million and $4 million in fiscal 2005, 2004 and 2003, respectively, is a result of in-processtechnologies associated with our acquisitions of: Pixo, Inc. (Pixo), Waveset Technologies, Inc. (Waveset), and Kealia,Inc. (Kealia) in fiscal 2004; and Pirus Networks, Inc. (Pirus) and Terraspring, Inc. (Terraspring) in fiscal 2003(Acquired Companies). At the date of each acquisition noted above, the projects associated with the IPRD efforts hadnot yet reached technological feasibility and the IPRD had no alternative future uses. The IPRD associated with theacquisition of Waveset was less than $1 million. Accordingly, these amounts were expensed on the respectiveacquisition dates of each of the Acquired Companies. There was no IPRD associated with our fiscal 2005 acquisitionsfor the following reasons:

• Acquisition of SevenSpace, Inc. (SevenSpace) — We acquired a services business with research and developmentactivities that were primarily devoted to upgrades and enhancements to the existing product and service deliveryprotocol, rather than the development of new products.

• Acquisition of certain assets of Procom Technology, Inc. (Procom) — We acquired intellectual property associatedwith Procom’s existing Netforce product line, certain tangible property, and certain employees. Research anddevelopment activity associated with the acquired intellectual property and employees was primarily devoted tosustaining the existing product, including bug fixes, platform integration, and competitive performance issues.

Also see Note 4 to the Consolidated Financial Statements for further discussion.

General Valuation

Amounts allocated to IPRD are calculated using established valuation techniques accepted in the high-technologyindustry. These calculations give consideration to relevant market sizes and growth factors, expected industry trends,the anticipated nature and timing of new product introductions by the company and our competitors, individual productsales cycles, and the estimated lives of each of the products’ underlying technology. The value of the IPRD reflects therelative value and contribution of the acquired research and development. We gave consideration to the R&D’s stage ofcompletion, the complexity of the work completed to date, the difficulty of completing the remaining development,costs already incurred, and the expected cost to complete the project in determining the value assigned to IPRD.

Approach Used for Valuation of IPRD in the Acquisitions Presented

The values assigned to developed technologies related to each acquisition were based upon discounted cash flowsrelated to the future products’ projected income stream. Elements of the projected income stream included revenues,cost of sales (COS), SG&A expenses, and R&D expenses. The discount rates used in the present value calculationswere generally derived from a weighted average cost of capital, adjusted upward to reflect the additional risks inherentin the development life cycle, including the useful life of the technology, profitability levels of the technology, and theuncertainty of technology advances that are known at the date of each acquisition. As each acquired entity’s IPRD isunique, the discount rate, revenue, COS, R&D and SG&A assumptions used varied on a case-by-case basis. Inaddition, we did not expect to achieve a material amount of expense reductions or synergies; therefore, the valuationassumptions did not include significant anticipated cost savings.

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Valuation Assumptions

The following table summarizes the significant assumptions underlying the valuations related to the IPRD from each ofthe Acquired Companies in fiscal 2004 and 2003 (dollars in millions):

Acquired Company IPRD

Estimated Costto CompleteTechnologyat Time ofAcquisition

PercentageCompleted at

Time ofAcquisition

AverageRevenue

Growth Rate

Percentage of RevenueAverage

COSAverageSG&A

AverageR&D

DiscountRate Used

Fiscal 2004Pixo . . . . . . . . . . . . . . . . . . $ 1 $— 50% 21% N/A 48% 2% 18%Kealia . . . . . . . . . . . . . . . . $69 $ 8 5% 37% 65% 20% 2% 35%Fiscal 2003Pirus . . . . . . . . . . . . . . . . . $ 3 $ 4 30% 15% 51% 31% 4% 22%Terraspring . . . . . . . . . . . . $ 1 $ 1 25% 23% 12% 22% 2% 31%

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

The following table provides information regarding the status of IPRD projects at the date of acquisition and as ofJune 30, 2005 (in millions):

Acquired Company/Business

Estimated Cost toComplete at Time

of Acquisition

Actual CostsIncurred as ofJune 30, 2005

Actual/ExpectedProduct

Release Date

Pixo . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $— $ 1 Q2FY2005Kealia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 8 $14.9 Q2FY2006Pirus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4 $ — N/A(1)

Terraspring . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1 $ — N/A(1)

(1) Projects identified as IPRD when we acquired the company have been delayed since the acquisition and are notcurrently part of any specific project roadmap.

Except for the acquisitions discussed under Note 4 to the Consolidated Financial Statements, we believe that theprojections we used in performing our valuations for each acquisition, are still valid in all material respects; however,we cannot offer assurance that the projected results will be achieved. We continue to make substantial progress relatedto the development and commercialization of acquired technologies. Although we have experienced delays in thecompletion of certain of our development efforts and their related commercialization, the expected total costs tocomplete such technologies have not materially increased, individually or in the aggregate, from our estimates at thetime of the acquisitions. We periodically evaluate our product development timeline and modify our overall businessplan in response to various factors. Modifications to our business plan include the reallocation of resources amongvarious alternative development projects.

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Gain (Loss) on Equity Investments, netFor the fiscal year ended June 30,(dollars in millions)

2005 Change 2004 Change 2003

Gain (loss) on equity investments, net . . . . . . . . . . . . . . . . $ 6 N/M* $ (64) (23.8)% $ (84)Percentage of net revenues . . . . . . . . . . . . . . . . . . . . . . . 0.0% 0.6 pts (0.6)% 0.1 pts (0.7)%

*N/M — Not meaningful

Our equity investments portfolio primarily consists of investments in publicly traded and privately-held technologycompanies. The net gain on equity investments in fiscal 2005 of $6 million was comprised of investment gains of $22million offset by investment losses of $16 million. Investment gains of $22 million for fiscal 2005 primarily related tothe sale of certain equity investments and income from our joint ventures and venture capital fund investments.Investment losses on equity investments of $16 million for fiscal 2005, were primarily related to a decline in the valueof our portfolio that was considered other than temporary. Investment gains of $22 million and $13 million in fiscal2004 and 2003, respectively, primarily related to the valuation of warrants and the sale of certain marketable equitysecurities. Investment losses on equity investments of $86 million and $97 million in fiscal 2004 and 2003,respectively, were primarily related to a decline in the value of our portfolio that was considered other than temporary.See Note 3 to the Consolidated Financial Statements for further detail.

As of June 30, 2005, our equity investment portfolio of $76 million consisted of $34 million in marketable equitysecurities, $26 million in equity investments in privately-held companies and $16 million in investments in venturecapital funds and joint ventures. The ongoing valuation of our investment portfolio remains uncertain and may besubject to fluctuations based on whether we participate in additional investment activity or as a result of the occurrenceof events outside of our control.

Interest and Other Income, netFor the fiscal year ended June 30,(dollars in millions)

2005 Change 2004 Change 2003

Interest and other income, net . . . . . . . . . . . . . . . . . . . . . . . $133 41.5% $ 94 (39.4)% $155Settlement income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 (96.6)% 1,597 100.0% —

Interest and other income, net . . . . . . . . . . . . . . . . . . . . . . . $187 (88.9)% $1,691 N/M $155Percentage of net revenues . . . . . . . . . . . . . . . . . . . . . . . 1.7% (13.4) pts 15.1% 13.7 pts 1.4%

During fiscal 2005, as compared with fiscal 2004, interest and other income, net increased primarily due to higher cashand marketable debt securities balances throughout fiscal 2005 as a result of the settlement income received fromMicrosoft. During fiscal 2004, as compared with fiscal 2003, interest and other income, net decreased primarily due tothe combination of lower interest rates and lower cash and marketable debt securities balances throughout fiscal 2004.During fiscal 2005, our loss on marketable debt securities, which is included in interest and other income, net, wasincreased by a $15 million impairment associated with our intent to liquidate a portion of our June 30, 2005 securitiesportfolio, due to our acquisition of StorageTek in the first quarter of fiscal 2006.

Our interest income and expense are sensitive primarily to changes in the general level of U.S. interest rates. In thisregard, 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 ourinvestment portfolio and our issued fixed-rate unsecured senior debt securities, we have entered into interest rate swaptransactions so that the interest associated with these debt securities effectively becomes variable. The average durationof our portfolio of marketable debt securities was 0.68 years, 0.82 years and 0.72 years as of June 30, 2005, 2004 and2003, respectively. In general, we would expect the volatility of this portfolio to decrease as its duration decreases.

On April 1, 2004, we entered into several agreements with Microsoft, including an agreement to settle all pendinglitigation between the two companies, a patent covenant and stand-still agreement, and a technical collaboration

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agreement. As further described in Note 13 to the Consolidated Financial Statements, based on the agreements withMicrosoft we received $54 million and $1,950 million in cash in fiscal 2005 and 2004, respectively, recognized $54million and $1,597 million in settlement income during fiscal 2005 and 2004, respectively, and deferred $350 millionin fiscal 2004 as other non-current obligations until the earlier of usage of the royalties by Microsoft or such time as allour obligations have been met. In fiscal 2004, we also deferred $3 million in connection with our obligation to providetechnical support in the terms of technical collaboration agreement, which is being amortized to income over the tenyear term of the agreement.

Income TaxesFor the fiscal year ended June 30,(dollars in millions)

2005 Change 2004 Change 2003

(Restated)

Provision for (benefit from) income taxes . . . . . . . . . . . . . $(77) N/M* $825 12.9% $731

*N/M — Not meaningful

During fiscal 2005, we recorded a net tax benefit of $77 million. This benefit included a $213 million tax benefitarising from adjustments to our income tax reserves resulting from the conclusion of both a U.S. income tax audit and aforeign income tax audit and a benefit of $69 million related to the impact of a change in the U.S.-Dutch withholdingtax treaty. This was offset by a tax expense of $205 million on income generated in certain foreign jurisdictions andadjustments for the differences between estimated amounts recorded and actual liabilities resulting from the filing ofprior periods’ tax return. For details regarding the Restatement, see “Restatement—Explanatory Note” in the forepartof this Form 10-K.

The tax expense for fiscal 2004 was due primarily to taxes on income generated from the Microsoft settlement, anincrease in the valuation allowance for U.S. and Japan deferred tax assets and income generated in certain foreignjurisdictions and adjustments for the difference between estimated amounts recorded and actual liabilities resultingfrom the filing of prior years’ tax returns.

In fiscal 2004, we recorded a non-cash charge of approximately $300 million to increase our valuation allowance forour deferred tax assets. This valuation allowance was determined in accordance with the provisions of SFAS No. 109,“Accounting for Income Taxes” (SFAS 109), which requires an assessment of both positive and negative evidencewhen determining whether it is more likely than not that deferred tax assets are realizable; such assessment is requiredon a jurisdiction-by-jurisdiction basis. Cumulative losses incurred in recent years represented sufficient negativeevidence under SFAS 109 to record a valuation allowance against the deferred tax assets in the U.S. and Japan.

The tax expense for fiscal 2003 was due primarily to the increase in our valuation allowance and the non-deductibilityof goodwill impairment.

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

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LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITIONAs of and for the fiscal year ended June 30,(dollars in millions)

2005 Change 2004 Change 2003

(Restated) (Restated)

Cash and cash equivalents . . . . . . . . . . . . . . . . . . . $2,051 $ (90) $ 2,141 $ 126 $2,015Marketable debt securities . . . . . . . . . . . . . . . . . . . 5,473 6 5,467 1,741 3,726

Total cash, cash equivalents and marketabledebt securities . . . . . . . . . . . . . . . . . . . . . . . . . $7,524 $ (84) $ 7,608 $ 1,867 $5,741

Percentage of total assets . . . . . . . . . . . . . . . . . . 53.0% 1.6 pts 51.4% 8.2 pts 43.2%

Cash provided by operating activities . . . . . . . . . . . $ 369 $(1,857) $ 2,226 $ 1,189 $1,037Cash used in investing activities . . . . . . . . . . . . . . . (425) 1,886 (2,311) (1,783) (528)Cash provided by (used in) financing activities . . . (34) (245) 211 729 (518)

Net increase (decrease) in cash and cashequivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (90) $ (216) $ 126 $ 135 $ (9)

Changes in Cash Flow

During fiscal 2005, our operating activities generated cash flows of $369 million, which is $1,857 million lower thanthe cash flows provided by operating activities during fiscal 2004, primarily due to $1,950 million received in fiscal2004 related to our settlement with Microsoft. The following items significantly impacted our cash provided byoperating activities during fiscal 2005:

• Net loss of $107 million included non-cash charges of approximately $486 million, which included depreciation andamortization of $671 million, offset by $315 million of deferred taxes;

• Payments towards severance and facilities restructuring liabilities totaling $317 million; and

• Payments of approximately $180 million to the Internal Revenue Services related to tax examinations for tax returnsfiled in the fiscal years 1997 through 2000.

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

During fiscal 2005, our cash used in investing activities of $425 million was primarily attributable to capital and sparespurchases of $347 million and cash used for acquisitions of $95 million. Cash used in financing activities of $34million was primarily attributable to a $252 million principal payment of our Senior Notes and other borrowingsoutstanding in the first quarter of fiscal 2005, partially offset by $218 million of proceeds from the sale of commonstock.

During fiscal 2004, our operating activities generated cash flows of $2,226 million, which is $1,189 million higher thanthe cash flows provided by operating activities during fiscal 2003. The following items significantly impacted our cashprovided by operating activities during fiscal 2004:

• Net loss of $388 million included non-cash charges of approximately $1,620 million, which included $730 millionof depreciation and amortization and $620 million of deferred taxes;

• Receipt of $1,950 million related to the settlement with Microsoft;

• Payments towards severance and facilities restructuring liabilities totaled $146 million; and

• Services contracts deferred revenues increase of $271 million.

In fiscal 2004, our $2,100 million use of cash for investing and financing activities was primarily attributable to the$1,820 million in purchases, net of proceeds from sales and maturities, of marketable debt securities and also includes$320 million in capital and spares purchases and $201 million paid for acquisitions during the period, which wereoffset by $239 million in proceeds from the issuance of our common stock.

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We have experienced positive cash flow from operations for the last 16 fiscal years, and anticipate being able tocontinue to generate positive cash flow from operations unless competition intensifies and we are unable to increaseour revenues and gross margins faster than we are able to reduce our costs of operations. Based on our current plan ofrecord, we expect to generate positive cash flow from operations for the full fiscal year ending June 30, 2006, althoughthere can be no assurance of this.

For the quarter ended June 30,(dollars in millions)

2005 Change 2004 Change 2003

Days sales outstanding (DSO)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 — 68 4 72Days of supply in inventory (DOS)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 — 22 — 22Days payable outstanding (DPO)(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (60) 10 (50) 2 (48)

Cash conversion cycle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 10 40 6 46

Inventory turns-products only . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.3 (0.5) 9.8 1.2 8.6

(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 fourth quarter of fiscal 2005 with a cash conversion cycle of 30 days, an improvement of 10 days fromJune 30, 2004. The cash conversion cycle is the duration between purchase of inventories and services and thecollection of the cash for the sale of our products and services and is a metric on which we have focused as we continueto 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). DSO and DOSremained relatively flat from June 30, 2004. However, inventories decreased $33 million from June 30, 2004 and ourproducts inventory turn rate remained relatively flat at 9.3 turns at June 30, 2005 from 9.8 turns at June 30, 2004.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 inventorylevels to help ensure competitive lead times with the risk of inventory obsolescence due to rapidly changing technologyand customer requirements. DPO improved 10 days and accounts payable increased $110 million from June 30, 2004due to negotiation of more favorable terms with our vendors.

We ended the fourth quarter of fiscal 2004 with a cash conversion cycle of 40 days, an improvement of 6 days fromJune 30, 2003. DSO decreased 4 days due to improved linearity and increased collection activity for service contractrenewals from the June 30, 2003 levels. DOS remained unchanged from June 30, 2003. DPO increased as a result ofnegotiation of more favorable terms with our vendors.

Completed Acquisitions

Our acquisition activities have historically addressed research and development, technology, and product developmentneeds and opportunities with respect to our existing technology roadmap and product development plans. As a result,our acquisitions consummated prior to June 30, 2005, have not typically been made to directly supplement revenuegrowth, and have not historically represented acquisitions of material revenue streams.

We consummated two acquisitions during fiscal 2005. On January 10, 2005, we acquired SevenSpace, a privately-heldcompany based in Ashburn, Virginia, by means of a merger pursuant to which we paid approximately $46 million incash for all of the outstanding shares of capital stock of SevenSpace. In addition, all outstanding options to purchaseSevenSpace capital stock were exchanged for options to purchase our common stock. SevenSpace delivered remotesystem monitoring and management across heterogeneous environments, including enterprise applications, databases,operating systems, and network devices, and will enhance our managed services offerings by adding support for non-Sun platforms. On June 9, 2005, we acquired rights to the Network Attached Storage (NAS) software intellectual

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property, certain tangible property, and certain employees of Procom for approximately $50 million in cash. Weacquired these assets from Procom in order to strengthen our existing NAS product offerings and to accelerate thedevelopment of our next-generation NAS solutions.

See Note 4 of our Consolidated Financial Statements for a detailed discussion of completed acquisitions and Note 18for a discussion of the acquisitions we completed subsequent to June 30, 2005 that will impact our liquidity. During thefirst quarter of fiscal 2006, we paid approximately $4.0 billion and $362 million in cash to the stockholders of theacquired companies, StorageTek and SeeBeyond, respectively. The $4.0 billion in cash paid for StorageTek waspartially funded through the use of approximately $1.0 billion in cash held by StorageTek at the time of acquisition.

Stock Repurchases

From time to time, our Board of Directors approves common stock repurchase programs allowing management torepurchase shares of our common stock in the open market pursuant to price-based formulas. In February 2001, weannounced our intention to acquire up to $1.5 billion of our outstanding common stock under a stock repurchaseprogram authorized by our Board of Directors. Under the February 2001 program, the timing and actual number ofshares subject to repurchase are at the discretion of management and are contingent on a number of factors, includingour projected cash flow requirements, our return to sustained profitability and our share price. During the fiscal yearsended June 30, 2005 and 2004, we did not repurchase common stock under our repurchase program. All priorrepurchases were made in compliance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended. As ofJune 30, 2005, approximately $230 million of the $1.5 billion authorized remains unused and available for repurchase.

Borrowings

Our $1.1 billion Senior Notes outstanding are due at various times between August 2006 and August 2009. The SeniorNotes are subject to compliance with certain covenants that do not contain financial ratios. We are currently incompliance with these covenants. If we failed to be in compliance with these covenants, the trustee of the Senior Notesor holders of not less than 25% in principal amount of the Senior Notes would have the ability to demand immediatepayment of all amounts outstanding. See Note 10 to our Consolidated Financial Statements for further detail.

Contractual Obligations and Certain Contingencies

The following table summarizes our contractual obligations at June 30, 2005 (in millions):

Contractual Obligations Total

Payments Duein Less

Than 1 Year

PaymentsDue in

1-3 Years

PaymentsDue in

4-5 Years

PaymentsDue After5 Years

Senior Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,050 $ — $500 $550 $ —Non-cancelable operating leases . . . . . . . . . . . . . . . . . . . $1,116 $236 $332 $236 $312Asset retirement obligations . . . . . . . . . . . . . . . . . . . . . . $ 41 $ 13 $ 9 $ 7 $ 12

The Senior Notes consist of $500 million (due on August 15, 2006 and bearing interest at 7.5%) and $550 million (dueon August 15, 2009 and bearing interest at 7.65%). Interest on the Senior Notes is payable semi-annually. We mayredeem all or any part of any tranche of the Senior Notes at any time at a price equal to 100% of the principal plusaccrued and unpaid interest in addition to an amount determined by a quotation agent, representing the present value ofthe remaining scheduled payments. We have hedged against the risk of changes in fair value associated with our fixedrate Senior Notes by entering into fixed-to-variable interest rate swap agreements, designated as fair value hedges, ofwhich eight are outstanding, with a total notional amount of $1.1 billion as of June 30, 2005. Due to these interest rateswap agreements, the interest associated with the Senior Notes effectively becomes variable.

Our asset retirement obligations arise from leased facilities where we have contractual commitments to removeleasehold improvements and return the property to a specified condition when the lease terminates.

Through the normal course of our business, we purchase or place orders for the necessary components of our productsfrom various suppliers and have also committed to purchase certain outsourced services where we would incur a

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penalty if the agreement was canceled prior to a contractual minimum term. We estimate that our contractualobligations at June 30, 2005 were $501 million due in less than 1 year from June 30, 2005. This amount does notinclude contractual obligations recorded on the balance sheet as current liabilities. In addition, we have a contractualobligation under the terms of our strategic alliance with Fujitsu, whereby we have committed to buy Fujitsu productswith a list price of $230 million within the first twelve months following full implementation of Sun’s distribution ofFujitsu products and approximately $265 million during the second twelve months following full implementation ofSun’s distribution of Fujitsu products, at a predetermined discount from list price, depending upon the type of productpurchased. Contractual obligations for the purchase of goods or services are comprised of agreements that areenforceable and legally binding on Sun and that specify all significant terms, including fixed or minimum quantities tobe purchased, fixed, minimum or variable price provisions, and the appropriate timing of the transactions. Ourpurchase orders are based on our current manufacturing needs and are fulfilled by our vendors within a short time.

See Note 18 of our Consolidated Financial Statements for a discussion of acquisitions completed subsequent toJune 30, 2005 that will impact our liquidity.

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 practicesliability, property, cargo and crime and directors and officers liability. We have self-insured between $2 million and$25 million per occurrence on these lines of coverage. Sun performs an annual actuarial analysis to develop an estimateof amounts to be paid for both claims reported and potential losses on activities that have occurred but have not yetbeen reported. Loss accruals were $33 million and $27 million as of June 30, 2005 and 2004, respectively.

During the normal course of our business, we issue guarantees and letters of credit to numerous third-parties and forvarious purposes such as lease obligations and state and local governmental agencies requirements. At June 30, 2005,we had approximately $18 million of outstanding financial letters of credit.

In the normal course of business, we may enter into contractual arrangements under which we may agree to indemnifythe third party to such arrangement from any losses incurred relating to the services they perform on behalf of Sun orfor losses arising from certain events as defined within the particular contract, which may include, for example,litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum lossclauses. Historically, payments made related to these indemnifications have not been material.

In addition, we have uncommitted lines of credit aggregating approximately $477 million. No amounts were drawnfrom these lines of credit as of June 30, 2005. Interest rates and other terms of borrowing under these lines of creditvary from country to country depending on local market conditions at the time of borrowing. There is no guarantee thatthe banks would approve our request for funds under these uncommitted lines of credit.

We are currently under examination by the IRS for tax returns filed in fiscal years 2001 through 2002. Although theultimate outcome is unknown, we have reserved for potential adjustments that may result from the current examinationand we believe that the final outcome will not have a material affect on our results of operations. If events occur whichindicate payment of these amounts is unnecessary, the reversal of the liabilities would result in tax benefits beingrecognized in the period when we determine the liabilities are no longer necessary. If our estimate of the federal, stateand foreign income tax liabilities proves to be less than the ultimate assessment, a further charge to expense wouldresult.

In fiscal 2005, the General Services Administration (GSA) began auditing our records under the schedule contracts ithad with us to verify our compliance with various contract provisions from October 1997 to February 2005. If the auditdetermines that we did not comply with such provisions, we may be required to pay the GSA a potential settlement.We have made a preliminary assessment of our exposure for such amounts potentially due and such assessment isreflected in our fiscal 2005 consolidated financial statements. The exact date for completion of the audit and thesubsequent negotiation process is unknown and may not be concluded for several quarters.

Off-Balance-Sheet Arrangements

As of June 30, 2005, we did not have any significant off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) ofSEC Regulation S-K.

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Capital Resources and Financial Condition

Our long-term strategy is to maintain a minimum amount of cash and cash equivalents in subsidiaries for operationalpurposes and to invest the remaining amount of our cash in interest bearing and highly liquid cash equivalents andmarketable debt securities. Accordingly, in addition to the approximately $2,051 million in cash and cash equivalents,at June 30, 2005 we had approximately $5,473 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 debtsecurities position of approximately $7,524 million. However, at June 30, 2005, approximately $1,095 million of thisbalance represented earnings generated from operations domiciled in foreign tax jurisdictions that were designated aspermanently invested in the respective tax jurisdictions. Should we decide to repatriate these earnings, we would berequired to accrue and pay additional taxes to repatriate these funds. Deposits in foreign countries of approximately$520 million are subject to local banking laws and may bear higher or lower risk than cash deposited in the UnitedStates. In addition, we are currently reviewing the provisions of the American Jobs Creation Act of 2004, and have notcompleted our evaluation of its impact to Sun.

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

DILUTIVE EFFECT OF STOCK OPTIONS ISSUED TO DIRECTORS AND EMPLOYEES

Our stock option program is a broad-based, long-term retention program that is intended to attract and retain talentedemployees and align stockholder and employee interests. We primarily rely on three stock option plans that providebroad discretion to our Board of Directors to create appropriate equity incentives for members of our board of directorsand our employees. Our 1990 Long-Term Equity Incentive Plan is the primary plan under which most of our optionsare granted. The 1996 Equity Compensation Acquisition Plan is the plan under which we grant options to employeeshired in connection with the acquisition of another company, and the 1988 Directors’ Stock Option Plan provides forthe automatic grant of stock options to non-employee directors on the date each person initially becomes a director, andon the date of each annual meeting of stockholders to non-employee directors who are elected and who have served asa member of our board of directors for at least six months. Substantially all of our employees participate in our stockoption program.

We also have a stock repurchase program in place whereby we can mitigate the dilutive effect generated by theexercise of stock options. In implementing our stock option program, we carefully monitor both the potential andactual dilution associated with our stock option program. However, during fiscal 2003, the shares we repurchasedunder our stock repurchase program negatively impacted our net loss per share amount by approximately four cents.We view dilution from stock option exercises as the difference between the number of options exercised reduced by thenumber of shares repurchased in a given fiscal year as a percentage of the number of shares outstanding at thebeginning of the year (exercise dilution). We also monitor the potential dilution from net option grants in a given yearby comparing the option grants reduced by cancellations in a given year with the number of shares outstanding at thebeginning of the year (grant dilution). In addition, we monitor the net cash cost of our stock repurchase programs.

On April 28, 2005, 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 directors, under our equity compensation plans. The acceleration of vesting waseffective for stock options outstanding as of May 30, 2005. Options to purchase approximately 45 million shares ofcommon stock or 18% of our outstanding unvested options were accelerated. The weighted-average exercise price ofthe options subject to the acceleration was $14.85. The purpose of the acceleration was to enable us to avoidrecognizing compensation expense associated with these options in future periods in our Consolidated Statements ofOperations upon adoption of SFAS 123R in July 2005. We also believe that because the options that were acceleratedhad exercise prices in excess of the then-current market value of our common stock, the options had limited economicvalue and were not fully achieving their original objective of incentive compensation and employee retention.

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As of June 30, 2005, the total outstanding options held by the five most highly compensated executive officersidentified in our 2005 Proxy Statement (the “Named Executive Officers”) amounted to approximately 29 million or5.2% of the approximately 557 million outstanding options held by all employees. For a given year, the percentage ofoptions granted to the Named Executive Officers is calculated by comparing the options granted to such executives tonet options granted as noted below.

The following table illustrates the grant dilution, exercise dilution and the net cash outlay for our stock repurchaseprograms associated with our stock option program (in millions, except percentages):

2005 2004 2003 2002 2001

Shares outstanding at beginning of year . . . . . . . . . . . . . . . . . . . . 3,602 3,587 3,537 3,536 3,495Less treasury stock outstanding at beginning of year . . . . . . . . . . (266) (351) (303) (288) (301)

Net shares outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,336 3,236 3,234 3,248 3,194

Grants and assumptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 111 115 119 124Less option cancellations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (97) (54) (58) (35) (18)

Net option grants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10) 57 57 84 106

Grant dilution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (0.3)% 1.8% 1.8% 2.6% 3.3%

Options exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 41 26 28 63Less shares repurchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — (126) (62) (52)

Net shares issued (repurchased) . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 41 (100) (34) 11

Exercise dilution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1% 1.3% (3.1)% (1.0)% 0.3%

Cost of shares repurchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ — $ — $ 499 $ 554 $1,123Less proceeds from options exercised . . . . . . . . . . . . . . . . . . . . . . (103) (103) (46) (78) (202)Less tax benefit from options exercised . . . . . . . . . . . . . . . . . . . . . (25) (4) (9) (98) (816)

Net cash (inflow) outflow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (128) $ (107) $ 444 $ 378 $ 105

Options granted to the five (seven in fiscal 2004) most highlycompensated executive officers . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 5.5 2.3 3.8 2.9

Options granted to the Named Executive Officers as a percentageof options granted and assumed during the year(1) . . . . . . . . . . . 3.8% 5.0% 2.0% 3.2% 2.3%

Options granted to the Named Executive Officers as a percentageof options granted and assumed net of cancellations during theyear(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . N/M* 9.6% 4.0% 4.5% 2.7%

* N/M — Not meaningful(1) Includes 5 Named Executive Officers for 2005 and 7 Named Executive Officers for 2004 and includes an

extraordinary grant of 1,000,000 shares to Mr. Schwartz in connection with his promotion to President and ChiefOperating Officer in April 2004.

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Options Granted During Fiscal 2005 to our Named Executive Officers

NameNumber of

Options Granted

WeightedAverage

Exercise Price

Scott G. McNealy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,250,000 $3.79Jonathan I. Schwartz . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800,000 $3.79Crawford W. Beveridge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000 $3.79Stephen T. McGowan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000 $3.79Gregory M. Papadopoulos . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000 $3.79

NON-AUDIT SERVICES OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Our auditors, Ernst & Young LLP, perform the following non-audit services that have been pre-approved by our AuditCommittee of the Board of Directors: expatriate tax and relocation services, international and U.S. tax planning andcompliance services, and tax due diligence for acquisitions. Starting in fiscal 2004, our expatriate officers no longerreceived tax services, including personal tax return preparation, from Ernst & Young LLP. In addition, for fiscal 2005we selected another firm to perform expatriate tax and relocation services and are in the process of transitioning theseservices from Ernst & Young LLP.

During fiscal 2005, Ernst & Young LLP notified the audit committee of Sun’s Board of Directors that certain non-auditwork it performed in Japan, Saudi Arabia and Greece raised questions regarding Ernst & Young LLP’s independencewith respect to its performance of audit services.

Sun and Ernst & Young LLP continue to evaluate and review processes relevant to the maintenance of Ernst & YoungLLP’s independence. The audit committee has discussed with Ernst & Young LLP its independence from theCompany.

RISK FACTORS

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

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

We compete in the computer systems (hardware and software) and network storage (hardware and software) productsand services markets. These markets are intensely competitive. If we fail to compete successfully in these markets, thedemand 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. Thesecompetitive 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 BusinessMachines Corporation (IBM), Hewlett-Packard Company (HP), EMC Corporation (EMC), Fujitsu Limited (Fujitsu)and the Fujitsu-Siemens joint venture. We also compete with systems manufacturers and resellers of systems based onmicroprocessors from Intel Corporation (Intel) and the Windows family of operating systems software from MicrosoftCorporation (Microsoft). These competitors include Dell Inc. (Dell) and HP, in addition to Intel and Microsoft. Certainof these competitors compete aggressively on price and seek to maintain very low cost structures. Some of thesecompetitors 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 seeingincreased competition and pricing pressures from competitors offering systems running Linux software and other opensource software. In addition, certain of our competitors, including IBM and HP, have financial and human resourcesthat are substantially greater than ours, which increases the competitive pressures we face.

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Customers make buying decisions based on many factors, including among other things, new product and serviceofferings 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 andavailability 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; vendorreputation and vendor viability. As competition increases, each factor on which we compete becomes more importantand the lack of competitive advantage with respect to one or more of these factors could lead to a loss of competitiveposition, resulting in fewer customer orders, reduced revenues, reduced margins, reduced levels of profitability andloss 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 substantialquantities of our products throughout the world. In addition, on May 31, 2004, we entered into a number of agreementswith Fujitsu intended to substantially increase the scope of our relationship with them, including through collaborativeselling efforts and joint development and marketing of a future generation of server products. However, Fujitsu is alsoa competitor of Sun and, as a licensee of various technologies from Sun and others, it has developed products thatcurrently compete directly with our products.

Over the last several years, we have invested significantly in our network storage products business with a view toincreasing 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 iscurrently a leader in the network storage products market and our primary competitor.

We are continuing the implementation of a solution-based selling approach. While our strategy is that this will enableus 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 theshort term, as we compete to attract business. In addition, if our emphasis on solution-based sales increases, we facestrong competition from systems integrators such as IBM, Fujitsu-Siemens and HP. Our inability to successfullyimplement this model in the long term would have a material adverse impact on our revenues and margins.

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

One of our business strategies is to derive a competitive advantage and a resulting enhancement of our gross marginsfrom our investment in innovative new technologies which customers value. As a result, as a percentage of total netrevenues, we incur higher fixed R&D costs than many of our competitors. To the extent that we are unable to developand sell products with attractive gross margins in sufficient volumes, our earnings may be materially and adverselyaffected by our cost structure. We continue to add new products to our entry-level server product line that are offered ata 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 grossmargin percentages, to the extent that the mix of our overall revenues represented by sales of lower gross marginproducts increases, as it did during much of fiscal 2005, our gross margins and earnings may be materially andadversely affected.

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

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The products we make are very complex. If we are unable to rapidly and successfully develop and introduce newproducts 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 todevelop and introduce new products that our customers choose to buy. If we are unable to develop new products, ourbusiness and operating results could be adversely affected. We must quickly develop, introduce, and deliver in quantitynew, complex systems, software, and hardware products and components. These include products that incorporate ourUltraSPARC IV architecture and the Solaris Operating System (Solaris OS), the Java platform, Sun Java Systemportfolio and N1 Grid architecture, among others. The development process for these complicated products is veryuncertain. It requires high levels of innovation from both our product designers and the suppliers of the componentsused in our products. The development process is also lengthy and costly. If we fail to accurately anticipate ourcustomers’ needs and technological trends, or are otherwise unable to complete the development of a product on atimely basis, we will be unable to introduce new products into the market on a timely basis, if at all, and our businessand 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 newproduct, we face several challenges in the manufacturing process. We must be able to manufacture new products insufficient volumes so that we can have an adequate supply of new products to meet customer demand. We must also beable to manufacture the new products at acceptable costs. This requires us to be able to accurately forecast customerdemand so that we can procure the appropriate components at optimal costs. Forecasting demand requires us to predictorder volumes, the correct mix of our hardware and software products, and the correct configurations of these products.We must manage new product introductions and transitions, such as the product transition from UltraSPARC III toUltraSPARC IV microprocessors to minimize the impact of customer-delayed purchases of existing products inanticipation of new product releases. We must also try to reduce the levels of older product and component inventoriesto minimize inventory write-offs. If we have excess inventory, it may be necessary to reduce our prices and write downinventory, which could result in lower gross margins. Additionally, our customers may delay orders for existingproducts in anticipation of new product introductions. As a result, we may decide to adjust prices of our existingproducts during this process to try to increase customer demand for these products. Our future operating results wouldbe materially and adversely affected if such pricing adjustments were to occur and we were unable to mitigate theresulting margin pressure by maintaining a favorable mix of systems, software, service and other products, or if wewere 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 customerdemand at acceptable costs, or if we are unable to correctly anticipate customer demand for our new and existingproducts, our business and operating results could be materially adversely affected.

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

On May 31, 2004, we entered into a number of agreements with Fujitsu intended to substantially increase the scope ofour relationship with them. These agreements contemplate collaborative sales and marketing efforts and the jointdevelopment 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 large proportion of our server product line and have agreed not tosell certain products which may compete with the APL at certain times as well as to purchase certain componentssolely from Fujitsu at certain times. In addition, the agreements contemplate that we dedicate substantial financial andhuman resources to this new relationship. As such, our future performance and financial condition will be substantiallyimpacted 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 tonumerous risks. If we do not satisfy certain development or supply obligations under the agreements, or if weotherwise 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 infringementclaims, supply difficulties, difficulties in meeting development milestones or financial challenges, these could impactour strategic relationship with them and could result in a material adverse effect on our business or results ofoperations.

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The contractual arrangements contain objectives and deliverables that are to be concluded in the near term, known inthe 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 ofthe agreements establishing the relationship will ultimately prove to be favorable to us. If any of the risks describedabove come to pass, they may result in a material adverse effect on our business, results of operations or financialcondition.

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

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

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

We depend on many suppliers for the necessary parts and components to manufacture our products. There are anumber of vendors producing the parts and components that we need. However, there are some components that canonly be purchased from a single vendor due to price, quality or technology reasons. For example, we currently dependon Texas Instruments for the manufacture of our UltraSPARC microprocessors and several other companies for customintegrated circuits. If we were unable to purchase on acceptable terms or experienced significant delays or qualityissues in the delivery of necessary parts and/or components from a particular vendor and we had to find a new supplierfor these parts and components, our new and existing product shipments could be delayed which could have a materialadverse effect on our business, results of operations and financial conditions.

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

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

Because we may order components from suppliers in advance of receipt of customer orders for our products whichinclude 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 receiptof customer orders. We occasionally enter into negotiated orders with vendors early in the manufacturing process ofour microprocessors to make sure we have enough of these components for our new products to meet anticipatedcustomer demand. Because the design and manufacturing process for these components is very complicated it ispossible that we could experience a design or manufacturing flaw that could delay or even prevent the production of

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the components for which we have previously committed to pay. We also face the risk of ordering too manycomponents, or conversely, not enough components, since supply orders are generally based on forecasts of customerorders rather than actual customer orders. In addition, in some cases, we make noncancelable order commitments toour suppliers for work-in-progress, supplier’s finished goods, custom sub-assemblies and Sun unique raw materials thatare necessary to meet our lead times for finished goods. If we cannot change or be released from supply orders, wecould incur costs from the purchase of unusable components, either due to a delay in the production of the componentsor other supplies or as a result of inaccurately predicting supply orders in advance of customer orders. Our business andoperating 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 couldseriously 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 JavaSystem portfolio, N1 Grid and Sun StorEdge array products. Any delay in the development, delivery or acceptance ofkey elements of the hardware or software included in our systems could delay our shipment of these systems. Delays inthe 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 couldalso delay customer acceptance of new hardware products tied to that release. Implementing a new release of anoperating 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 systemand make sure these applications will run on the new operating system. As a result, customers may decide to delaytheir adoption of a new release of an operating system because of the cost of a new system and the effort involved toimplement it. Such delays in product development and customer acceptance and implementation of new products couldmaterially 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 softwareproducts contain defects, including defects in our engineering, design and manufacturing processes, as well as defectsin third-party components included in our products, which may be beyond our control. Often defects are identifiedduring our design, development and manufacturing processes and we are able to correct many of these. Sometimesdefects are identified after introduction and shipment of new products or enhancements to existing products.

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

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

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

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could result in greater costs to us for our overseas operations. Changes to and compliance with a variety of foreign lawsand regulations may increase our cost of doing business in these jurisdictions. Trade protection measures and importand export licensing requirements subject us to additional regulation and may prevent us from shipping products to aparticular market, and increase our operating costs. In addition, we could be subject to regulations, fines and penaltiesfor violations of import and export regulations. Although we implement policies and procedures designed to ensurecompliance with these laws, there can be no assurance that all of our employees, contractors and agents, as well asthose companies to which we outsource certain of our business operations, including those based in or from countrieswhere practices which violate such United States laws may be customary, will not take actions in violations of ourpolicies. Such violations could result in penalties, including prohibiting us from exporting our products to one or morecountries, 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 additionallegal compliance costs associated with our international operations and could become subject to legal penalties inforeign countries if we do not comply with local laws and regulations, which may be substantially different from thosein the United States. In many foreign countries, particularly in those with developing economies, it is common toengage in business practices that are prohibited by United States regulations applicable to us such as the ForeignCorrupt Practices Act. Although we implement policies and procedures designed to ensure compliance with these laws,there can be no assurance that all of our employees, contractors and agents, as well as those companies to which weoutsource certain of our business operations, including those based in or from countries where practices which violatesuch United States laws may be customary, will not take actions in violations of our policies. Any such violation, evenif 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 todevelop and implement our global resourcing strategy and operating model which includes activities that are focusedon increasing workforce flexibility and scalability, and improving overall competitiveness by leveraging external talentand skills worldwide. To the extent we rely on partners or third party service providers for the provision of keybusiness process functions, we may incur increased business continuity risks. We may no longer be able to exercisecontrol 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 couldadversely affect our business. If we are unable to effectively develop and implement our resourcing strategy due to,among other things, data protection contractual or regulatory compliance issues, we may not realize cost structureefficiencies and our operating and financial results could be materially and adversely affected. In addition, if we areunable to effectively utilize or integrate and interoperate with external resources or if our partners or third party serviceproviders experience business difficulties or are unable to provide business process services as anticipated, we mayneed to seek alternative service providers or resume providing such business processes internally, which could becostly 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 offactors, including:

Seasonality. Although our sales and other operating results can be influenced by a number of factors and historicalresults are not necessarily indicative of future results, our sequential quarterly operating results generally fluctuatedownward 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 suchquarter’s total revenues occur in the last month and weeks and days of the quarter. This pattern can make prediction ofrevenues, earnings and working capital for each financial period difficult and uncertain and increase the risk ofunanticipated variations in quarterly results and financial condition. Although we have seen more linearity in thetiming of our revenues throughout recent quarters, there can be no assurance that we will not see a return to thesehistorical patterns.

Foreign Currency Fluctuations. As a large portion of our business takes place outside of the U.S., we enter intotransactions in other currencies. Although we employ various hedging strategies, we are exposed to changes in

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exchange rates, which causes fluctuations in our quarterly operating results. See Part II, Item 7A. “Quantitative andQualitative 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 thedetermination of the recoverability of certain of the deferred tax assets, which arise from net operating losses, taxcarryforwards and temporary differences between the tax and financial statement recognition of revenue and expense.SFAS No. 109, “Accounting for Income Taxes,” also requires that the deferred tax assets be reduced by a valuationallowance, if based on the weight of available evidence, it is more likely than not that some portion or all of therecorded 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 andnegative evidence including our past operating results, the existence of cumulative losses in the most recent fiscal yearsand 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-taxoperating income, the reversal of temporary differences and the implementation of feasible and prudent tax planningstrategies. These assumptions require significant judgment about the forecasts of future taxable income and areconsistent with the plans and estimates we are using to manage the underlying businesses. Cumulative losses incurredin the U.S. and certain foreign jurisdictions in recent years and insufficient forecasted future taxable income in certainother foreign jurisdictions represented sufficient negative evidence to require full and partial valuation allowances inthese 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 ourvaluation 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 anannual basis or whenever events occur that may indicate impairment possibly exists. Goodwill is deemed to beimpaired if the net book value of the reporting unit exceeds the estimated fair value. The impairment of a long-livedintangible asset is only deemed to have occurred if the sum of the forecasted undiscounted future cash flows related tothe asset are less than the carrying value of the intangible asset we are testing for impairment. If the forecasted cashflows are less than the carrying value, then we must write down the carrying value to its estimated fair value. Werecognized an impairment charge of $49 million related to our goodwill during the fourth quarter of fiscal 2004 and animpairment charge of $2.1 billion related to our goodwill and other intangible assets during the second quarter of fiscal2003. As of June 30, 2005, we had a goodwill balance of $441 million. Going forward we will continue to review ourgoodwill and other intangible assets for possible impairment. Any additional impairment charges could adverselyaffect our future earnings.

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

As a multinational corporation, we are subject to income taxes in both the U.S. and various foreign jurisdictions. Ourdomestic 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 jurisdictionsin which we operate. We are regularly subject to audits by tax authorities. While we believe we have complied with allapplicable income tax laws, there can be no assurance that a governing tax authority will not have a differentinterpretation of the law and reallocate revenues and expenses resulting in additional taxes. We regularly review thelikelihood of adverse outcomes resulting from these audits to determine if additional income taxes, penalties andinterest would be assessed. There can be no assurance that the outcomes from these audits will not have an adverseeffect 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 GEwas generated through GE subsidiaries acting as either a reseller or financier of our products. The vast majority of thisrevenue 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 endusers. No other customer accounted for more than 10% of net revenues. The revenues from GE are generated in theProduct Group and Sun Services segments.

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We also depend on the telecommunications, financial services and government sectors for a significant portion of ourrevenues. Our revenues are dependent on the level of technology capital spending in the U.S. and internationaleconomies. If the current uncertain economic conditions continue in some or all of these sectors and geographies, wewould expect that the significant reduction and deferrals of capital spending could continue. If capital spendingdeclines in these industries over an extended period of time, our business will continue to be materially and adverselyaffected. We continue to execute on our strategy to reduce our dependence on these industries by expanding ourproduct 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 resellerchannel. We face ongoing business risks due to our reliance on our channel partners to maintain customer relationshipsand create customer demand with customers where we have no direct relationships. Should the effectiveness of ourchannel partners 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 rightsof others. Responding to such claims, regardless of their merit, can be time consuming, result in costly litigation, divertmanagement’s attention and resources and cause us to incur significant expenses. Several pending claims are in variousstages of evaluation. From time to time, we consider the desirability of entering into licensing agreements in certain ofthese cases. No assurance can be given that licenses can be obtained on acceptable terms or that litigation will notoccur. In the event there is a temporary or permanent injunction entered prohibiting us from marketing or sellingcertain 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 substitutetechnology, our business, results of operations or financial condition could be materially adversely affected. See Part I,Item 3, “Legal Proceedings” for further discussion.

Our acquisition and alliance activities could disrupt our ongoing business.

We expect to continue to make investments in companies, products, and technologies, either through acquisitions orinvestments or alliances. For example, we have purchased several companies in the past and have also formedalliances, such as our strategic relationship with Fujitsu for the development, manufacturing and marketing of serverproducts and our OEM relationship with Hitachi Data Systems for the collaboration on, and delivery of, a broad rangeof storage products and services. We also rely on IT services partners and independent software developers to enhancethe 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 acquiredtechnology 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 competitorsacquire or enter into exclusive arrangements with companies with whom we do business or may do business in thefuture. Reductions in the number of partners with whom we may do business in a particular context may reduce ourability to enter into critical alliances on attractive terms or at all, and the termination of an existing alliance by abusiness partner may disrupt our operations.

In August 2005, we acquired StorageTek and SeeBeyond, both U.S. publicly traded companies. In addition to the riskswe generally face in connection with acquisitions, there are several unique risks we face in connection with theStorageTek 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 littleexperience 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, theycould significantly disrupt our business. In particular, the simultaneous integration of both StorageTek and SeeBeyond,as well as our acquisition of Tarantella, could divert management’s attention from managing our existing on-going

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business. Additionally, we could fail to coordinate and integrate the substantial international operations, relationshipsand facilities, of these companies which may be subject to additional constraints imposed by local laws andregulations. Moreover, we may have higher than anticipated costs in continuing support and development of theproducts from these acquisitions. Our failure to effectively consolidate our facilities, IT operations and otheradministrative operations with those of these companies could affect anticipated synergies. In addition, coordinatingour sales and marketing efforts to effectively and efficiently sell the products of our combined company may proveunsuccessful. Our failure to properly motivate the sales forces of these companies could cause retention issues thatcould materially affect the success of the acquisitions. Finally, our failure to persuade employees that our businesscultures are compatible, or our inability to maintain good employee morale and retain key employees, could materiallyaffect our business operations. If we fail to successfully address these integration challenges in a timely manner, or atall, 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 thetransactions, which are based on forecasts which are subject to numerous assumptions which may prove to beinaccurate. Any one of these integration challenges or any combination thereof could materially affect our results ofoperations.

Our credit rating is subject to downgrade.

Three credit rating agencies follow Sun. Fitch Ratings and Moody’s Investor Services, have rated us BBB- and Baa3,respectively, which are investment grade ratings. Standard & Poor’s has assigned us a long-term non-investment graderating of BB+ and a short-term investment-grade rating of A-3. Fitch Ratings and Standard &Poor’s have placed us onstable outlook while Moody’s Investor Services has placed us under review for possible downgrade. These ratingsreflect those credit agencies’ expectations that the intense competitive environment facing Sun in its core markets willcontinue to challenge Sun’s revenue and profitability, at least over the near term. If we were to be downgraded by theseratings 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 theinterest characteristics of any new debt. Any of these events could materially and adversely affect our business andfinancial 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 toreplace. We generally do not have employment contracts with our key employees. Further, we do not maintain keyperson 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 bedifficult due to morale challenges posed by our workforce reductions, global resourcing strategies and relateduncertainties. Should these conditions continue, we may not be able to retain highly qualified employees in the futurewhich could adversely affect our business.

Our use of a self-insurance program to cover certain claims for losses suffered and costs or expenses incurred couldnegatively 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 assupplemental coverage for certain potential liabilities including, but not limited to general liability, directors andofficers liability, workers compensation, errors and omissions liability and property. We self-insure when we believethe lack of availability and high cost of commercially available insurance products do not make the transfer of this riska reasonable approach. In the event that the frequency of losses experienced by Sun increased unexpectedly, theaggregate 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 ofcertain insurance products while increasing the costs of such products, we will continue to evaluate the levels of claimswe include in our self-insurance program. Any increases to this program increase our risk exposure and thereforeincrease the risk of a possible material adverse effect on our financial condition, liquidity, cash flows and results ofoperations. In addition, we have made certain judgments as to the limits on our existing insurance coverage that webelieve are in line with industry standards, as well as in light of economic and availability considerations. Unforeseen

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catastrophic loss scenarios could prove our limits to be inadequate, and losses incurred in connection with the knownclaims we self-insure could be substantial. Either of these circumstances could materially adversely affect our financialand 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. Inaddition, some of our facilities are located on filled land and, therefore, may be more susceptible to damage if anearthquake occurs. We do not carry earthquake insurance for direct earthquake-related losses. In addition, we do notcarry business interruption insurance for, nor do we carry financial reserves against, business interruptions arising fromearthquakes or certain other events. If a business interruption occurs, our business could be materially and adverselyaffected.

Recently issued regulations related to equity compensation could adversely affect our ability to attract and retain keypersonnel.

Since our inception, we have used stock options and other long-term equity incentives as a fundamental component ofour employee compensation packages. We believe that stock options and other long-term equity incentives directlymotivate our employees to maximize long-term stockholder value and, through the use of vesting, encourageemployees to remain with Sun. The FASB issued changes to U.S. GAAP that requires us to record a charge to earningsfor new and unvested employee stock option grants beginning on July 1, 2005. This regulation will negatively impactour earnings. For example, recording a charge for employee stock options under SFAS 123, “Accounting for Stock-Based Compensation” would have increased our net loss by $747 million, $818 million and $555 million for fiscal2005, 2004 and 2003, respectively. See also Note 3 to the Notes to Consolidated Financial Statements — Summary ofSignificant Accounting Policies: Stock Options Plans and Recent Pronouncements. In addition, regulations of theNasdaq National Market that require shareholder approval for all stock option plans, and regulations implemented bythe 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 difficultfor us to grant options to employees in the future. To the extent that new regulations make it more difficult orexpensive to grant stock options to employees, we may incur increased compensation costs, change our equitycompensation strategy or find it difficult to attract, retain and motivate employees, each of which could materially andadversely 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 forpricing, data protection and other terms. In connection with these contracts, we are in some cases required to allow thecustomer to audit certain of our records to verify compliance with these terms. In particular, government agencycustomers audit and investigate government contractors, including us. These agencies review our performance underthe applicable contracts as well as compliance with applicable laws, regulations and standards. It is the general practiceof government agencies to subject commercial companies, such as ours, to renegotiation of existing contracts. To theextent that significant adjustments to our government contractual terms result from such renegotiations, our businessand results of operations could be materially impacted. The government also may review the adequacy of, and ourcompliance 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 uncoversimproper or illegal activities, we may be subject to penalties and other sanctions. In addition, we could suffer seriousharm to our reputation if allegations of impropriety were made against us. The General Services Administration iscurrently 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 toachieve the cost savings and operating efficiencies anticipated by these restructuring plans is dependent on our ability

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to effectively implement the workforce and excess capacity reductions contemplated. If we are unable to implementthese initiatives effectively, we may not achieve the level of cost savings and efficiency benefits expected for fiscal2006 and beyond.

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

In response to the global economic slowdown, we implemented facility exit plans in each of the last five fiscal years aspart of our ongoing efforts to consolidate excess facilities. The uncertain economic conditions in the United States andin many of the countries in which we have significant leased properties have resulted in a surplus of business facilitiesmaking it difficult to sublease properties. We may be unable to sublease our excess properties, or we may not meet ourexpected estimated levels of subleasing income, and accordingly our results of operations could be materially andadversely 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 theseenvironmental laws, yet compliance with such laws could increase our operations and product costs; increase thecomplexities of product design, procurement, and manufacture; limit our sales activities; and impact our futurefinancial results. Any violation of these laws can subject us to significant liability, including fines, penalties, andprohibiting sales of our products into one or more states or countries, and result in a material adverse effect on ourfinancial condition.

Currently, a significant portion of our revenues come from international sales. Recent environmental legislation withinthe European Union (EU) may increase our cost of doing business internationally and impact our revenues from EUcountries as we comply with and implement these new requirements. The EU has published Directives on therestriction of certain hazardous substances in electronic and electrical equipment (the RoHS Directive), and onelectronic 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 therestrictions on lead and certain other chemical substances as of July 1, 2006. We must adjust our product compositionand 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 areunable to introduce new products to conform to the RoHS Directive substance restrictions, sales of our products withinthe EU could decline. In addition, certain electronic products that we maintain in inventory may be rendered obsolete ifnot in compliance with the substance restriction, which could negatively impact our ability to generate revenue fromthose products.

The WEEE Directive makes producers of certain electrical and electronic equipment financially responsible forcollection, reuse, recycling, treatment, and disposal of equipment placed on the EU market after August 13, 2005. TheWEEE Directive also makes commercial end users of electronic equipment financially responsible for the collectionand management of equipment placed on the market before the August 2005 date. In our capacity as a producer ofelectronic equipment, we must bear the costs of taking back products we sell into the EU and managing the treatmentand ultimate disposal of these products. As an end user of electronic equipment in our EU business operations, we mustalso bear the cost of managing this waste equipment at the end of its useful life. The WEEE Directive also requireslabeling products placed on the EU market after the August 2005 date. As a result of these obligations, our productdistribution, logistics and waste management costs may increase and may adversely impact our financial condition. Asof July 2005, many member states within the EU have not enacted enabling legislation under the WEEE Directive, andin the absence of such legislation, it is difficult to determine the amount of expenses necessary to comply with theWEEE Directive. However, in our capacity as an end user, we will account for our historic waste equipment inaccordance 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 electronicand electrical equipment is not covered by the FASB pronouncement and is assumed to be treated as a a non-currentaccrued liability starting on August 13, 2005.

Similar environmental legislation has been or may be enacted in other jurisdictions, including the U.S. (under federaland state laws), and China, the cumulative impact of which could be significant. We are committed to offering products

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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 beaffected by many factors such as quarterly increases or decreases in our earnings, speculation in the investmentcommunity 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, acquisitionsor divestitures by us or one of our competitors or the loss of key management personnel. In addition, generalmacroeconomic and market conditions unrelated to our financial performance may also affect our stock price.

We face costs and risks associated with compliance with Section 404 of the Sarbanes-Oxley Act.

We continue to evaluate our internal control systems in order to allow our management to report on, and ourindependent auditors to attest to, our internal controls over financial reporting, as required by Section 404 of theSarbanes-Oxley Act. As a result, we continue to incur substantial expenses and management’s time continues to bediverted. In addition, we acquired two publicly-traded companies in the first quarter of fiscal 2006. There can be noassurance that we will be able to properly integrate the internal controls processes of the acquired companies. If we arenot able to implement the requirements of Section 404 in a timely manner or not able to implement them with adequatecompliance with regard to the acquired companies, we might be subject to harm to our reputation and/or investigationby regulatory authorities. Any such action could adversely affect our financial results and the market price of ourcommon stock.

FORWARD-LOOKING STATEMENTS

This annual report, including the following sections, contains forward-looking statements within the meaning of thePrivate Securities Litigation Reform Act of 1995, particularly statements regarding our belief that errors related to theaccounting for deferred taxes were immaterial to our financial statements and selected financial information for fiscal2004 and 2003; the core elements of our business strategy; our focus on technological innovation; that we intend tocontinue our investments into new computing technologies and are focused on the development and delivery ofleading-edge network computing products based upon our innovations; our expectation that our joint authorship andcommitment to the system management specification with Microsoft will enable full system management across ourSolaris OS and Microsoft Windows environments; our belief that any necessary licenses or other rights associated withour patents or other intellectual property rights could be obtained on commercially reasonable terms; our commitmentto reduce regulated chemicals from our products and operations; our intent to meet or exceed all requirements andsimilar environmental legislation related to RoHS; our intent to meet all requirements of the Directive in a timelymanner; our expectation to increase our headcount by approximately 8,500 employees as a result of our SeeBeyondand StorageTek acquisitions; that we may not be able to retain highly qualified employees in the future and this couldharm our business; that we continually evaluate our facility requirements in light of our business needs and stage thefuture construction accordingly; that we intend to present a vigorous defense in the Gobelli patent infringement case;our anticipation of retaining available funds to finance future growth and have no present intention to pay cashdividends; that our focus on cash management remains a top priority; our plan to continue to drive improvement in ourcash conversion cycle; our belief that our estimates and judgments are reasonable under the circumstances; our beliefthat the critical accounting policies are the most critical to our financial statements because their application places themost significant demands on management’s judgment; that we may continue to engage in restructuring actions andactivities associated with productivity improvements initiatives; our expectation that the adoption of SFAS123R willhave a material impact on our results of operations; our belief that to maintain our competitive position in a marketcharacterized by rapid rates of technological advancement, we must continue to invest significant resources in newsystems, software, and microprocessor development, as well as continue to enhance existing products; our continuingfocus on achieving additional operating efficiencies by reviewing and improving upon our existing business processesand cost structure; our estimates of the obligations we expect to incur in connection with our sublease arrangementswith third parties; our plan to reduce our workforce by approximately 1,000 employees across certain employee levels,business functions, operating units, and geographic regions; our plan to eliminate excess facility capacity in light ofrevised facility requirements; our anticipation to record additional charges related to our workforce and facilities

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reductions over the next several quarters; our anticipation of incurring additional charges associated with productivityimprovement initiatives and expense reduction measures; our expectation to pay the remaining restructuring accrualrelated to severance over the next few quarters; our belief that there was a reasonable chance of realizing the economicreturn expected from the acquired in-process technology; our belief that the projections we used in performing ourvaluations for each acquisition are still valid in all material respects; that we continue to make substantial progressrelated to the development and commercialization of acquired technologies; that the ongoing valuation of ourinvestment portfolio remains uncertain and may be subject to fluctuations; our expectation that the volatility of thisportfolio will decrease as its duration decreases; our expectation not to achieve a material amount of expensereductions or synergies; our intention to maintain this valuation allowance until sufficient positive evidence exists tosupport reversal of the valuation allowance; our expectation to generate positive cash flow from operations for the fullfiscal year ending June 30, 2006; our focus on the cash conversion cycle as we continue to try to efficiently manage ourassets; that inventory management will continue to be an area of focus; our long-term strategy to maintain a minimumamount of cash and cash equivalents in subsidiaries for operational purposes and how to invest the remaining amountof our cash; our belief that the liquidity will provide sufficient capital to meet our requirements for at least 12 months;and our belief that our level of financial resources is a significant competitive factor.

These forward-looking statements involve risks and uncertainties, and the cautionary statements set forth below and thosecontained in “RISK FACTORS,” identify important factors that could cause actual results to differ materially from thosepredicted in any such forward-looking statements. Such factors include, but are not limited to, the delay or cancellation ofnew product introductions, our failure to timely meet the environmental directives, our failure to successfully integraterecently acquired companies, the decrease in our negotiating leverage, our failure to retain the current level of financialresources, increased competition, continued adverse economic conditions in the U.S. and internationally, includingadverse economic conditions in the specific markets for our products, adverse business conditions, failure to design,develop and manufacture new products, lack of success in technological advancements, pricing pressures, lack ofacceptance of new products, unexpected changes in the demand for our products and services, the inability to successfullymanage inventory pricing pressures, failure to reduce costs or improve operating efficiencies, changes to and compliancewith international laws and regulations, currency fluctuations, failure in our Microsoft relationship, failure to prevail inpatent infringement cases and our ability to attract, hire and retain key and qualified employees.

ITEM 7A. 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 securityprices. To mitigate some of these risks, we utilize derivative financial instruments to hedge these exposures. We do notuse derivative financial instruments for speculative or trading purposes. All of the potential changes noted below arebased on sensitivity analyses performed on our financial position at June 30, 2005. Actual results may differ materially.

Interest Rate Sensitivity

Our debt investment portfolio consists primarily of fixed income instruments with an average duration of 0.68 years asof June 30, 2005, as compared to 0.82 years as of June 30, 2004 and 0.72 years as of June 30, 2003. The primaryobjective of our investments in debt securities is to preserve principal while maximizing yields, without significantlyincreasing risk. These available-for-sale securities are subject to interest rate risk. The fair market value of thesesecurities may fluctuate with changes in interest rates. A sensitivity analysis was performed on this investmentportfolio based on a modeling technique that measures the hypothetical fair market value changes (using a three monthhorizon) 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 $67 million decrease inthe fair value of our investments in debt securities as of June 30, 2005, as compared with a $75 million decrease as ofJune 30, 2004.

We also entered into various interest-rate swap agreements to modify the interest characteristics of the Senior Notes sothat the interest payable on the Senior Notes effectively becomes variable and thus matches the shorter-term ratesreceived from our cash and marketable securities. Accordingly, interest rate fluctuations impact the fair value of ourSenior 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 ratesmay increase. For example, at June 30, 2005, a hypothetical 150 BPS increase in interest rates would result in anapproximate $17 million increase in interest expense over a one-year period.

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Foreign Currency Exchange Risk

Our revenue, expense, and capital purchasing activities are primarily transacted in U.S. dollars. However, since aportion of our operations consists of manufacturing and sales activities outside of the U.S., we enter into transactions inother 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 beadversely 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 sales and operating marginsas expressed in U.S. dollars. To minimize currency exposure gains and losses, we often borrow funds in localcurrencies, enter into forward exchange contracts, purchase foreign currency options and promote natural hedges bypurchasing components and incurring expenses in local currencies. Currently, we have no plans to discontinue ourhedging programs, however, we continually evaluate the benefits of our hedging strategies and may choose todiscontinue them in the future.

Based on our foreign currency exchange instruments outstanding at June 30, 2005, we estimate a maximum potentialone-day loss in fair value of approximately $2 million, as compared with $4 million as of June 30, 2004, 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 threethousand randomly generated market price paths. Anticipated transactions, firm commitments, receivables, andaccounts payable denominated in foreign currencies were excluded from the model. The VAR model is a riskestimation 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, aloss 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 equityinvestments. These investments are generally in companies in the high-technology industry sector, many of which aresmall 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 $7 million decrease in the fair value of ouravailable-for-sale equity investments as of June 30, 2005, as compared with $7 million as of June 30, 2004. At June 30,2005, three equity securities represented approximately $33 million of the $34 million total fair value of the marketableequity securities, as compared with June 30, 2004, at which time, three equity securities represented approximately $27million of the $35 million total fair value of the marketable equity securities. Refer to Note 3 to the ConsolidatedFinancial Statements for additional discussion on Sun’s marketable equity securities.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

As described in “Restatement—Explanatory Note” in the forepart of this Form 10-K, we have restated some of theconsolidated financial statements and related notes presented in this index.

Page

Consolidated Financial Statements of Sun Microsystems, Inc.:Consolidated Statements of Operations for each of the three fiscal years ended June 30, 2005 . . . . . . . . . . . . . . 62Consolidated Balance Sheets at June 30, 2005 and June 30, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63Consolidated Statements of Cash Flows for each of the three fiscal years ended June 30, 2005 . . . . . . . . . . . . . 64Consolidated Statements of Stockholders’ Equity for each of the three fiscal years ended June 30, 2005 . . . . . . 65Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66Reports of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106

Schedules not listed above have been omitted since they are not applicable or are not required, or the informationrequired to be set forth therein is included in the Consolidated Financial Statements or Notes thereto.

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SUN MICROSYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS(in millions, except per share amounts)

Fiscal Years Ended June 30,

2005 2004 2003

(Restated)

Net revenues:Products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,126 $ 7,355 $ 7,793Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,944 3,830 3,641

Total net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,070 11,185 11,434Cost of sales:

Cost of sales-products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,174 4,290 4,342Cost of sales-services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,307 2,379 2,150

Total cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,481 6,669 6,492

Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,589 4,516 4,942Operating expenses:

Research and development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,785 1,926 1,837Selling, general and administrative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,919 3,317 3,329Restructuring charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262 344 371Impairment of goodwill and other intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . — 49 2,125Purchased in-process research and development . . . . . . . . . . . . . . . . . . . . . . . . . . . — 70 4

Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,966 5,706 7,666

Operating loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (377) (1,190) (2,724)Gain (loss) on equity investments, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 (64) (84)Interest and other income, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133 94 155Settlement income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 1,597 —

Income (loss) before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (184) 437 (2,653)Provision for (benefit from) income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (77) 825 731

Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (107) $ (388) $ (3,384)

Net loss per common share-basic and diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.03) $ (0.12) $ (1.06)

Shares used in the calculation of net loss per common share-basic and diluted . . . . . . . 3,368 3,277 3,190

See accompanying notes.

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SUN MICROSYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS(in millions, except par values)

June 30,

2005 2004

(Restated)

ASSETSCurrent assets:

Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,051 $ 2,141Short-term marketable debt securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,345 1,460Accounts receivable, net of bad debt reserves of $86 in 2005 and $91 in 2004 . . . . . . . . . . . . . . 2,231 2,339Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 431 464Deferred and prepaid tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255 322Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 878 837

Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,191 7,563Property, plant and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,769 1,996Long-term marketable debt securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,128 4,007Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 441 406Other acquisition-related intangible assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113 127Other non-current assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 548 706

$14,190 $14,805

LIABILITIES AND STOCKHOLDERS’ EQUITYCurrent liabilities:

Current portion of long-term debt and short-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . $ — $ 257Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,167 1,057Accrued payroll-related liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 713 622Accrued liabilities and other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,014 1,325Deferred revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,648 1,617Warranty reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224 252

Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,766 5,130Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,123 1,175Long-term deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 544 557Other non-current obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,083 1,460Commitments and contingencies (Note 12)Stockholders’ equity:

Preferred stock, $0.001 par value, 10 shares authorized (1 share of which has been designatedas Series A Preferred participating stock); no shares issued and outstanding . . . . . . . . . . . . . . — —

Common stock and additional paid-in-capital, $0.00067 par value, 7,200 shares authorized;issued and outstanding: 3,602 shares in 2005 and 3,602 shares in 2004 . . . . . . . . . . . . . . . . . . 6,524 6,607

Treasury stock, at cost: 194 shares in 2005 and 266 shares in 2004 . . . . . . . . . . . . . . . . . . . . . . . (1,411) (2,776)Unearned equity compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (34) (47)Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,387 2,526Accumulated other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208 173

Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,674 6,483

$14,190 $14,805

See accompanying notes.

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SUN MICROSYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS(in millions)

Fiscal Years Ended June 30,

2005 2004 2003

(Restated) (Restated)Cash flows from operating activities:

Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (107) $ (388) $(3,384)Adjustments to reconcile net loss to net cash provided by operating activities:

Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 671 730 918Amortization of other intangible assets and unearned equity compensation . . . . . . 96 83 110Impairment of goodwill and other intangible assets . . . . . . . . . . . . . . . . . . . . . . . . — 49 2,125Tax benefits from employee stock plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 4 9Deferred taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (315) 620 654Loss on investments, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 64 84Purchased in-process research and development . . . . . . . . . . . . . . . . . . . . . . . . . . . — 70 4Changes in operating assets and liabilities:

Accounts receivable, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 61 387Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 (44) 181Prepaid and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (19) (288) (231)Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 158 (133)Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (239) 1,107 313

Net cash provided by operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369 2,226 1,037

Cash flows from investing activities:Purchases of marketable debt securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (7,154) (8,469) (6,958)Proceeds from sales of marketable debt securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,181 5,795 6,476Proceeds from maturities of marketable debt securities . . . . . . . . . . . . . . . . . . . . . . . . 941 854 578Purchases of equity investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1) (19) (21)Proceeds from sales of equity investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 49 17Acquisition of property, plant and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . (257) (249) (373)Acquisition of spare parts and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (90) (71) (217)Payments for acquisitions, net of cash acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (95) (201) (30)

Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (425) (2,311) (528)

Cash flows from financing activities:Acquisition of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — (499)Proceeds from issuance of common stock, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 218 239 182Principal payments on borrowings and other obligations . . . . . . . . . . . . . . . . . . . . . . (252) (28) (201)

Net cash provided by (used in) financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (34) 211 (518)

Net increase (decrease) in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . (90) 126 (9)Cash and cash equivalents, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,141 2,015 2,024

Cash and cash equivalents, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,051 $ 2,141 $ 2,015

Supplemental disclosures of cash flow information:Interest paid (net of interest received from swap agreements of $62, $72 and $70 in

fiscal 2005, 2004 and 2003, respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 27 $ 26 $ 36Income taxes paid (received) (net of refunds of $34, $143 and $351 in fiscal 2005,

2004 and 2003, respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 371 $ 70 $ (91)Supplemental schedule of noncash investing activities:

Stock and options issued in connection with acquisitions . . . . . . . . . . . . . . . . . . . . . . $ 1 $ 125 $ 193

See accompanying notes.

64

SUN MICROSYSTEMS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(in millions)

Common Stockand AdditionalPaid-in-Capital Treasury Stock Unearned

EquityCompensation

RetainedEarnings

AccumulatedOther

ComprehensiveIncome (Loss)

TotalStockholders’

EquityShares Amount Shares Amount

(Restated) (Restated)

Balances as of June 30, 2002 (as reported) . . . . . . . 3,537 $6,485 (303) $(2,905) $(46) $ 6,298 $ (31) $ 9,801

Net loss (as restated) . . . . . . . . . . . . . . . . . . . . . . . . — — — — — (3,384) — (3,384)

Change in unrealized gain (loss) on investments,net of taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — 6 6

Change in unrealized gain (loss) on derivativeinstruments and other, net of taxes . . . . . . . . . . . — — — — — — 11 11

Translation adjustments . . . . . . . . . . . . . . . . . . . . . . — — — — — — 191 191

Total comprehensive loss (as restated) . . . . . . . . . . — — — — — — — (3,176)

Issuance of stock, net of repurchases . . . . . . . . . . . — (51) 78 235 — — — 184

Treasury stock purchased . . . . . . . . . . . . . . . . . . . . — — (126) (499) — — — (499)

Tax benefit from employee stock transactions andother . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 20 — — — — — 20

Issuance of common stock and assumption of stockoptions in connection with acquisitions . . . . . . . 50 193 — — (19) — — 174

Amortization of unearned equity compensation . . . — — — — 32 — — 32

Balances as of June 30, 2003 (as restated) . . . . . . . 3,587 6,647 (351) (3,169) (33) 2,914 177 6,536

Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — (388) — (388)

Change in unrealized gain (loss) on investments,net of taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — (48) (48)

Change in unrealized gain (loss) on derivativeinstruments and other, net of taxes . . . . . . . . . . . — — — — — — 14 14

Translation adjustments . . . . . . . . . . . . . . . . . . . . . . — — — — — — 30 30

Total comprehensive loss . . . . . . . . . . . . . . . . . . . . — — — — — — — (392)

Issuance of stock, net of repurchases . . . . . . . . . . . — (157) 85 393 — — — 236

Tax benefit from employee stock transactions andother . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 4 — — — — — 4

Issuance of common stock and assumption of stockoptions in connection with acquisitions . . . . . . . 15 113 — — (38) — — 75

Amortization of unearned equity compensation . . . — — — — 24 — — 24

Balances as of June 30, 2004 (as restated) . . . . . . . 3,602 6,607 (266) (2,776) (47) 2,526 173 6,483

Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — (107) — (107)

Change in unrealized gain on investments, net oftaxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — — 28 28

Change in unrealized gain on derivativeinstruments and other, net of taxes . . . . . . . . . . . — — — — — — 8 8

Translation adjustments . . . . . . . . . . . . . . . . . . . . . . — — — — — — (1) (1)

Total comprehensive loss . . . . . . . . . . . . . . . . . . . . — — — — — — — (72)

Issuance of stock, net of repurchases . . . . . . . . . . . — (115) 72 1,365 — (1,032) — 218

Tax benefit from employee stock transactions andother . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 25 — — — — — 25

Issuance of common stock and assumption of stockoptions in connection with acquisitions . . . . . . . — 7 — — (6) — — 1

Amortization of unearned equity compensation . . . — — — — 19 — — 19

Balances as of June 30, 2005 . . . . . . . . . . . . . . . . . 3,602 $6,524 (194) $(1,411) $(34) $ 1,387 $208 $ 6,674

See accompanying notes.

65

SUN MICROSYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Description of Business

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

2. Restatement of Financial Statements

We have restated our historical consolidated financial statements for fiscal 2004 and 2003 for the cumulative impact oferrors in accounting for deferred taxes in certain foreign jurisdictions totaling $41 million and corrections to provisionsfor State and foreign tax returns and withholding taxes of $4 million, which were identified in the third and fourthquarters of fiscal 2005. In addition, as a result of evaluating certain pre-tax accounting adjustments recordedthroughout fiscal year 2005, we restated the previously reported quarters of fiscal 2005.

The determination to restate these consolidated financial statements was made as a result of our assessment that theseitems, although immaterial to the consolidated financial statements for fiscal 2004 and 2003, would be consideredmaterial to the consolidated financial statements for the full fiscal year and previously reported quarters of 2005.

The adjustments associated with the above corrections in our accounting for taxes reduced our net loss by $45 millionor net loss per share by $0.01 in fiscal 2003 and had no net impact on the previously reported annual net loss for fiscal2004, but did result in restatements to our previously filed quarterly financial information for fiscal 2004.

The information included in this Form 10-K sets forth the effects of the Restatement on the previously reportedfinancial statements of operations for fiscal 2004 and 2003 and the affected quarters of 2005 and 2004.

Consolidated Statements of Operations

Our restatement resulted in no net impact to the Consolidated Statement of Operations for fiscal 2004. The followingtables represents the effect of the Restatement on the Consolidated Statements of Operations for fiscal 2003 and thequarters for fiscal 2005 and 2004 (in millions, except per share amounts):

Fiscal 2003

AsPreviouslyReported Adjustments

AsRestated

Income (loss) before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(2,653) $ — $(2,653)

Provision for (benefit from) income taxes . . . . . . . . . . . . . . . . . . . . . . . 776 (45) 731

Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(3,429) $ 45 $(3,384)

Net loss per common share—basic and diluted . . . . . . . . . . . . . . . . . . . $ (1.07) $ 0.01 $ (1.06)

Shares used in the calculation of net loss per common share—basicand diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,190 3,190 3,190

66

Fiscal 2005

(unaudited)First

QuarterSecondQuarter

ThirdQuarter

FourthQuarter

Year endedJune 30, 2005

(Restated) (Restated) (Restated)

Impact of pre-tax adjustments to income (loss) beforetaxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 14 $ (14) $ (3) $ 3 $ —

Impact of tax adjustments to provision for (benefit from)income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — 22 23 45

Net impact of adjustments to net income (loss) . . . . . . . . . . . . $ 14 $ (14) $ (25) $ (20) $ (45)

Net income (loss)—as previously reported/announced . . . . . . $ (147) $ 18 $ (3) $ 70(*) $ (62)(*)Impact of restatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 (14) (25) (20) (45)

Net income (loss)—as restated . . . . . . . . . . . . . . . . . . . . . . . . . $ (133) $ 4 $ (28) $ 50 $ (107)

Net income (loss) per share—basic and diluted—aspreviously reported/announced . . . . . . . . . . . . . . . . . . . . . . . $(0.04) $ 0.01 $(0.00) $ 0.02(*) $(0.02)(*)

Impact of restatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — (0.01) (0.01) (0.01) $(0.01)

Net income (loss) per share—basic and diluted, as restated . . . $(0.04) $ 0.00 $(0.01) $ 0.01 $(0.03)

(*) Amount reflects the impact of certain adjustments made to our reported results subsequent to the date of ourearnings announcement. See Item 7. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations for further information.

Fiscal 2004

(unaudited)First

QuarterSecondQuarter

ThirdQuarter

FourthQuarter

Year endedJune 30, 2004

(Restated) (Restated) (Restated) (Restated)

Impact of adjustments to provision for(benefits from) income taxes . . . . . . . . . . $ 2 $ 1 $ (6) $ 3 $ —

Net income (loss)—as previouslyreported . . . . . . . . . . . . . . . . . . . . . . . . . . $ (286) $ (125) $ (760) $ 783 $ (388)

Impact of restatement . . . . . . . . . . . . . . . . . . (2) (1) 6 (3) —

Net income (loss)—as restated . . . . . . . . . . . $ (288) $ (126) $ (754) $ 780 $ (388)

Net income (loss) per share—basic—aspreviously reported . . . . . . . . . . . . . . . . . . $(0.09) $(0.04) $(0.23) $ 0.24 $(0.12)

Impact of restatement . . . . . . . . . . . . . . . . . . — — — (0.01) —

Net income (loss) per share—basic—asrestated . . . . . . . . . . . . . . . . . . . . . . . . . . . $(0.09) $(0.04) $(0.23) $ 0.23 $(0.12)

Net income (loss) per share—diluted—aspreviously reported . . . . . . . . . . . . . . . . . . $(0.09) $(0.04) $(0.23) $ 0.23 $(0.12)

Impact of restatement . . . . . . . . . . . . . . . . . . — — — — —

Net income (loss) per share—diluted—asrestated . . . . . . . . . . . . . . . . . . . . . . . . . . . $(0.09) $(0.04) $(0.23) $ 0.23 $(0.12)

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The following table presents the effect of the Restatement on the Consolidated Balance Sheet for fiscal 2004 (inmillions):

AsPreviouslyReported Adjustments

AsRestated

Selected Balance Sheet Data at June 30, 2004:Deferred and prepaid tax assets (*) . . . . . . . . . . . . . . . . . . . . . . . . . $ 306 $16 $ 322Total current assets (*) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,547 $16 $ 7,563Other non-current assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 664 $42 $ 706Total assets (*) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $14,747 $58 $14,805Accrued liabilities and other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,308 $17 $ 1,325Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,113 $17 $ 5,130Other non-current obligations (*) . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,464 $ (4) $ 1,460Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,481 $45 $ 2,526Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,438 $45 $ 6,483Total liabilities and stockholders’ equity (*) . . . . . . . . . . . . . . . . . . $14,747 $58 $14,805

(*) The amounts presented as originally reported have been changed from the prior year to reflect reclassificationsrelated to deferred taxes to conform to the current year presentation.

The Restatement had no net effect on operating cash flows for fiscal 2004 and 2003 or on the quarters of fiscal 2005.The following table presents the effect to the individual line items within operating cash flows on the ConsolidatedStatements of Cash Flows for fiscal 2004 and 2003 (in millions):

Fiscal Years Ended June 30,

2004 2003

AsPreviouslyReported

AsRestated

AsPreviouslyReported

AsRestated

Selected Cash Flow Data:Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (388) $ (388) $(3,429) $(3,384)Deferred taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 620 $ 620 $ 706 $ 654Prepaid and other assets (*) . . . . . . . . . . . . . . . . . . . . . . . . $ (278) $ (288) $ (231) $ (231)Other liabilities (*) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,097 $1,107 $ 306 $ 313

(*) The amounts presented as originally reported have been changed from the prior year to reflect reclassificationsrelated to deferred taxes to conform to the current year presentation.

3. Summary of Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include the accounts of Sun and its subsidiaries. Intercompany accounts andtransactions have been eliminated. Certain amounts in our fiscal 2004 Consolidated Balance Sheet and Statement ofCash Flows related to deferred income taxes have been adjusted to reflect the change in allocation of valuationallowance on deferred income tax assets. This resulted in a $244 million increase to both our deferred tax assets andliabilities in fiscal 2004 and had no impact to our Consolidated Results of Operations.

Our consolidated financial statements have been prepared in accordance with generally accepted accounting principlesin the United States (U.S. GAAP). The preparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts in the consolidated financial statements and accompanying notes. Theseestimates form the basis for judgments we make about the carrying values of assets and liabilities that are not readilyapparent from other sources. We base our estimates and judgments on historical experience and on various otherassumptions that we believe are reasonable under the circumstances. U.S. GAAP requires us to make estimates andjudgments in several areas, including those related to impairment of intangible assets and equity investments, revenue

68

recognition, recoverability of inventory and accounts receivable, the probability that restoration provisions of assetretirement obligation will not be enforced, the fair value of derivative financial instruments, the recording of variousaccruals (including our accrual for restructuring charges), the useful lives of long-lived assets such as property andequipment, income taxes, warranty obligations and potential losses from contingencies and litigation. These estimatesare based on management’s knowledge about current events and expectation about actions the company may undertakein the future. Actual results could differ materially from those estimates.

Cash Equivalents

Cash equivalents consist primarily of highly liquid investments with insignificant interest rate risk and remainingmaturities of three months or less at the date of purchase.

Investments

We invest in marketable debt securities, marketable equity securities and other investments.

Marketable Debt Securities

Investments in marketable debt securities consist primarily of corporate notes and bonds, asset and mortgage backedsecurities and U.S. government notes and bonds with original maturities beyond three months. Short-term investmentsare marketable debt securities with maturities of less than one year from the balance sheet date (except cashequivalents), while long-term investments represent all other marketable debt securities. All marketable debt securitiesare held in Sun’s name and deposited primarily with one major financial institution. Sun’s policy is to protect the valueof its investment portfolio and minimize principal risk by earning returns based on current interest rates. We onlyinvest in marketable debt securities with a minimum rating of BBB- or above from a nationally recognized credit ratingagency. At June 30, 2005 and 2004, all of Sun’s marketable debt securities were classified as available-for-sale andwere carried at fair market value. The unrealized gains (losses) on available-for-sale securities, net of taxes, arerecorded in accumulated other comprehensive loss. See Note 8 for further detail.

Marketable Equity Securities

Investments in marketable equity securities consist of equity holdings in public companies. Marketable equitysecurities are initially recorded at cost upon acquisition and are classified as available-for-sale when there are norestrictions on Sun’s ability to liquidate such securities within 12 months. Investments in marketable equity securitieswere $34 million and $35 million at June 30, 2005 and 2004, respectively. At June 30, 2005, all marketable equityinvestments were classified as available-for-sale and are included in “Other non-current assets, net” in the ConsolidatedBalance Sheet. Changes in the fair value of these securities are recognized in “Accumulated other comprehensiveincome (loss),” in the Consolidated Statements of Stockholders’ Equity. Net unrealized gains on marketable equityinvestments were $23 million, $7 million and $5 million at June 30, 2005, 2004 and 2003, respectively. Marketableequity securities at June 30, 2005 and 2004 were (in millions):

2005

AdjustedCost

GrossUnrealized

Gains

GrossUnrealized

LossesFair

Value

Marketable equity securities with no unrealized losses . . . . . . . . . . . . . . . . . . . $11 $23 $— $34Marketable equity securities with unrealized losses . . . . . . . . . . . . . . . . . . . . . — — — —

Total marketable equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11 $23 $— $34

2004

AdjustedCost

GrossUnrealized

Gains

GrossUnrealized

LossesFair

Value

Marketable equity securities with no unrealized losses . . . . . . . . . . . . . . . . . . . $ 5 $ 9 $— $14Marketable equity securities with unrealized losses . . . . . . . . . . . . . . . . . . . . . 23 — (2) 21

Total marketable equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $28 $ 9 $ (2) $35

69

Realized gains on sales of marketable equity securities totaled $5 million, $2 million and $6 million in fiscal 2005,2004 and 2003, respectively, and are recognized in “Gain (loss) on equity investments, net” in the ConsolidatedStatements of Operations. In addition, we review all marketable equity securities for other than temporary declines infair value. In doing so, we evaluate the length of the time and the extent to which the market value has been less thancost, the financial condition and near-term prospects of the portfolio company, and our intent and ability to retain theinvestment for a period of time sufficient to allow for any anticipated recovery in market value. We considercircumstances where, as of the end of any quarter, the carrying value of a marketable equity security has been greaterthan its market value for the last six consecutive months, to be de-facto evidence of other than temporary impairment.We perform our evaluation of other than temporary impairment on a quarterly basis. Based on our evaluation, if asecurity is considered to be other than temporarily impaired, an impairment charge is recognized in “Gain (loss) onequity investments, net” in the Consolidated Statements of Operations. For fiscal years 2005, 2004 and 2003, $1million, none and $8 million were recorded as impairment charges related to marketable equity securities, respectively.

Other Investments

Other investments include equity investments in privately-held companies that develop products, markets and servicesthat are strategic to Sun, investments in venture capital funds and other joint ventures, securities lent under oursecurities lending program and the cash surrender value of life insurance policies.

Our equity investments are generally made in connection with a round of financing with other third-party investors. Asour investments in privately-held companies do not permit us to exert significant influence or control over the entity inwhich we are investing, the recorded amounts generally represent our cost of the investment less any adjustments wemake when we determine that an investment’s carrying value is other-than-temporarily impaired. At June 30, 2005, wehad approximately 35 investments in various high technology companies. These investments totaled $26 million and$59 million at June 30, 2005 and 2004, respectively, and were included in “Other non-current assets, net” in theConsolidated Balance Sheets.

The process of assessing whether a particular equity investment’s fair value is less than its carrying cost requires asignificant amount of judgment due to the lack of a mature and stable public market for these securities. In making thisjudgment, we carefully consider the investee’s most recent financial results, cash position, recent cash flow data,projected cash flows (both short and long-term), financing needs, recent financing rounds, most recent valuation data,the current investing environment, management or ownership changes, and competition. This process is basedprimarily on information that we request and receive from these privately-held companies, and is performed on aquarterly basis. Although we evaluate all of our privately-held equity investments for impairment based on the criteriaestablished above, each investment’s fair value is only estimated when events or changes in circumstances haveoccurred that may have a significant effect on its fair value (because the fair value of each investment is not readilydeterminable). Where these factors indicate that the equity investment’s fair value is less than its carrying cost, andwhere we consider such diminution in value to be other than temporary, we record an impairment charge to reducesuch equity investment to its estimated net realizable value. Based on our evaluations, we recorded impairmentcharges, net of realized gains on sales, related to our investments in privately-held companies of zero, $67 million and$72 million for fiscal 2005, 2004 and 2003, respectively.

Investments in venture capital funds and other joint ventures totaled $16 million at both June 30, 2005 and 2004, andwere accounted for using the equity method of accounting. We recorded income (loss) of $2 million, $1 million and($10) million for fiscal 2005, 2004 and 2003, respectively, related to these investments which was reflected in “Gain(loss) on equity investments, net.”

From time to time, we enter into securities lending agreements with financial institutions to enhance investmentincome. Selected securities are loaned and are secured by collateral equal to at least 102% of the fair market value ofthe securities. Collateral is in the form of cash or securities issued or guaranteed by the U.S. government, and oursecurities lending agent has provided us with counterparty indemnification in the event of borrower default. Loanedsecurities continue to be classified as investment assets on the consolidated balance sheet. Cash collateral is recorded asan asset with a corresponding liability. For lending agreements collateralized by securities, no accompanying asset orliability is recorded as we are not permitted to sell or repledge the associated collateral. The maximum amount loanedunder Sun’s securities lending program in fiscal 2005 was $923 million. As of June 30, 2005, there were nooutstanding securities lending transactions.

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We maintain certain investments in life insurance contracts to generate returns that offset changes in certain liabilitiesrelated to deferred compensation arrangements. These assets consist of the cash surrender value of the life insurancepolicies and are stated at fair value. Both realized and unrealized gains and losses, which have not been material, areincluded in income and expense and generally offset the change in the deferred compensation liability.

Bad Debt Reserves

We evaluate the collectibility of our accounts receivable based on a combination of factors. In cases where we areaware of circumstances that may impair a specific customer’s ability to meet its financial obligations to us, we record aspecific allowance against amounts due to us, and thereby reduce the net recognized receivable to the amount wereasonably believe will be collected. For all other customers, we recognize allowances for doubtful accounts based onthe length of time the receivables are past due, the current business environment and our historical experience. AtJune 30, 2005 and 2004, our bad debt reserves were $86 million and $91 million, respectively. We expensed amountsrelated to bad debt reserves of $10 million, $4 million and $37 million for fiscal 2005, 2004 and 2003, respectively.During fiscal years 2005, 2004 and 2003, we wrote-off bad debt reserves against gross accounts receivable ofapproximately $15 million, $25 million and $39 million, respectively.

Inventories

Inventories are stated at the lower of cost (first in, first out) or market (net realizable value). Inventory in-transit(included in finished goods) consists of products shipped but not recognized as revenue because they did not meet therevenue recognition criteria. We evaluate our ending inventories for estimated excess quantities and obsolescence. Thisevaluation includes analyses of sales levels by product and projections of future demand within specific time horizons(generally six months or less). Inventories in excess of future demand are reserved. In addition, we assess the impact ofchanging technology on our inventory-on-hand and we write-off inventories that are considered obsolete.

Long-lived Assets

Property, Plant and Equipment

Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation is provided principally onthe straight-line method over the estimated useful lives of the assets. The estimated useful lives for machinery andequipment range from one to ten years, buildings and building improvements range from seven to twenty-five yearsand furniture and fixtures are five years. Leasehold improvements are depreciated over the life of the lease or theassets, whichever is shorter. Land is not depreciated.

Intangible Assets Other than Goodwill

Long-lived assets, such as property, plant and equipment and purchased intangible assets with finite lives, are evaluatedfor impairment semi-annually and whenever events or changes in circumstances indicate that the carrying value of anasset may not be recoverable in accordance with Statement of Financial Accounting Standards (SFAS) No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). We assess the recoverability of long-lived assets (other than goodwill) by comparing the estimated undiscounted cash flows associated with the related assetor group of assets against their respective carrying amounts. The amount of an impairment, if any, is calculated basedon the excess of the carrying amount over the fair value of those assets.

Our acquisition-related intangible assets are amortized over periods ranging from two to five years on a straight-linebasis.

Goodwill

We test goodwill for impairment on an annual basis (or whenever events occur which may indicate possibleimpairment) in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (SFAS 142). We perform theimpairment analysis at one level below the operating segment level (see Note 16) as defined in SFAS 142. Thisanalysis requires management to make a series of critical assumptions to: (1) evaluate whether any impairment exists,and (2) measure the amount of impairment.

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In testing for a potential impairment of goodwill, SFAS 142 requires us to: (1) allocate goodwill to the various Sunbusinesses to which the acquired goodwill relates; (2) estimate the fair value of those Sun businesses to which goodwillrelates; and (3) determine the carrying value (book value) of those businesses, as some of the assets and liabilitiesrelated to those businesses, such as accounts receivable and property, plant and equipment, are not held by thosebusinesses but by functional departments (for example, our Global Sales Organization and Worldwide Operationsorganization). Prior to this allocation of the assets to the reporting units, we are required to assess long-lived assets forimpairment in accordance with SFAS 144. Furthermore, if the estimated fair value is less than the carrying value for aparticular business, then we are required to estimate the fair value of all identifiable assets and liabilities of thebusiness, in a manner similar to a purchase price allocation for an acquired business. This can require independentvaluations of certain internally generated and unrecognized intangible assets such as in-process research anddevelopment and developed technology. Only after this process is completed is the amount of goodwill impairmentdetermined.

In estimating the fair value of the businesses with recognized goodwill for the purposes of our annual or periodicanalyses, we make estimates and judgments about the future cash flows of these businesses. Our cash flow forecastsare based on assumptions that are consistent with the plans and estimates we are using to manage the underlyingbusinesses. In addition, we make certain judgments about allocating shared assets such as accounts receivable andproperty, plant and equipment to the estimated balance sheet for those businesses. We also consider our marketcapitalization (adjusted for unallocated monetary assets such as cash, marketable debt securities and debt) on the datewe perform the analysis.

Capitalized Software

Costs related to internally-developed software and software purchased for internal use, which are required to becapitalized pursuant to Statement of Position (SOP) No. 98-1, “Accounting for Costs of Computer Software Developedor Obtained for Internal Use,” are included in property, plant and equipment under machinery and equipment.

Concentration of Credit Risk

Cash deposits in foreign countries of approximately $520 million are subject to local banking laws and may bear higheror lower risk than cash deposited in the United States. As part of our cash and investment management processes, weperform periodic evaluations of the credit standing of the financial institutions and we have not sustained any creditlosses from instruments held at these financial institutions.

Financial instruments that potentially subject Sun to concentrations of credit risk consist principally of marketablesecurities, foreign exchange contracts, interest rate instruments and trade receivables. The counterparties to theagreements relating to Sun’s investment securities, foreign exchange contracts, and interest rate instruments consist ofvarious major corporations and financial institutions of high credit standing. We do not believe there is significant riskrelated to non-performance by these counterparties because the amount of credit exposure to any one financialinstitution and any one type of investment (excluding U.S. government and agency securities) is limited to 5%. Thecredit risk on receivables due from counterparties related to foreign exchange and currency option contracts wasinsignificant at June 30, 2005 and 2004. Our trade receivables are derived primarily from sales of computer systemsand network storage products and services to end-user customers in diversified industries, as well as various resellers.We perform ongoing credit evaluations of our customers’ financial condition and limit the amount of credit extendedwhen deemed necessary, but generally require no collateral.

Revenue Recognition

Multiple Deliverable Arrangements

Sun enters into revenue arrangements to sell products (hardware and software) and services in which we are obligatedto deliver to our customers multiple products and/or services (multiple deliverables). Revenue arrangements withmultiple deliverables are evaluated to determine if the deliverables (items) can be divided into more than one unit ofaccounting. An item can generally be considered a separate unit of accounting if all of the following criteria are met:

• The delivered item(s) has value to the customer on a standalone basis;

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• There is objective and reliable evidence of the fair value of the undelivered item(s); and

• If the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of theundelivered item(s) is considered probable and substantially in the control of Sun.

Items which do not meet these criteria are combined into a single unit of accounting. If there is objective and reliableevidence of fair value for all units of accounting, the arrangement consideration is allocated to the separate units ofaccounting based on their relative fair values. In cases where there is objective and reliable evidence of the fair value ofthe undelivered item(s) in an arrangement but no such evidence for the delivered item(s), the residual method is used toallocate the arrangement consideration. For units of accounting which include more than one deliverable, we generallydefer all revenue for the unit of accounting until the period over which the last undelivered item is delivered. Therevenue policies described below are then applied to each unit of accounting.

We recognize revenue when the following criteria are met: 1) persuasive evidence of an arrangement exists; 2) deliveryhas occurred or services have been rendered; 3) the sales price is fixed or determinable; and 4) collectibility isprobable. Our standard agreements generally do not include customer acceptance provisions. However, if there is acustomer acceptance provision or there is uncertainty about customer acceptance, the associated revenue is deferreduntil we have evidence of customer acceptance.

Products Revenue

Products revenue for sales to both end-user customers and resellers is generally recognized upon the passage of title ifall other revenue recognition criteria have been met. End-user customers generally do not have return rights. Ourprogram offerings to certain of our resellers and distributors (Channel Partners) provide for the limited right to returnour product for stock rotation. We reduce revenue for rights to return our product based upon our historical experiencewith the Channel Partners. In accordance with contractual provisions, we offer price protection to certain of ourChannel Partners. We also offer margin protection to our Channel Partners on certain transactions. For our priceprotection and margin protection programs, we reduce revenue based upon our historical experience. In accordancewith contractual provisions, to certain of our Channel Partners we also offer co-operative marketing funds based on afixed dollar percentage of product sales. We record the amount as a reduction to revenue or, if we have evidence of fairvalue of the advertising benefit received as marketing expense.

In addition, we sell products to leasing companies that, in turn, lease these products to end-users. In transactions wherethe leasing companies have no recourse to Sun in the event of default by the end-user, we recognize revenue at point ofshipment or point of delivery, depending on the shipping terms and if all the other revenue recognition criteria havebeen met. In arrangements where the leasing companies have full recourse to Sun in the event of default by the end-user (defined as recourse leasing), we recognize both the product revenue and the related cost of the product as thepayments are made to the leasing company by the end-user, generally ratably over the lease term. We had deferredrevenue and related deferred costs of $37 million and $16 million, respectively, at June 30, 2005 and $16 million and$7 million, respectively, at June 30, 2004, related to recourse leases which will be recognized in future periods.

For revenue arrangements with multiple deliverables that include software products and services as well as any non-software deliverables for which a software deliverable is essential to its functionality, we apply the accountingguidance in SOP 97-2, “Software Revenue Recognition” in determining the timing of revenue recognition. The criteriaassessed include the following: 1) the functionality of the delivered element(s) is not dependent on the undeliveredelement; 2) there is Sun-specific objective evidence of fair value of the undelivered element(s), and 3) delivery of thedelivered element(s) represents the culmination of the earnings process for those element(s). If these criteria are notmet, revenue is deferred until such criteria are met or until the last element is delivered.

Services Revenue

Maintenance contract revenue is recognized ratably over the contractual period. Educational services revenue isrecognized as the services are rendered. Time and material, and fixed price Client solutions contract revenue isrecognized as the professional services are rendered, or upon completion of the services contract. If we can reliablyevaluate progress to completion (based on total projected hours to be incurred as compared with hours alreadyincurred), we recognize the revenue as the services are rendered and recognize the related costs as they are incurred. Ininstances where we cannot reliably estimate the total projected hours, we recognize revenue and the associated costs

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upon completion of the services contract. For fixed price Client solutions contracts when the current estimates of totalcontract revenue and contract cost indicate a loss, the estimated loss is recognized in the period the loss becomesevident.

Research and Development Expenditures

Costs related to the research, design, and development of products are charged to research and development expensesas incurred. Software development costs are capitalized beginning when a product’s technological feasibility has beenestablished and ending when a product is available for general release to customers. Generally, Sun’s products arereleased soon after technological feasibility has been established. As a result, costs subsequent to achievingtechnological feasibility have not been significant and all software development costs have been expensed as incurred.

Shipping Costs

Sun’s shipping and handling costs for product sales are included in cost of sales for all periods presented.

Advertising Costs

Advertising costs consist of development and placement costs of our advertising campaigns and are charged to expensewhen incurred. Advertising expense was $48 million, $53 million and $84 million for fiscal 2005, 2004 and 2003,respectively.

Self-Insurance

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 practicesliability, property, cargo and crime and directors and officers liability. We have self-insured between $2 million and$25 million per occurrence on these lines of coverage. Sun performs an annual actuarial analysis to develop an estimateof amounts to be paid for both claims reported and potential losses on activities that have occurred but have not yetbeen reported. Loss accruals were $33 million and $27 million as of June 30, 2005 and 2004, respectively.

Computation of Net Income (Loss) per Common Share (Restated)

Basic net income (loss) per common share is computed using the weighted average number of common sharesoutstanding during the period. Diluted net income (loss) per common share is computed using the weighted averagenumber of common and dilutive common equivalent shares outstanding during the period. Dilutive common equivalentshares consist primarily of stock options.

The following table sets forth the computation of basic and diluted earnings per share for each of the past three fiscalyears (in millions, except per share amounts):

Fiscal Years Ended June 30,

2005 2004 2003

(Restated)

Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (107) $ (388) $(3,384)Weighted average shares outstanding:

Basic and diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,368 3,277 3,190

Net loss per common share-basic and diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.03) $ (0.12) $ (1.06)

U.S. GAAP requires all anti-dilutive securities, including stock options, to be excluded from the diluted earnings pershare computation. For fiscal 2005, 2004 and 2003, due to our net loss, all of our outstanding options totaling 557million, 603 million and 587 million, respectively, were excluded from the diluted loss per share calculation becausetheir inclusion would have been anti-dilutive. If we had earned a profit during fiscal 2005, 2004 and 2003, we wouldhave added 23 million, 30 million and 28 million equivalent shares to our basic weighted average shares outstanding tocompute the diluted weighted average shares outstanding.

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Stock-Based Compensation (Restated)

SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), amended by SFAS No. 148, “Accountingfor Stock-Based Compensation — Transition and Disclosure” (SFAS 148), permits companies to measurecompensation cost of stock-based awards based on their estimated fair value at the date of grant and recognize thatamount over the related service period. We believe the existing stock option valuation models do not necessarilyprovide a reliable single measure of the fair value of stock-based awards. Therefore, as permitted by SFAS 148, weapply the existing accounting rules under APB Opinion No. 25, “Accounting for Stock Issued to Employees,” andrelated Interpretations. In general, as the exercise price of all options granted under these plans is equal to the marketprice of the underlying common stock on the grant date, no stock-based employee compensation cost is recognized innet income (loss). In addition, under these plans, options to purchase shares of common stock may be granted at lessthan fair market value, which results in compensation expense equal to the difference between the market value on thedate of grant and the purchase price. This expense is recognized in net income (loss) straight-line over the vestingperiod of the award. As required, we provide pro forma net loss and pro forma net loss per common share disclosuresfor stock-based awards made during fiscal 2005, 2004 and 2003, as if the fair-value-based method defined in SFAS123 had been applied.

The fair value of stock-based awards granted in fiscal years 2005, 2004 and 2003 was estimated using the Black-Scholes model with the following weighted-average assumptions for fiscal years ended June 30:

Options Employee Stock Purchase Plan

2005 2004 2003 2005 2004 2003

Expected life (in years) . . . . . . . . . . . . . . . . . . . . . . . . 5.7 6.4 6.5 0.5 0.5 0.5Interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.68% 3.42% 3.41% 1.74% 1.28% 1.64%Volatility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64.60% 67.45% 66.77% 41.31% 56.35% 74.30%Dividend yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — — —

In the fourth quarter of fiscal 2005, in anticipation of adopting SFAS 123R in July 2005, we evaluated the variablesused in the Black-Scholes model and as a result, changed our computation of expected volatility from being basedsolely on historical volatility to being based on a combination of historical and market-based implied volatility. Also,our computation of expected life was adjusted to be more representative of future exercise patterns. The estimatedweighted-average fair value at the grant date for options granted under Sun’s various stock option plans during fiscal2005, 2004 and 2003 was $2.36, $2.72 and $2.51 per option, respectively. The estimated weighted-average fair value atthe date of grant for shares granted under the Employee Stock Purchase Plan during fiscal 2005, 2004 and 2003 was$1.05, $1.20 and $1.75 per option, respectively.

If the fair values of the options granted during a fiscal year had been recognized as compensation expense on a straight-line basis over the vesting period of the grant, stock-based compensation costs would have impacted our net loss andnet loss per common share for the fiscal years ended June 30, as follows (in millions, except per share amounts):

2005 2004 2003

(Restated)Pro forma net loss:

Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (107) $ (388) $(3,384)Add: stock-based compensation costs included in reported net loss (net of tax

effects of none, none and $14, respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 16 23Deduct: stock-based compensation costs (net of tax effects of none, none and

$377, respectively) under SFAS 123(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (766) (834) (578)

Pro forma net loss after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (854) $(1,206) $(3,939)

Pro forma basic net loss per common share:Pro forma shares used in the calculation of pro forma net loss per common share-

basic and diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,368 3,277 3,190Pro forma net loss per common share-basic and diluted . . . . . . . . . . . . . . . . . . . . . $ (0.25) $ (0.37) $ (1.23)Reported net loss per common share-basic and diluted . . . . . . . . . . . . . . . . . . . . . $ (0.03) $ (0.12) $ (1.06)

(1) The tax effect was not reflected in the fiscal 2005 and 2004 amount as a result of the uncertainty in realizing ourdeferred tax assets.

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Foreign Currency Translation

Sun translates most of the assets and liabilities of international non-U.S. functional currency subsidiaries into dollars atthe rates of exchange in effect during the period. Revenue and expenses are translated using rates that approximatethose in effect during the period. Translation adjustments are included in stockholders’ equity in the consolidatedbalance sheet caption “Accumulated other comprehensive income (loss).” Currency transaction gains (losses), net ofour hedging activities (See Note 9), derived from monetary assets and liabilities stated in a currency other than thefunctional currency, are recognized in current operations and were $20 million, $(5) million and $(9) million in fiscal2005, 2004 and 2003, respectively. The effect of foreign currency rate changes on cash and cash equivalents is notmaterial.

Recent Pronouncements

In March 2004, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 03-01, “The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments” (EITF 03-01). EITF 03-01 providesguidance on other-than-temporary impairment models for marketable debt and equity securities accounted for underSFAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” and SFAS 124, “Accounting forCertain Investments Held by Not-for-Profit Organizations,” and non-marketable equity securities accounted for underthe cost method. The EITF developed a basic three-step model to evaluate whether an investment is other-than-temporarily impaired. The Financial Accounting Standards Board (FASB) issued EITF 03-01-1 in September 2004,which delayed the effective date of the recognition and measurement provisions of EITF 03-01. We do not expect theadoption of EITF 03-01 to have a material impact on our results of operations or financial condition.

In October 2004, The American Jobs Creation Act of 2004 (the Act) was signed into law. The Act creates a temporaryincentive for U.S. multinationals to repatriate accumulated income earned outside the U.S. at an effective tax rate of5.25%. On December 21, 2004, the FASB issued their staff position, “Accounting and Disclosure Guidance for theForeign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (SFAS 109-2). SFAS 109-2allows companies additional time to evaluate the impact of the law and to record the tax effect of repatriation overseveral interim periods as they complete their assessment of repatriating all or a portion of these unremitted earnings.Should we decide to repatriate these earnings, which as of June 30, 2005, did not exceed $1,095 million of cumulativenet undistributed earnings, a one-time charge to our results of operations would be recorded.

In November 2004, the FASB issued SFAS 151, “Inventory Costs.” SFAS 151 requires that the allocation of fixedproduction overhead costs be based on the normal capacity of the production facilities and unallocated overhead costsrecognized as an expense in the period incurred. In addition, other items such as abnormal freight, handling costs andwasted materials require treatment as current period charges rather than a portion of the inventory cost. SFAS 151 iseffective for inventory costs incurred during periods beginning after June 15, 2005. We do not expect the adoption ofSFAS 151 to have a material impact on our results of operations or financial condition.

In December 2004, the FASB issued SFAS 123 (revised 2004), “Share-Based Payment” (SFAS 123R). SFAS 123Rrequires measurement of all employee stock-based compensation awards using a fair-value method and the recordingof such expense in the consolidated financial statements. In addition, the adoption of SFAS 123R will requireadditional accounting related to the income tax effects and disclosure regarding the cash flow effects resulting fromshare-based payment arrangements. In January 2005, the United States Securities and Exchange Commission (SEC)issued Staff Accounting Bulletin No. 107, which provides supplemental implementation guidance for SFAS 123R.SFAS 123R is effective for our first quarter of fiscal 2006. We have selected the Black-Scholes option-pricing modelas the most appropriate fair-value method for our awards and will recognize compensation cost on a straight-line basisover our awards’ vesting periods. We expect that the adoption of SFAS 123R will have a material impact on our resultsof operations. However, uncertainties, including our future stock-based compensation strategy, stock price volatility,estimated forfeitures and employee stock option exercise behavior, make it difficult to determine whether the stock-based compensation expense that we will incur in future periods will be similar to the SFAS 123 pro forma expensedisclosed in Note 3 to the Consolidated Financial Statements. In addition, the amount of stock-based compensationexpense to be incurred in future periods will be reduced by our acceleration of certain unvested and “out-of-the-money” stock options in fiscal 2005 as disclosed in Note 15 to the Consolidated Financial Statements.

In December 2004, the FASB issued SFAS 153, “Exchanges of Nonmonetary Assets,” (SFAS 153) an amendment ofAPB Opinion No. 29. SFAS 153 addresses the measurement of exchanges of nonmonetary assets and redefines the

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scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS 153 is effectivefor nonmonetary asset exchanges beginning in our first quarter of fiscal 2006. We do not expect the adoption of SFAS153 to have a material impact on our results of operations or financial condition.

In May 2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections” (SFAS 154) which replacesAccounting Principles Board Opinions No. 20 “Accounting Changes” and SFAS 3, “Reporting Accounting Changes inInterim Financial Statements — An Amendment of APB Opinion No. 28.” SFAS 154 provides guidance on theaccounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or theearliest practicable date, as the required method for reporting a change in accounting principle and restatement withrespect to the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errorsmade in fiscal years beginning after December 15, 2005 and is required to be adopted by Sun in the first quarter of fiscal2007.

In June 2005, the FASB issued a FASB Staff Position (FSP) interpreting FASB Statement 143, “Accounting for AssetRetirement Obligations,” specifically FSP 143-1, “Accounting for Electronic Equipment Waste Obligations” (FSP 143-1).FSP 143-1 addresses the accounting for obligations associated with Directive 2002/96/EC, Waste Electrical and ElectronicEquipment, which was adopted by the European Union (EU). The FSP provides guidance on how to account for the effectsof the Directive but only with respect to historical waste associated with products placed on the market on or before August13, 2005. FSP 143-1 is effective the later of the first reporting period ending after June 8, 2005, or the date of the adoptionof the law by the applicable EU-member country. The adoption of FSP 143-1 did not have a material impact on our resultsof operations or financial condition.

In June 2005, the EITF reached a consensus on Issue No. 05-06, “Determining the Amortization Period for LeaseholdImprovements” (EITF 05-06). EITF 05-06 provides guidance for determining the amortization period used forleasehold improvements acquired in a business combination or purchased after the inception of a lease, collectivelyreferred to as subsequently acquired leasehold improvements). EITF 05-06 provides that the amortization period usedfor the subsequently acquired leasehold improvements to be the lesser of (a) the subsequently acquired leaseholdimprovements’ useful lives, or (b) a period that reflects renewals that are reasonably assured upon the acquisition or thepurchase. EITF 05-06 is effective on a prospective basis for subsequently acquired leasehold improvements purchasedor acquired in periods beginning after the date of the FASB’s ratification, which was on June 29, 2005. We anticipatethe adoption of EITF 05-06 may affect our results of operations and financial conditions in fiscal 2006, due to ouracquisitions of Storage Technology Corporation (StorageTek) and SeeBeyond Technology Corporation (SeeBeyond),but we will not be able to quantify the impact to our financial statements until the purchase accounting for thesetransactions is completed.

4. Acquisitions

During the three fiscal years ended June 30, 2005, we completed 10 acquisitions. Pro forma results of operations havenot been presented for any of the acquisitions because the effects of these acquisitions were not material to Sun oneither an individual or an aggregate annual basis. The results of operations of each purchase acquisition are included inSun’s consolidated statements of operations from the date of each acquisition.

The amounts allocated to purchased in-process research and development (IPRD) were determined through establishedvaluation techniques in the high-technology computer industry and were expensed upon acquisition becausetechnological feasibility had not been established and no future alternative uses existed. Research and developmentcosts to bring the products from the acquired companies to technological feasibility are not expected to have a materialimpact on Sun’s future results of operations or cash flows. Intangible assets subject to amortization are being amortizedon a straight-line basis over periods not exceeding five years.

The amounts allocated to unearned equity compensation were determined in accordance with the method prescribed inFASB Interpretation No. 44 “Accounting for Certain Transactions Involving Stock Compensation.” Under this method,unearned equity compensation related to equity instruments assumed in acquisitions (generally restricted stock andstock options) is calculated as the pro-rata unearned portion of the intrinsic value (the difference between the fair valueand the exercise price) of the equity instrument as of the date of acquisition. Subsequent to the acquisition, this amountis recognized as compensation expense as earned, generally classified under either research and development expenseor selling, general and administrative expense.

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A summary of Sun’s acquisitions for the fiscal years ended June 30, 2005, 2004 and 2003 is included in the followingtable (in millions, except share, warrant and option amounts):

Entity Name and Descriptionof Acquisition Date Consideration Goodwill

DevelopedTechnology

Other Net Assets(Liabilities) and

UnearnedCompensation IPRD

Form of Considerationand Other Information

Fiscal 2005 Acquisitions

SevenSpace, Inc.Remote system monitoring

and management

01/05 $ 48 $ 37 $ 4 $ 7 — • $ 47

• $ 1

Cash paid, includingacquisition costsFair value of 312,000options assumed

Procom Technology, Inc.Network attached storage

intellectual property

06/05 $ 52 — $50 $ 2 — • $ 51

• $ 1

Cash paid, includingacquisition costsFair value of surrenderedshares in Procom

Fiscal 2004 Acquisitions

Kealia, Inc.Next generation server

technology

4/04 $ 93 — $16 $ 8 $69 • $ 65

• $ 27

• $ 1

11,513,000 shares commonstock issued(1)

Fair value of 4,968,000options assumedCash paid for acquisitioncosts

Nauticus Networks, Inc.Technology for a high-

performance content-switch, including SSL,security, load-balancingand virtualization

1/04 $ 12 $ 4 $16 $ (8) — • $ 12 Cash paid, includingacquisition costs

Waveset Technologies, Inc.Identity Management

12/03 $136 $ 77 $39 $ 20 — • $122

• $ 14

Cash paid, includingacquisition costsFair value of 3,492,000options assumed

CenterRun, Inc.Provisioning technologyfor data centers

8/03 $ 65 $ 46 $ 9 $ 10 — • $ 63

• $ 2

Cash paid, includingacquisition costsFair value of 374,000options assumed

Pixo, Inc.Technology-based server

software

7/03 $ 23 $ 17 $ 4 $ 1 $ 1 • $ 23 Cash paid, includingacquisition costs

Fiscal 2003 Acquisitions

Pirus Networks, Inc.Storage networkingsystems

11/02 $167 $143 $36 $(15) $ 3 • $158

• $ 8

• $ 1

47,650,000 shares commonstock issuedFair value of 2,609,000options assumedCash paid for acquisitioncosts

Terraspring, Inc.Automated networking

solutions

11/02 $ 30 $ 27 $ 3 — — • $ 30 Cash paid, includingacquisition costs

Afara Websystems, Inc.Next generation, SPARC

microprocessor-basedtechnology

7/02 $ 28 — — $ 28 — • $ 26

• $ 1

• $ 1

4,867,000 shares commonstock issuedFair value of 210,000options assumed and109,000 warrantsCash paid for acquisitioncosts

(1) In addition to the purchase price, 3,519,000 shares of Sun’s common stock were issued and are being held inescrow pending the completion of future employment requirements.

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Our fiscal 2005 acquisitions of SevenSpace and Procom are described below.

SevenSpace

On January 10, 2005, we acquired SevenSpace, a privately-held company based in Ashburn, Virginia. SevenSpacedelivers remote system monitoring and management across heterogeneous environments, including enterpriseapplications, databases, operating systems and network devices. We acquired SevenSpace to enhance our managedservices offerings by adding support for non-Sun platforms. SevenSpace was acquired by means of a merger pursuant towhich all of the outstanding shares of capital stock of SevenSpace were exchanged for cash. In addition, all outstandingoptions to purchase SevenSpace common stock were converted into options to purchase shares of our common stock.

We purchased SevenSpace for approximately $46 million in cash, $1 million in assumed options, and approximately$1 million in transaction costs. The total purchase price of $48 million was allocated as follows (in millions):

Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $37Other intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9Tangible assets acquired and net liabilities assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $48

Procom

On June 9, 2005, we acquired the Network Attached Storage (NAS) intellectual property, certain tangible assets andcertain employees of Procom, a privately-held company based in Irvine, California, by means of an asset purchaseagreement. We acquired these assets from Procom in order to strengthen our existing NAS product offerings and toaccelerate the development of our next-generation NAS solutions.

In accordance with SFAS 141 “Business Combinations,” this transaction was accounted for as a purchase of assets asdefined by EITF Issue No. 98-3 “Determining Whether a Nonmonetary Transaction Involves Receipt of ProductiveAssets or of a Business” rather than as a business combination. Accordingly, no goodwill was recorded from thisacquisition, as consideration in excess of the fair value of identified assets was allocated pro-rata to the identifiedintangible assets. The total purchase price was approximately $52 million and consisted of $50 million in cash,approximately $1 million in transaction costs, and approximately $1 million related to the fair value of our investmentin Procom which was surrendered as part of the asset purchase agreement. The total purchase price of $52 million wasallocated as follows (in millions):

Developed technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $50Assembled workforce . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $52

5. Goodwill and Other Intangible Assets

Goodwill

Changes in the carrying amount of goodwill for the years ended June 30, 2005 and 2004, by reportable segment, are asfollows (in millions):

ProductGroup

SunServices Total

Balance as of June 30, 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $240 $ 86 $326Goodwill acquired during the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 45 144Utilization of acquired deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . (13) (2) (15)Impairments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — (49) (49)

Balance as of June 30, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 326 80 406Goodwill acquired during the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 37 37Utilization of acquired deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2) — (2)

Balance as of June 30, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $324 $117 $441

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We perform our impairment analysis at one level below the operating segment level (See Note 16) as defined inSFAS 142. This analysis requires management to make a series of critical assumptions to: (1) evaluate whether anyimpairment exists; and (2) measure the amount of impairment. SFAS 142 requires that we estimate the fair value of ourreporting units as compared with their estimated book value. If the estimated fair value of a reporting unit is less thanthe estimated book value, then an impairment is deemed to have occurred. In estimating the fair value of our reportingunits, we primarily use the income approach (which utilizes forecasted discounted cash flows to estimate the fair valueof the reporting unit) and the market approach (which estimates fair value based on market prices for comparablecompanies). We also consider our total market capitalization as of each date on which we conclude an analysis isrequired, and our average market capitalization for a period of time prior to and subsequent to each date on which weconclude an analysis is required, to adequately consider the impact of volatility on market capitalization on that day. Asrequired by SFAS 142, prior to conducting our goodwill impairment analysis, we assess long-lived assets forimpairment in accordance with SFAS 144.

We performed our annual goodwill impairment analysis in the fourth quarter of each of our past three fiscal years. Inaddition, in October 2002, based on a combination of factors, particularly: (1) our then current and projected operatingresults; (2) our decision to reduce our workforce and eliminate excess facility space; and (3) our then current marketcapitalization, we concluded there were sufficient indicators to require us to assess whether any portion of our recordedgoodwill balance was impaired. Based on our estimates of forecasted discounted cash flows as well as our marketcapitalization, at each of these dates, we concluded that goodwill impairment charges of none, $49 million and $2,027million were necessary during fiscal 2005, 2004 and 2003, respectively.

The fiscal 2004 impairment charges related to the goodwill in our Educational services reporting unit. The lowerdiscounted cash flows attributable to our Educational services reporting unit in fiscal 2004 were primarily due to adecrease in revenue and gross margin, mostly resulting from the end-of-life of new enterprise learning platformlicensing and hosting agreements, as well as reduced expectations for other products. Educational services revenuesdeclined in fiscal 2004 by approximately 16% as compared to fiscal 2003. In measuring the amount of goodwillimpairment, we estimated fair value of the reporting unit based on our estimates of forecasted discounted cash flows aswell as our market capitalization and concluded it was negative. Any allocation of such negative fair value would haveresulted in no implied value of the existing goodwill. As a result, we concluded that all of the recorded goodwill in theEducational services reporting unit was impaired and needed to be expensed as a non-cash charge to continuingoperations during the fourth quarter of 2004. The resulting impairment charge of $49 million primarily related togoodwill acquired through our acquisitions of ISOPIA, Inc. of $39 million and Ed Learning Systems, Inc. of$7 million.

The fiscal 2003 impairment charges related to the goodwill in our then Volume Systems and Network Storagereporting units, which was established primarily as a result of our acquisition of Cobalt, Inc. As required by SFAS 142,in measuring the amount of goodwill impairment, we made a hypothetical allocation of the estimated fair value of thereporting units to the tangible and intangible assets (other than goodwill) within these reporting units. Based on thisallocation, we concluded that all of the recorded goodwill in the Volume Systems reporting unit ($1,566 million) andthe Network Storage reporting unit ($461 million) was impaired and needed to be expensed as a non-cash charge tocontinuing operations during the second quarter of fiscal 2003. When we conducted our fiscal 2003 annual analysis inthe fourth quarter of fiscal 2003, we concluded at that time that we did not have any impairment of goodwill based onour then forecasted discounted cash flows as well as our market capitalization.

During fiscal 2004, we released valuation allowances of approximately $18 million recorded on acquired deferred taxassets which were realized as a result of income generated by the Microsoft settlement. In accordance with SFAS 109,“Accounting for Income Taxes” we applied releases of our valuation allowances first to reduce goodwill related to theacquired companies (in the amount of $15 million in fiscal 2004) and next to reduce other acquisition-relatedintangible assets (in the amount of $3 million in fiscal 2004).

Reporting units in our Product Group segment accounted for approximately 73% of the carrying value of our goodwillat June 30, 2005.

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Other Acquisition-Related Intangible Assets

SFAS 144 is the authoritative standard on the accounting for the impairment of other intangible assets. This analysisdiffers from our goodwill analysis in that an impairment is only deemed to have occurred if the sum of the forecastedundiscounted future cash flows related to the asset are less than the carrying value of the intangible asset we are testingfor impairment. If the forecasted cash flows are less than the carrying value, then we must write down the carryingvalue to its estimated fair value.

In accordance with SFAS 144 and our internal accounting policies, we performed semi-annual other intangible assetsimpairment analyses in the second and fourth quarters of each of our past three fiscal years. In addition, based on the sameconsiderations outlined in the above discussion on goodwill, in October 2002, we concluded there were sufficient indicatorsto require us to assess whether a portion of our other intangible assets was impaired. Based on our estimates of forecastedundiscounted cash flows at each of these dates, we concluded that other acquisition-related intangible asset impairmentexpenses of none was needed in fiscal 2005 and 2004 and $42 million in our Product Group segment was necessary duringfiscal 2003, to reduce our other acquisition-related intangible assets balance to its estimated fair value. The fiscal 2003impairment of non-goodwill intangible assets was recognized before we made a hypothetical allocation of the estimated fairvalue of the reporting units to the tangible and intangible assets (other than goodwill) within each reporting unit tested forgoodwill impairment, as required by SFAS 142. The estimated fair value of the other acquisition-related intangibles wasdetermined using the income approach (discounted cash flows). Approximately $31 million and $11 million of theimpairment related to intangible assets acquired in our acquisitions of Cobalt Networks, Inc. and HighGround Systems,Inc., respectively. Information regarding our other acquisition-related intangible assets is as follows (in millions):

Gross Carrying Amount Accumulated Amortization Net

June 30,2004 Additions

June 30,2005

June 30,2004 Additions

June 30,2005

June 30,2005

Developed technology . . . . . . . . . . . . . . . . . . . . . . $383 $54 $437 $(295) $(44) $(339) $ 98Customer base . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 5 55 (45) (3) (48) 7Acquired workforce and other . . . . . . . . . . . . . . . . 86 2 88 (52) (28) (80) 8

$519 $61 $580 $(392) $(75) $(467) $113

Gross Carrying Amount Accumulated Amortization Net

June 30,2003 Additions

June 30,2004

June 30,2003 Additions

June 30,2004

June 30,2004

Developed technology . . . . . . . . . . . . . . . . . . . . . . $300 $ 83 $383 $(256) $(39) $(295) $ 88Customer base . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 7 50 (42) (3) (45) 5Acquired workforce and other . . . . . . . . . . . . . . . . 74 12 86 (28) (24) (52) 34

$417 $102 $519 $(326) $(66) $(392) $127

Amortization expense of other acquisition-related intangible assets was $75 million, $66 million and $78 million forthe fiscal years ended June 30, 2005, 2004 and 2003, respectively.

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

2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 522007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

$113

Other Non-Acquisition Related Intangible Assets

As a result of our settlement with Kodak in October 2004, we recorded a $27 million intangible asset in other non-currentassets which is being amortized to cost of sales — products on a straight-line basis over the remaining patent life throughfiscal 2010. As of June 30, 2005, its net book value was $23 million net of accumulated amortization of $4 million.

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As a result of our strategic alliance with Time Warner, Inc. in fiscal 1999, we recorded an intangible asset associated witha revenue generating technology license in other non-current assets. This intangible asset had a net book value of$5 million, net of accumulated amortization of $217 million at June 30, 2005, and a net book value of $14 million, net ofaccumulated amortization of $208 million at June 30, 2004. We recorded amortization expense of $9 million, $9 millionand $32 million on this technology license for the fiscal years ended June 30, 2005, 2004 and 2003, respectively. Based onthe considerations outlined in the previous discussion on goodwill, in October 2002, we concluded that sufficientindicators existed to require us to perform an analysis in accordance with SFAS 144 to assess whether a portion of thetechnology license was impaired. We concluded that the carrying value of the intangible asset was impaired andrecognized a non-cash impairment expense of $56 million during fiscal 2003.

6. Restructuring Charges and Workforce Rebalancing Efforts

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) or, for actions prior to December 31,2002, EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring),” we recognized a total of $262 million, $344 millionand $371 million in restructuring charges in fiscal 2005, 2004 and 2003, respectively.

We estimated the cost of exiting and terminating our facility leases by referring to the contractual terms of theagreements and by evaluating the current real estate market conditions. In addition, we have estimated sublease incomeby evaluating the current real estate market conditions or, where applicable, by referring to amounts being negotiated.As of June 30, 2005, our estimated sublease income to be generated from sublease contracts not yet negotiatedapproximated $85 million. Our ability to generate this amount of sublease income, as well as our ability to terminatelease obligations at the amounts we have estimated, is highly dependent upon the commercial real estate marketconditions in certain geographies at the time we perform our evaluations or negotiate the lease termination andsublease arrangements with third parties. The amounts we have accrued represent our best estimate of the obligationswe expect to incur and could be subject to adjustment as market conditions change.

The following describes restructuring actions we have initiated over the past five fiscal years:

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 planto reduce our workforce by approximately 1,000 employees across all employee levels, business functions, operatingunits, and geographic regions. In addition, we plan to eliminate excess facility capacity in light of revised facilityrequirements. In fiscal 2005, we recognized a total of $44 million in charges associated with Restructuring Plan V,which consisted only of workforce reduction charges. We anticipate recording additional charges related to ourworkforce and facilities reductions over the next several quarters, the timing of which will depend upon the timing ofnotification 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 andexpense reduction measures. The total amount and timing of these charges will depend upon the nature, timing, andextent 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 ourworkforce, 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 workforceby approximately 4,150 employees under this plan. This plan also included eliminating excess facility capacity in lightof revised facility requirements and other actions. In fiscal 2004, we recognized $343 million in total charges,consisting of $215 million in workforce reduction charges and $128 million in excess facility charges. During fiscal2004, the charge relating to the consolidation of excess facilities included:

• $95 million of estimated future obligations for non-cancelable lease payments (net of estimated sublease income of$35 million) and/or termination fees resulting from exiting excess rental facilities; and

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• $33 million for the impairment of property and equipment (primarily leasehold improvements) for which there areinsufficient cash flows to support the carrying cost. The property and equipment impairment was determined basedon the difference between the assets’ estimated fair value and their carrying value.

Under this plan to date, we have recognized $551 million in charges, consisting of $290 million in workforce reductioncharges and $261 million in excess facility charges.

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

As of June 30, 2005, substantially all employees to be terminated as a result of the restructuring had been notified.While most of the severance and related fringe benefits have been paid, in accordance with local employment laws, weexpect to pay the remaining restructuring accrual related to severance over the next few quarters.

Restructuring Plan III

In October 2002, we implemented a workforce reduction and facility exit plan (Restructuring Plan III). The goal of thisplan was to reduce costs and improve operating efficiencies. We implemented the plan by reducing our workforce byapproximately 3,200 employees across all employee levels, business functions, operating units, and geographic regionsand eliminating excess facility capacity in light of revised facility requirements. During fiscal 2003, we recognized$308 million in total charges, consisting of $176 million in workforce reduction and $132 million in excess facilitycharges. During fiscal 2003, the charge relating to the consolidation of excess facilities included:

• $114 million of estimated future obligations for non-cancelable lease payments and/or termination fees resultingfrom exiting excess rental facilities; and

• $18 million for the impairment of property and equipment (primarily leasehold improvements) for which there areinsufficient cash flows to support the carrying cost. The property and equipment impairment was determined basedon the difference between the assets’ estimated fair value and their carrying value.

Under this plan to date, we have recognized $302 million in restructuring charges, consisting of $169 million inworkforce reduction charges and $133 million in excess facility charges.

All facilities relating to the amounts accrued under this restructuring plan were exited by June 30, 2004.

Restructuring Plan II

In the second quarter of fiscal 2002, we implemented a workforce reduction and facility exit plan (Restructuring PlanII). The goal of the restructuring was to reduce costs and improve operating efficiencies. Specifically, we reduced ourworkforce by approximately 9% (or 3,400 employees and 500 contractors) across all employee levels, businessfunctions, operating units, and geographic regions and eliminated excess facilities in light of revised facilityrequirements. During fiscal 2002, we recognized $511 million in total charges, consisting of $146 million in workforcereduction and $365 million in excess facility charges.

Under this plan to date, we have recognized $533 million in restructuring charges, consisting of $144 million inworkforce reduction charges and $389 million in excess facility charges.

All facilities relating to the amounts accrued under this restructuring plan were exited by December 31, 2002.

Facility Exit Plan I

In the fourth quarter of fiscal 2001, we elected to exit certain building leases and discontinue certain building projects.We incurred approximately $75 million for facility exit costs associated with this decision. As a result of the continueddeterioration of certain commercial real estate markets, we reduced our sublease income assumptions and, accordingly,recorded an additional $33 million and $26 million charge in fiscal 2003 and fiscal 2002, respectively, to reflect thischange in our estimates.

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The following table sets forth an analysis of the restructuring accrual activity for the fiscal years ended June 30, 2005,2004 and 2003 (in millions):

RestructuringPlan V Restructuring Plan IV Restructuring Plan III Restructuring Plan II

FacilityExit Plan I

Total

Severanceand

Benefits

Severanceand

Benefits

FacilitiesRelated

and Other

Severanceand

BenefitsFacilitiesRelated

Severanceand

BenefitsFacilitiesRelated

FacilitiesRelated

Balance as of June 30, 2002 . . . . . . . . $— $ — $ — $ — $ — $ 19 $169 $ 53 $ 241Severance and benefits . . . . . . . . . . — — — 176 — — — — 176Accrued lease costs . . . . . . . . . . . . . — — — — 114 — — — 114Property and equipment

impairment . . . . . . . . . . . . . . . . . . — — — — 18 — — — 18Provision adjustments . . . . . . . . . . . — — — (4) (4) (2) 40 33 63

Total restructuring charges . . . . . — — — 172 128 (2) 40 33 371Cash paid . . . . . . . . . . . . . . . . . . . . . . . — — — (148) (5) (17) (31) (26) (227)Non-cash . . . . . . . . . . . . . . . . . . . . . . . — — — — (13) — 3 — (10)

Balance as of June 30, 2003 . . . . . . . . — — — 24 110 — 181 60 375Severance and benefits . . . . . . . . . . — 215 — — — — — — 215Accrued lease costs and other . . . . . — — 95 — — — — — 95Property and equipment

impairment . . . . . . . . . . . . . . . . . . — — 33 — — — — — 33Provision adjustments . . . . . . . . . . . — — — (3) (3) — — 7 1

Total restructuring charges . . . . . — 215 128 (3) (3) — — 7 344Cash paid . . . . . . . . . . . . . . . . . . . . . . . — (49) (6) (21) (19) — (28) (23) (146)Non-cash . . . . . . . . . . . . . . . . . . . . . . . — — (34) 1 2 — — 1 (30)

Balance as of June 30, 2004 . . . . . . . . — 166 88 1 90 — 153 45 543Severance and benefits . . . . . . . . . . 44 83 — — — — — — 127Accrued lease costs . . . . . . . . . . . . . — — 111 — — — — — 111Property and equipment

impairment . . . . . . . . . . . . . . . . . . — — 16 — — — — — 16Provision adjustments . . . . . . . . . . . — (8) 6 — 8 — 4 (2) 8

Total restructuring charges . . . . . 44 75 133 — 8 — 4 (2) 262Cash paid . . . . . . . . . . . . . . . . . . . . . . . — (204) (47) (1) (20) — (28) (17) (317)Non-cash . . . . . . . . . . . . . . . . . . . . . . . — — (17) — (1) — — — (18)

Balance as of June 30, 2005 . . . . . . . . $44 $ 37 $157 $ — $ 77 $ — $129 $ 26 $ 470

The remaining cash expenditures relating to workforce reductions are expected to be paid over the next few quarters.Our accrual as of June 30, 2005 for facility-related leases (net of anticipated sublease proceeds) will be paid over theirrespective lease terms through fiscal 2023. As of June 30, 2005, $178 million of the total $470 million accrual forworkforce reductions and facility-related leases was classified as current accrued liabilities and other and the remaining$292 million was classified as other non-current obligations.

The above restructuring charges are based on estimates that are subject to change. Changes to the previous estimateshave been reflected as “Provision adjustments” on the above table in the period the changes in estimates were made.

Workforce Rebalancing Efforts

Prior to the initiation of our Restructuring Plan IV, we had initiated certain workforce rebalancing efforts during thefirst six months of fiscal 2004. As a result, we incurred $55 million of separation costs during this period.Approximately $3 million, $14 million and $38 million of these separation costs were included in cost of sales,research and development and selling, general and administrative expenses, respectively. During fiscal 2005 and fiscal2004, we paid $1 million and $54 million, respectively.

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7. Balance Sheet Details

Inventories

At June 30, Inventories consisted of the following (in millions):

2005 2004

Raw materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 48 $ 82Work in process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 134Finished goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262 248

$431 $464

As of June 30, 2005 and 2004, our inventory balances were net of write-downs of approximately $38 million and $48million, respectively.

Prepaid Expenses and Other Current Assets

At June 30, Prepaid expenses and other current assets consisted of the following (in millions):

2005 2004

Refundable income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $184 $222Other prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 694 615

$878 $837

Property, Plant and Equipment, net

At June 30, Property, plant, and equipment, net, consisted of the following (in millions):

2005 2004

Machinery and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,574 $ 2,787Land, buildings, and building improvements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,492 1,490Leasehold improvements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 486 493Furniture and fixtures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 256 264

4,808 5,034Less accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,039) (3,038)

$ 1,769 $ 1,996

Depreciation expense was $495 million, $589 million and $653 million for fiscal 2005, 2004 and 2003, respectively.

Other Non-Current Assets, net (Restated)

At June 30, Other non-current assets, net, consisted of the following (in millions):

2005 2004

(Restated)

Marketable equity securities and other equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . $ 76 $111Spare parts, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162 214Interest-rate swap agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74 127Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236 254

$548 $706

Spare parts are amortized using the straight-line method over their useful lives of three years. Amortization expensewas $144 million, $108 million and $192 million for fiscal 2005, 2004 and 2003, respectively.

For further discussion on interest-rate swap agreements, see Notes 9 and 10.

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Accrued Liabilities and Other (Restated)

At June 30, Accrued liabilities and other consisted of the following (in millions):

2005 2004

(Restated)

Income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 120 $ 314Restructuring accrual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 178 273Other accrued liabilities and other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 716 738

$1,014 $1,325

Deferred Revenues

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

Deferred servicesrevenues

Other deferredrevenues Total

Balance at June 30, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,612 $ 562 $ 2,174Revenue deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,402 899 2,301Revenue recognized . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,362) (921) (2,283)

Balance at June 30, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,652 540 2,192Less short-term portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,185) (463) (1,648)

Total long-term deferred revenues . . . . . . . . . . . . . . . . . . . . . . . $ 467 $ 77 $ 544

Deferred services revenues consist primarily of billings to our customers related to: (1) maintenance contract revenue,which is recognized ratably over the contractual period; (2) Educational services revenue, which is recognized as theservices are rendered; (3) time and material Client solutions contract revenue, which is recognized as the services arerendered; and (4) fixed price Client solutions contract revenue, which is recognized as the services are rendered orupon completion of the Client solutions services contract.

Other deferred revenues primarily comprised revenue deferred in connection with product installations, software OEMsales and customer deposits.

Warranty Reserve

We accrue for our product warranty costs at the time of shipment. Product warranty costs are estimated based upon ourhistorical experience and specific identification of the products requirements, which may fluctuate based on productmix.

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

Total

Balance at June 30, 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 267Charged to costs and expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 331Utilized . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (346)

Balance at June 30, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252Charged to costs and expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 304Utilized . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (332)

Balance at June 30, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 224

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Accumulated Other Comprehensive Income (Loss)

At June 30, the components of Accumulated other comprehensive income (loss), reflected in the ConsolidatedStatements of Stockholders’ Equity, net of related taxes, consisted of the following (in millions):

2005 2004 2003

Unrealized gains (losses) on investments, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 11 $ (17) $ 31Unrealized gains (losses) on derivative instruments and other, net . . . . . . . . . . . . . . 2 (6) (20)Cumulative translation adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195 196 166

$208 $173 $177

At June 30, the net change in unrealized gains (losses) on available-for-sale securities, net of related taxes, consisted ofthe following (in millions):

2005 2004 2003

Net unrealized gains (losses) arising during the period, net of tax (benefit) expense ofnone, $(8) and $13 in 2005, 2004 and 2003, respectively . . . . . . . . . . . . . . . . . . . . . $ 7 $(52) $ 20

Add (gains) losses:Included in net loss for the period, net of tax expense of none, none and $(12) in

2005, 2004 and 2003, respectively . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 4 (19)Written off due to impairment, net of tax benefit of none, none and $3 in 2005, 2004

and 2003, respectively . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 — 5

Net change in unrealized gains (losses) on available-for-sale securities . . . . . . . . . . . . $28 $(48) $ 6

8. Fair Value of Financial Instruments

Cash equivalents and accounts receivable are carried at cost as this approximates fair value due to their short termnature. The fair value of long-term debt was estimated based on current interest rates available to Sun for debtinstruments with similar terms, degrees of risk, and remaining maturities. The estimated fair value of forward foreigncurrency exchange contracts is based on the estimated amount at which they could be settled based on market exchangerates. The fair value of foreign currency option contracts and the interest-rate swap agreements is obtained from dealerquotes and represents the estimated amount we would receive or pay to terminate the agreements. However, analysis ofmarket data is required to develop the estimates of fair value. Accordingly, the estimates presented herein are notnecessarily indicative of the amounts that we could realize in a current market exchange.

At June 30, the fair values of Sun’s short-term and long-term marketable debt securities were as follows (in millions):2005

AdjustedCost(1)

GrossUnrealized

Gains

GrossUnrealized

Losses(1)Fair

Value

Fair Value ofSecurities with

UnrealizedLosses(1)

Corporate notes and bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,185 $— $ (6) $ 1,179 $ 749Asset and mortgage-backed securities . . . . . . . . . . . . . . . . . . 2,301 1 (13) 2,289 1,435U.S. government notes and bonds . . . . . . . . . . . . . . . . . . . . . 1,977 1 (9) 1,969 1,259Money market securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,480 — — 1,480 2State and local government debt . . . . . . . . . . . . . . . . . . . . . . 21 — — 21 21Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 — — 15 10

Total marketable securities . . . . . . . . . . . . . . . . . . . . . . . . . . $6,979 $ 2 $(28) $ 6,953 $3,476

Less cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,480)

Total marketable debt securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,473Less short-term portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,345)

Total long-term marketable debt securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,128

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2004

AdjustedCost

GrossUnrealized

Gains

GrossUnrealized

LossesFair

Value

Fair Value ofSecurities with

UnrealizedLosses

Corporate notes and bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,405 $ 3 $ (7) $ 1,401 $ 769Asset and mortgage-backed securities . . . . . . . . . . . . . . . . . . 2,204 3 (16) 2,191 1,675U.S. government notes and bonds . . . . . . . . . . . . . . . . . . . . . 1,844 2 (8) 1,838 1,052Money market securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,693 — — 1,693 —State and local government debt . . . . . . . . . . . . . . . . . . . . . . 16 — — 16 8Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 — — 21 10

Total marketable securities . . . . . . . . . . . . . . . . . . . . . . . . . . $7,183 $ 8 $(31) $ 7,160 $3,514

Less cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,693)

Total marketable debt securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,467Less short-term portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,460)

Total long-term marketable debt securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,007

(1) Adjusted cost and unrealized losses include our $15 million impairment loss associated with our intent to liquidatea portion of our June 30, 2005 securities portfolio, due to our acquisition of StorageTek in the first quarter offiscal 2006.

All securities with unrealized losses have primarily been in loss positions for less than 12 months. We only invest indebt securities with a minimum rating of BBB- or above from a nationally recognized credit rating agency. At June 30,2005, we had investments in debt instruments of four issuers exceeding 2% of the fair market value of our marketabledebt securities, including cash equivalents, of $6,953 million. At June 30, 2005, investment concentration by issuer wasas follows (dollars in millions):

Issuer Fair Value ($) Fair Value (%)

Federal National Mortgage Association . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 718 10%U.S. Treasuries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 638 9%Federal Home Loan Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 444 6%Federal Home Loan Mortgage Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . 379 6%All others(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,774 69%

$6,953 100%

(1) Investments in all other issuers were, individually, less than $140 million or 2% of the fair market value of ourmarketable debt securities of $6,953 million.

Net realized gains (losses) before taxes on marketable debt securities totaled $(25) million, $(6) million and $32million in fiscal 2005, 2004 and 2003, respectively, recorded in Interest and other income, net. The fiscal 2005 realizedloss included a $15 million impairment loss associated with our intent to liquidate a portion of our June 30, 2005securities portfolio, due to our acquisition of StorageTek in the first quarter of fiscal 2006. The cost of securities soldduring the year was determined based on the specific identification method.

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At June 30, 2005, the cost and estimated fair values of short-term and long-term marketable debt securities (excludingcash equivalents) by contractual maturity were as follows (in millions):

Cost Fair Value

Less than one year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,350 $1,345Mature in 1-2 years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,387 1,380Mature in 3-5 years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,531 1,521Mature after 5 years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,231 1,227

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,499 $5,473

Mortgage-backed assets were allocated based on their contractual maturity.

At June 30, the fair value of Sun’s borrowing arrangements and other financial instruments was as follows (inmillions):

2005Asset (Liability)

2004Asset (Liability)

CarryingAmount

FairValue

CarryingAmount

FairValue

Current portion of long-term debt and short-term borrowings . . . . . . . . . . . . . . $ — $ — $ (257) $ (251)7.0-7.65% Senior Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,123) (1,118) (1,175) (1,126)Forward foreign exchange contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 9 (4) (4)Foreign currency option contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 11 3 3Interest-rate swap agreements (non-current portion of $74 and $127 in fiscal

2005 and 2004, respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74 74 134 134

9. Derivative Financial Instruments

We have interest rate swaps that are designated and qualify as fair value hedges. The gains or losses on the derivativeinstruments as well as the offsetting gains or losses on the hedged items attributable to the hedged risk are recognizedin earnings in the current period.

We enter into foreign exchange forward and option contracts that are designated and qualify as cash flow hedges underSFAS 133 “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133). Changes in the fair value ofthe effective portion of these outstanding forward and option contracts are recognized in Other Comprehensive Income(OCI). These amounts are reclassified from OCI and recognized in earnings when either the forecasted transactionoccurs or it becomes probable that the forecasted transaction will not occur. Gains or losses resulting from changes inforecast probability were not material during fiscal 2005, 2004 and 2003.

Changes in the ineffective portion of a derivative instrument are recognized in earnings (classified in selling, generaland administrative expense) in the current period. Effectiveness for forward cash flow hedge contracts is measured bycomparing the fair value of the forward contract to the change in the forward value of the anticipated transaction. Thefair market value of the hedged exposure is presumed to be the market value of the hedge instrument when criticalterms match. Ineffectiveness during fiscal 2005, 2004 and 2003 was not significant.

We do not use derivative financial instruments for speculative or trading purposes, nor do we hold or issue leveragedderivative financial instruments.

Foreign Exchange Exposure Management. We have significant international sales and purchase transactionsdenominated in foreign currencies. As a result, we purchase currency option and forward contracts as cash flow hedgesto reduce or eliminate certain foreign currency exposures that can be identified and quantified. These contractsgenerally expire within 12 months.

Our hedging contracts are primarily intended to protect against changes in the value of the U.S. dollar. Accordingly, forforecasted transactions, U.S. dollar functional subsidiaries hedge foreign currency revenues and non-U.S. dollarfunctional subsidiaries selling in foreign currencies hedge U.S. dollar inventory purchases. Gains and losses arereclassified from OCI as an adjustment to revenue or cost of sale in the same period that the underlying revenue and

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cost of sale is recognized in the Consolidated Statement of Operations. All values reported in OCI at June 30, 2005 willbe reclassified to earnings within 12 months.

We also enter into foreign currency forward contracts to hedge against changes in the fair value of monetary assets andliabilities denominated in a non-functional currency. These derivative instruments are not designated as hedginginstruments; therefore, changes in the fair value of these contracts are recognized immediately in selling, general andadministrative expense as an offset to the changes in the fair value of the monetary assets or liabilities being hedged.

Interest Rate Risk Management. We are exposed to interest rate risk from both investments and debt. We havehedged against the risk of changes in fair value associated with our fixed rate Senior Notes (See Note 10) by enteringinto fixed-to-variable interest rate swap agreements, designated as fair value hedges, of which 8 are outstanding, with atotal notional amount of $1.1 billion as of June 30, 2005. We assume no ineffectiveness as each interest rate swapmeets the short-cut method requirements under SFAS 133 for fair value hedges of debt instruments. As a result,changes in the fair value of the interest rate swaps are offset by changes in the fair value of the debt, both reported ininterest expense, and no net gain or loss is recognized in earnings.

Accumulated Derivative Gains or Losses. The following table summarizes activity in OCI, net of related taxes,related to foreign exchange derivatives held by Sun during the fiscal years ended June 30, (in millions):

2005 2004 2003

Unrealized gain (loss), net, on derivative instruments, at beginning of period . . . . . . . $ (6) $(20) $(31)Decrease in fair value of derivatives, net of taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (7) (13) (60)Losses reclassified from OCI:

Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 21 56Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 6 15

Unrealized gain (loss), net, on derivative instruments, at end of period . . . . . . . . . . . . $11 $ (6) $(20)

10. Borrowing Arrangements

At June 30, 2005 and 2004, Sun and its subsidiaries had uncommitted lines of credit aggregating approximately $477million and $566 million, respectively. No amounts were drawn from these lines of credit as of June 30, 2005 and2004. Interest rates and other terms of borrowing under these lines of credit vary from country to country depending onlocal market conditions at the time of borrowing. There is no guarantee that the banks would approve our request forfunds under these uncommitted lines of credit.

In August 1999, we issued $1.5 billion of unsecured senior debt securities in four tranches (the Senior Notes). TheSenior Notes consist of the following notes: $200 million (paid on August 15, 2002 and bore interest at 7%); $250million (paid on August 15, 2004 and bore interest at 7.35%); $500 million (due on August 15, 2006 and bearinginterest at 7.5%); and $550 million (due on August 15, 2009 and bearing interest at 7.65%). Interest on the SeniorNotes is payable semi-annually. We may redeem all or any part of any tranche of the Senior Notes at any time at aprice equal to 100% of the principal plus accrued and unpaid interest in addition to an amount determined by aquotation agent, representing the present value of the remaining scheduled payments. The Senior Notes are subject tocompliance with certain covenants that do not contain financial ratios. We are currently in compliance with thesecovenants. If we failed to be in compliance with these covenants, the trustee of the Senior Notes or holders of not lessthan 25% in principal amount of the Senior Notes would have the ability to demand immediate payment of all amountsoutstanding. As discussed in Note 9, we also entered into various interest-rate swap agreements to modify the interestcharacteristics of the Senior Notes so that the interest associated with the Senior Notes effectively becomes variable. Inaddition, we currently have effective shelf registration statements on file with the Securities and Exchange Commissionthat permit us to offer an additional $2.5 billion of debt securities and common and preferred stock in one or moreseparate series, in amounts, at prices, and on terms to be set forth in the prospectus contained in these registrationstatements and in one or more supplements to the prospectus. However, there is no guarantee that we will be able toraise money under these shelf registration statements.

Total interest expense was $49 million, $37 million and $43 million in fiscal 2005, 2004 and 2003, respectively.

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11. Income Taxes (Restated)

Income tax expense is based on pretax financial accounting income. Deferred tax assets and liabilities are determinedbased on the difference between the U.S. GAAP financial statements and tax basis of assets and liabilities usingenacted tax rates in effect for the year in which the differences are expected to reverse.

In the fiscal years ended June 30, income (loss) before income taxes and the provision for (benefit from) income taxesconsisted of the following (in millions):

2005 2004 2003

(Restated) (Restated)

Income (loss) before income taxes:United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(526) $448 $(2,705)Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 342 (11) 52

Total income (loss) before income taxes . . . . . . . . . . . . . . . . . . . . . . . . $(184) $437 $(2,653)

Provision for (benefit from) income taxes:Current:

United States federal(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (20) $ 80 $ —State(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 (1) 24Foreign(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 107 53

Total current income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128 186 77Deferred:

United States federal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (122) 284 536State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 286 168Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (83) 69 (50)

Total deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (205) 639 654

Provision for (benefit from) income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . $ (77) $825 $ 731

(1) Net of $310 million tax benefit of operating loss carryforwards in fiscal 2004.

(2) Net of $54 million tax benefit of operating loss and tax credit carryforwards in fiscal 2004.

(3) Net of $26 million of tax credit carryforwards in fiscal 2004.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets andliabilities for financial reporting purposes and the amounts used for income tax purposes.

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Significant components of our deferred tax assets and liabilities, at June 30, were as follows (in millions):

2005 2004

(Restated)

Deferred tax assets:Inventory valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 29 $ 67Reserves and other accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209 239Compensation not currently deductible . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 80Net operating loss carryforwards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 495 232Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240 236Tax credits carryforward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 538 620Investment impairments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195 202Restructuring liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 156 118Acquisition-related intangibles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106 122Tax credits on undistributed profits of subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . 956 921Fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135 74Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171 228

Gross deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,329 3,139Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,092) (1,967)

Realizable deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,237 1,172Deferred tax liabilities:

Net undistributed profits of subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (993) (1,124)Acquisition-related intangibles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (21) (45)Unrealized gain on investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (50) (50)Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10) —

Gross deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,074) (1,219)

Net deferred tax assets (liabilities) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 163 $ (47)

The following table set forth an analysis of our valuation allowance activity (in millions):

Total

Balance at June 30, 2003 (as reported) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,090Effect of restatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211

Balance at June 30, 2003 (as restated) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,301Charged to income tax provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 563Charged to other accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103Credited to income tax provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —

Balance at June 30, 2004 (as restated) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,967Charged to income tax provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108Charged to other accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20Credited to income tax provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3)

Balance at June 30, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,092

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The provision for (benefit from) income taxes differs from the amount computed by applying the statutory federalincome tax rate to income before income taxes. The sources and tax effects of the difference, for fiscal years endedJune 30, were as follows (in millions):

2005 2004 2003

(Restated) (Restated)

Expected tax rate at 35% . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (64) $153 $(929)State income taxes, net of federal tax benefit . . . . . . . . . . . . . . . . . . . . . . . . 4 182 125Foreign earnings permanently reinvested in foreign operations . . . . . . . . . . 51 135 30Foreign income tax rate differential . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (53) 2 (45)Goodwill impairment/amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 3 693Acquired in-process research and development . . . . . . . . . . . . . . . . . . . . . . — 25 1Research and development credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (35) (33) (24)Utilization of acquired net operating loss carryforwards . . . . . . . . . . . . . . . 2 18 —Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217 339 911U.S. and foreign tax settlements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (213) — —Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 1 (31)

Provision (benefit) for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (77) $825 $ 731

U.S. income taxes were not provided for a cumulative total of approximately $1,095 million of undistributed earningsfor certain foreign subsidiaries. These earnings are considered to be permanently invested in operations outside of theU.S.

As of June 30, 2005, Sun had aggregate federal net operating loss carryforwards of $872 million. If not utilized, thesecarryforwards will expire in fiscal years 2008 through 2025. The use of the federal net operating loss carryforwards inany one fiscal year is limited due to prior changes in ownership incurred by acquired companies. As of June 30, 2005,Sun had aggregate state net operating loss carryforwards of $1,371 million. If not utilized, these carryforwards willexpire in fiscal years 2006 through 2025.

As of June 30, 2005, Sun had aggregate foreign net operating loss carryforwards of $429 million. Foreign net operatingloss carryforwards of $31 million, if unused, will expire in fiscal years 2007 through 2015. The remaining foreignoperating loss carryforwards of $398 million have an indefinite life.

As of June 30, 2005, Sun had federal and state tax credit carryforwards for income tax purposes of $338 million and$308 million, respectively. If not utilized, the federal credits will expire in fiscal years 2006 through 2025. State taxcredit carryforwards of $45 million will expire in fiscal years 2006 through 2020. The remaining state tax creditcarryforwards of $263 million have an indefinite life.

The federal and state provisions do not reflect the tax savings resulting from deductions associated with our variousstock option plans. These savings were zero, $4 million and $9 million in fiscal 2005, 2004 and 2003, respectively.

Deferred tax assets of approximately $90 million as of June 30, 2005 pertain to certain tax credits and net operatingloss carryforwards resulting from the exercise of employee stock options, which have been fully offset by a valuationallowance. When recognized, the reversal of the valuation allowance will be accounted for as a credit to shareholders’equity rather than as a reduction of the income tax provision.

In addition, net deferred tax assets of approximately $33 million pertained to certain deductible temporary differencesand net operating loss carryforwards acquired in certain purchase business combinations. When recognized, thereversal of the valuation allowance will be accounted for as a credit to existing goodwill or other long-term intangiblesof the acquired entity rather than as a reduction of the period’s income tax provision. If no goodwill or long-termintangible assets remain, the credit would reduce the income tax provision in the current period.

We believe it is more likely than not that all but $163 million of deferred tax assets will not be realized in theforeseeable future. Realization of our net deferred tax assets is dependent upon our generation of sufficient taxableincome in future years in appropriate tax jurisdictions to obtain benefit from the reversal of temporary differences, netoperating loss carryforwards, and from tax credit carryforwards. The amount of deferred tax assets consideredrealizable is subject to adjustment in future periods if estimates of future taxable income are reduced.

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During the third quarter of fiscal 2005, we recorded a tax benefit of $69 million from actions taken in response to theU.S. and the Netherlands tax treaty. These actions resulted in a reduction of the Dutch withholding taxes previouslyprovided on undistributed earnings which were not permanently invested outside of the U.S.

During the fourth quarter of fiscal 2005, we settled the Internal Revenue Service (IRS) income tax audit for the fiscalyears 1997 through 2000 and the Dutch income tax audit for the fiscal years 2000 through 2004. As a result, wereduced our income tax reserves resulting in a total benefit of $213 million.

We are currently under examination by the IRS for tax returns filed in fiscal years 2001 through 2002. Although theultimate outcome is unknown, we have reserved for potential adjustments that may result from the current examinationand we believe that the final outcome will not have a material affect on our results of operations. If events occur whichindicate payment of these amounts are unnecessary, the reversal of the liabilities would result in tax benefits beingrecognized in the period when we determine the liabilities are no longer necessary. In addition, although specificforeign country transfer pricing exposures have not been identified, the risk of potential adjustment exists. If ourestimate of the federal, state and foreign income tax liabilities proves to be less than the ultimate assessment, a furthercharge to expense would result.

In evaluating our ability to recover our deferred tax assets we consider all available positive and negative evidenceincluding our past operating results, the existence of cumulative losses in the most recent fiscal years and our forecastof future taxable income. In determining future taxable income, we are responsible for assumptions utilized includingthe amount of state, federal and international pre-tax operating income, the reversal of temporary differences and theimplementation of feasible and prudent tax planning strategies. These assumptions require significant judgment aboutthe forecasts of future taxable income and are consistent with the plans and estimates we are using to manage theunderlying businesses.

12. Commitments and Contingencies

Operating Lease Commitments

We lease certain facilities and equipment under non-cancelable operating leases. During fiscal 2005, 2004 and 2003,we elected to exit certain building leases and building projects, but still have obligations on these particular facilities.See Note 6 for further detail.

At June 30, 2005, the future minimum annual lease payments for all occupied and exited facility leases wereapproximately (in millions):

Non-cancelableOperating Leases

Non-cancelableSubleases Net Payments

Fiscal 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 236 $ (20) $216Fiscal 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189 (16) 173Fiscal 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143 (12) 131Fiscal 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125 (8) 117Fiscal 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 (8) 103Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 312 (58) 254

$1,116 $(122) $994

Rent expense under the non-cancelable operating leases was $125 million, $201 million and $253 million in fiscal2005, 2004 and 2003, respectively.

Asset Retirement Obligations

We have asset retirement obligations from certain leased facilities where we have contractual commitments to removeleasehold improvements and return the property to a specified condition when the lease terminates. At June 30, 2005and 2004, the net present value of these obligations was $36 million in both years and are primarily classified in othernon-current obligations. At June 30, 2005 and 2004, the leasehold assets solely related to our asset retirementobligations approximated $11 million and $15 million, respectively. The amount of amortization of the associatedleasehold assets and accretion expense associated with our asset retirement obligations have not been material.

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Guarantees, Letters of Credit and Indemnification Obligations

In the normal course of our business, we issue guarantees and letters of credit to numerous third-parties and for variouspurposes such as lease obligations and state and local governmental agencies requirements. At June 30, 2005, we hadapproximately $18 million of outstanding financial letters of credit.

In the normal course of business, we may enter into contractual arrangements under which we may agree to indemnifythe third party to such arrangement from any losses incurred relating to the services they perform on behalf of Sun orfor losses arising from certain events as defined within the particular contract, which may include, for example,litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum lossclauses. Historically, payments made related to these indemnifications have not been material.

Through the normal course of our business, we purchase or place orders for the necessary components of our productsfrom various suppliers and we commit to purchase services where we would incur a penalty if the agreement wascanceled. We estimate that our contractual obligations at June 30, 2005 was $501 million due within the followingtwelve months. This amount does not include contractual obligations recorded on the balance sheet as currentliabilities.

Litigation and Other Contingencies

On February 11, 2002, Eastman Kodak Company (Kodak) filed a patent infringement lawsuit against us (Civil ActionNo. 02-CV-6074) in the United States District Court for the Western District of New York. Kodak alleged that some ofour products infringed or contributed to the infringement of one or more patent claims owned by Kodak. EffectiveOctober 7, 2004, we reached an agreement with Kodak to settle all claims in the lawsuit, which included a release anda perpetual, non-exclusive, worldwide irrevocable license to certain Kodak patents, including the patents at issue in thelawsuit. In return, we paid Kodak $92 million. Of this amount, $10 million was expensed in fiscal 2004 and $55million was expensed to cost of sales-products in the first quarter of fiscal 2005. The remaining amount represents theestimated future benefit that we will obtain from the licenses granted under the settlement. This $27 million intangibleasset was recorded in other non-current assets and is being amortized ratably to cost of sales-products over theremaining patent life through fiscal 2010.

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

We entered into settlement agreements with the United States Department of Commerce, Bureau of Industry andSecurity, Office of Export Enforcement (BIS) on December 15, 2003 addressing certain BIS charges that we hadviolated export control regulations. The settlement included a one year suspended denial of our worldwide exportprivileges, which expired on December 15, 2004 without incident.

In fiscal 2005, the General Services Administration (GSA) began auditing our records under the schedule contracts ithad with us to verify our compliance with various contract provisions from October 1997 to February 2005. If the auditdetermines that we did not comply with such provisions, we may be required to pay the GSA a potential settlement.We have made a preliminary assessment of our exposure for such amounts potentially due and such assessment isreflected in our fiscal 2005 consolidated financial statements. The exact date for completion of the audit and thesubsequent negotiation process is unknown and may not be concluded for several quarters.

13. Settlement Income

On March 8, 2002, we filed suit against Microsoft Corporation (Microsoft) in the United States District Court for theNorthern District of California, pursuant to United States and State of California antitrust and other laws. In ourcomplaint and as modified in subsequent filings, we alleged that Microsoft had engaged in illegal conduct, includingefforts to acquire, maintain and expand a number of illegal monopolies; illegal tying arrangements; illegal exclusivedealings; copyright infringement; unreasonable restraints of trade; and unfair competition. In February 2003, Microsoft

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filed four counterclaims against Sun alleging unfair competition and breach of a settlement agreement regarding ourJava technology. The presiding judge dismissed two of those counterclaims.

On April 1, 2004, Sun and Microsoft entered into several agreements including an agreement to settle all pendinglitigation between the two companies. Pursuant to the settlement agreement, Sun agreed to dismiss its litigation againstMicrosoft with prejudice and agreed to not initiate further steps to participate in the proceedings pending againstMicrosoft instituted by the Commission of the European Communities, and each party entered into a release of claimswith respect to such matters. Microsoft also agreed to pay to Sun the amount of $700 million under this settlementagreement.

Pursuant to a patent covenant and stand-still agreement, the parties agreed not to sue each other for past damages forpatent infringement with respect to the other party’s products and technologies (the Covenant Not to Sue for Damages).Each year until 2014, Microsoft has the option of extending the Covenant Not to Sue for Damages to apply to thepreceding year in exchange for an annual extension payment, so long as Microsoft has made all previous annualextension payments and so long as Microsoft has not sued Sun or authorized licensees of its commercial products forpatent infringement prior to such time. At the end of the ten-year term, if Microsoft has made all such payments andnot brought any such suits, then each party will automatically grant to the other party irrevocable, non-exclusive,perpetual licenses under all of its patents and patent applications existing at the end of such period in order to allowsuch other party to continue to commercialize its products shipping at the end of such period and any related successorproducts. In addition, the parties agreed, for a period of six months, not to bring any patent infringement suit (includinga suit for injunctive relief) against the other party or authorized licensees of its commercial products relating to suchother party’s products. Microsoft also agreed to pay to Sun the amount of $900 million under this patent covenant andstandstill agreement.

Pursuant to a technical collaboration agreement, each party agreed to provide the other party with access to aspects ofits desktop and server-based technology for use in developing interoperable server products. Microsoft also agreed topay to Sun the amount of $350 million as a prepaid nonrefundable royalty under this technical collaboration agreement.

Based on the agreements with Microsoft described above, we recognized $54 million and $1,597 million in settlementincome during fiscal 2005 and 2004, respectively, and deferred $350 million in fiscal 2004 as other non-currentobligations until the earlier of usage of the royalties by Microsoft or such time as all our obligations have been met. Infiscal 2004, we also deferred $3 million in connection with our obligation to provide technical support under the termsof the technical collaboration agreement, which is being recognized to income over the 10 year term of the agreement.

14. Stockholders’ Equity

Stockholders’ rights plan

We have adopted a share purchase rights plan to protect stockholders’ rights in the event of a proposed takeover notapproved by our Board of Directors. Under the plan, a preferred share purchase right (a Right) is associated with eachshare of our common stock. Upon becoming exercisable, each Right will entitle its holder to purchase 1/10,000th of ashare of Series A participating preferred stock of Sun, a designated series of preferred stock for which each 1/10,000thof a share has economic attributes and voting rights equivalent to one share of our common stock at an exercise price of$250, subject to adjustment. The Rights are not exercisable or transferable apart from the common stock until theearlier of: (1) the tenth day or a later date as determined by the Board after a public announcement that a person orgroup (an Acquiring Person) has acquired or obtained the right to acquire 10% or more (20% or more for an AcquiringPerson who has filed a Schedule 13G in accordance with the Securities Act of 1934, a 13G Filer,) of our outstandingCommon Shares, or (2) the tenth business day (or a later date as determined by the Board) after a person or grouppublicly announces a tender or exchange offer for 10% or more of the outstanding Common Shares. Unless the Rightsare redeemed, for example, in the event that an Acquiring Person acquires 10% or more (20% or more if the AcquiringPerson is a 13G Filer) of our outstanding common stock, each Right not held by the Acquiring Person will entitle theholder to purchase for the exercise price that number of our shares of common stock having a market value equal totwo times the exercise price. In the event that: (1) Sun is acquired in a merger or business combination in which we arenot the surviving corporation or in which our common stock is exchanged for stock or assets of another entity, or: (2)50% or more of our consolidated assets or earning power is sold, each Right not held by an Acquiring Person willentitle the holder to purchase for the exercise price that number of shares of common stock of the acquiring company

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having a market value equal to two times the exercise price. The Rights are redeemable, in whole but not in part, atSun’s option, at $0.00125 per Right at any time on or before the fifth day (or such later day as determined by theBoard) after an acquiring person has acquired or obtained the right to acquire 10% or more (20% or more if theAcquiring Person is a 13G Filer), of our outstanding common stock. Sun may, at its option, at any time after anAcquiring Person has acquired or obtained the right to acquire 10% or more (20% or more if the Acquiring Person is a13G Filer) of our common stock but before the Acquiring Person acquires or obtains the right to acquire 50% or moreof our common stock, exchange each Right (other than Rights held by an Acquiring Person) for one share of ourcommon stock. The Rights expire on July 25, 2012.

Common stock repurchase programs

From time to time, our Board of Directors approves common stock repurchase programs allowing management torepurchase shares of our common stock in the open market. In February 2001, we announced our intention to acquireup to $1.5 billion of our outstanding common stock under a stock repurchase program authorized by our Board ofDirectors. Under the February 2001 program, the timing and actual number of shares subject to repurchase are at thediscretion of our management and are contingent on a number of factors, including our projected cash flowrequirements, our return to sustained profitability and our share price. During fiscal 2005 and 2004, we did notrepurchase common stock under any repurchase programs, while we repurchased 126 million shares under allrepurchase programs for an aggregate purchase price of $499 million in fiscal 2003. All such repurchases were made incompliance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended. As of June 30, 2005,approximately $230 million of the $1.5 billion remains available for repurchase.

When treasury shares are reissued, any excess proceeds over the average acquisition cost of the shares are recorded asadditional paid-in-capital. Any excess of the average acquisition cost of the shares over the proceeds from reissuance ischarged to additional paid-in-capital to the extent of previous credits on similar transactions, with any remainingamounts charged to retained earnings.

15. Employee Benefit Plans

Stock option and incentive plans

Sun’s 1990 Long-Term Equity Incentive Plan and 1986 Equity Compensation Acquisition Plan provide the Board ofDirectors broad discretion in creating employee equity incentives. These plans authorize the grant of incentive stockoptions, in the case of the 1990 Incentive Plan, and non-statutory stock options, in the case of both plans, as well ascertain other awards. In addition, these plans provide for issuance of non-statutory stock options to eligible employeesto purchase common stock, at or below fair market value, at the date of grant, subject to certain limitations set forth inthe plans. Options expire up to ten years from the date of grant or up to three months following termination ofemployment, whichever occurs earlier, and are exercisable at specified times prior to such expiration. Under the plans,common stock may also be issued pursuant to stock purchase agreements that grant Sun certain rights to repurchase theshares at their original issue price in the event that the employment of the employee is terminated prior to certain pre-determined vesting dates. In addition, shares of common stock may be sold at less than fair market value, which resultsin compensation expense equal to the difference between the market value on the date of grant and the purchase price.This expense is recognized over the vesting period of the shares. Sun’s 1988 Directors’ Stock Option Plan provides forthe automatic grant of stock options to non-employee directors on the date such person initially becomes a director, andon the date of each annual meeting of stockholders to non-employee directors who are elected and who have served asa member of our Board of Directors for at least six months. These options are granted at fair market value on the dateof grant, expire five years from the date of grant or three months following termination of service on the Board,whichever occurs earlier, and are exercisable at specified times prior to such expiration.

On April 28, 2005, 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 directors, under our equity compensation plans. The acceleration of vesting waseffective for stock options outstanding as of May 30, 2005. Options to purchase approximately 45 million shares ofcommon stock or 18% of our outstanding unvested options were subject to the acceleration. The weighted averageexercise price of the options that were accelerated was $14.85. The purpose of the acceleration was to enable us toavoid recognizing compensation expense associated with these options in future periods in our Consolidated

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Statements of Operations upon the adoption of SFAS 123R in July 2005. We also believe that because the options thatwere accelerated had exercise prices in excess of the current market value of our common stock, the options hadlimited economic value and were not fully achieving their original objective of incentive compensation and employeeretention.

Information with respect to stock option and stock purchase rights activity is as follows (in millions, except per shareamounts):

SharesAvailable for

Grant

Outstanding Options

Number ofShares

WeightedAverage

Exercise Price

Balance at June 30, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 244 556 $15.86Additional shares reserved . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135 — —Grants and assumptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (112) 115 3.72Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — (26) 1.74Cancellations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 (58) 17.54Plan expiration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (17) — —

Balance at June 30, 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305 587 13.95Grants and assumptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (103) 111 3.87Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — (41) 2.52Cancellations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 (54) 14.04

Balance at June 30, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 256 603 12.85Grants and assumptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (87) 87 3.80Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — (36) 2.85Cancellations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 (97) 13.61

Balance at June 30, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264 557 $11.94

The following table summarizes significant ranges of outstanding and exercisable options at June 30, 2005 (shares andaggregate intrinsic value in millions):

Outstanding Options Options Exercisable

Range of Exercise Prices Shares

WeightedAverage

RemainingLife

in Years

WeightedAverageExercise

Price

AggregateIntrinsic

ValuePotentialDilution Shares

WeightedAverageExercise

Price

AggregateIntrinsic

ValuePotentialDilution

$0.01 - $3.73 . . . . . . . . 74 5.7 $ 3.22 $38 2.2% 27 $ 3.11 $17 0.8%$3.73 - $5.01 . . . . . . . . 189 6.4 4.10 — 5.5% 40 4.18 — 1.2%$5.02 - $10.00 . . . . . . . 122 3.2 7.32 — 3.6% 119 7.36 — 3.5%$10.01 - $15.00 . . . . . . 35 2.9 12.61 — 1.0% 35 12.61 — 1.0%$15.01 - $20.00 . . . . . . 66 3.4 17.93 — 1.9% 66 17.93 — 1.9%$20.01 - $40.00 . . . . . . 37 2.8 38.11 — 1.1% 37 38.11 — 1.1%$40.01 - $201.02 . . . . . 34 3.0 49.89 — 1.0% 34 49.89 — 1.0%

557 4.6 $11.94 $38 16.3% 358 $16.40 $17 10.5%

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (i.e., the difference betweenSun’s closing stock price of $3.73 at June 30, 2005, and the exercise price, times the number of shares) that would havebeen received by the option holder had all option holders exercised their options on June 30, 2005. This amountchanges based on the fair market value of Sun’s stock.

At June 30, 2004, options to purchase 313 million shares were exercisable at a weighted average exercise price of$16.15. At June 30, 2003, options to purchase 292 million shares were exercisable at a weighted average exercise price

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of $14.16. At June 30, 2005, Sun retained repurchase rights to 2 million shares issued pursuant to stock purchaseagreements and other stock plans at a weighted average price of approximately $0.01.

Potential dilution is computed by dividing the options in the related range of exercise prices by the shares of commonstock issued, adjusted by treasury stock, as of June 30, 2005 (3,408 million shares).

The 557 million options outstanding have vested or will vest as follows (in millions):2005 and

Prior 2006 2007 2008 20092010 and

Thereafter Total

Number of Options . . . . . . . . . . . . . . . . . . . . . 358 51 50 49 33 16 557

As of June 30, 2005, Sun had approximately 396 million shares of common stock reserved for future issuance under itsstock plans.

Employee stock purchase plan

To provide employees with an opportunity to purchase Sun common stock through payroll deductions, Sun establishedthe 1990 Employee Stock Purchase Plan (ESPP). Under the ESPP, Sun employees, subject to certain restrictions, maypurchase shares of common stock at 85% of the fair market value at either the date of enrollment or the date ofpurchase, whichever is less. Sun issued approximately 36 million, 45 million and 52 million shares of common stock infiscal 2005, 2004 and 2003, respectively, under the ESPP. At June 30, 2005, approximately 132 million sharesremained available for future issuance.

Employee 401(k) plan

Sun has a 401(k) plan known as the Sun Microsystems, Inc. Tax Deferred Retirement Savings Plan (Plan). The Plan isavailable to all regular employees on Sun’s U.S. payroll and provides employees with tax deferred salary deductionsand alternative investment options. The Plan does not provide employees with the option to invest in Sun’s commonstock. Employees may contribute up to 30% of their salary, subject to certain limitations. Sun matches employees’contributions to the Plan at a maximum of 4% of eligible compensation up to the annual maximum of $6,800. Weexpensed $74 million, $79 million and $78 million in the fiscal 2005, 2004 and 2003, respectively, for ourcontributions to the Plan. Sun’s contributions to the Plan vest 100% upon contribution.

Non-U.S. benefits plans

Sun provides defined benefit pension plans in certain countries outside the U.S.. We deposit funds for certain of theseplans, consistent with the requirements of local law, with insurance companies, third-party trustees, or intogovernment-managed accounts, and accrue for the unfunded portion of the obligation. The assumptions used incalculating the obligation for the non-U.S. plans depend on the local economic environment. The projected benefitobligations were $189 million and $137 million as of June 30, 2005 and 2004, respectively. The related fair value ofplan assets were $126 million and $97 million as of June 30, 2005 and 2004, respectively.

Sun’s practice is to fund the various pension plans in amounts at least sufficient to meet the minimum requirements oflocal laws and regulations. The assets of the various plans are invested in corporate equities, corporate debt securities,government securities and other institutional arrangements. The portfolio of each plan depends on plan design andapplicable local laws. Depending on the design of the plan, and local custom and market circumstances, the minimumliabilities of a plan may exceed qualified plan assets. Our contributions for fiscal 2005 and 2004 approximated$15 million and $21 million, respectively. The net amount recognized related to the funded status of the Plansapproximated $20 million and $13 million, at June 30, 2005 and 2004, respectively.

16. Industry Segment, Geographic, and Customer Information

We design, manufacture, market and service network computing infrastructure solutions that consist of ComputerSystems (hardware and software), Network Storage systems (hardware and software), Support services and Clientsolutions and Educational services. Our organization is primarily structured in a functional manner. Effective April 1,2004, our President and Chief Operating Officer was identified as our Chief Operating Decision Maker (CODM) asdefined by SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information” (SFAS 131). Our

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CODM managed our company based primarily on broad functional categories of sales, services, manufacturing,product development and engineering and marketing and strategy. Our CODM reviewed consolidated financialinformation on revenues and gross margins for products and services and also reviewed operating expenses, certain ofwhich had been allocated to our two segments described below.

We operated in two segments: Product Group and Sun Services. Our Product Group segment comprised our end-to-endnetworking architecture of computing products including our Computer Systems and Network Storage systems productlines. In the Sun Services segment, we provided a full range of services to existing and new customers, includingSupport services and Client solutions and Educational services.

We have a Worldwide Operations (WWOPS) organization and a Global Sales Organization (GSO) that, respectively,manufacture and sell all of our products. The CODM held the GSO accountable for overall products and servicesrevenue and margins on a consolidated level. GSO and WWOPS managed the majority of our accounts receivable andinventory, respectively. In addition, we have a Worldwide Marketing Organization (WMO) that is responsible fordeveloping and executing Sun’s overall corporate, strategic and product marketing and advertising strategies. TheCODM looked to this functional organization for advertising, pricing and other marketing strategies for the productsand services delivered to market. Operating expenses (primarily sales, marketing and administrative) related to theGSO and the WMO are not allocated to the reportable segments and, accordingly, are included under the Othersegment reported below.

Segment information (Restated)

The following table presents revenues, interdivision revenues, operating income (loss) and total assets for our segmentsfor the three years ended June 30, 2005. The Other segment consists of certain functional groups that did not meet therequirements for a reportable segment as defined by SFAS 131, such as GSO and WMO and other miscellaneousfunctions such as Finance, Human Resources, and Legal (in millions):

ProductGroup

SunServices Other Total

(Restated) (Restated)

2005Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,126 $3,944 $ — $11,070Interdivision revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 646 400 (1,046) —Operating income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,172 1,476 (3,025)(1) (377)Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 627 398 13,165 14,190

2004Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,355 $3,830 $ — $11,185Interdivision revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 671 424 (1,095) —Operating income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,006 1,127 (3,323)(1) (1,190)Total assets (as restated) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 779 332 13,694 14,805

2003Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,793 $3,641 $ — $11,434Interdivision revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 625 478 (1,103) —Operating income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,206 1,193 (5,123)(1) (2,724)Total assets (as restated) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 613 469 12,213 13,295

(1) Includes restructuring charges, impairment of goodwill and other intangible assets and purchased in-processresearch and development.

Product information

Our product classes comprise revenue from Computer Systems products and Network Storage products. Our servicesrevenue consists of sales from two classes of services: (1) Support services which consists of maintenance contractsand (2) Client solutions and Educational services, which consists of technical consulting to help customers plan,implement, and manage distributed network computing environments and developing and delivering integratedlearning solutions for enterprises, IT organizations, and individual IT professionals. The following table providesexternal revenue for similar classes of products and services for the last three fiscal years (in millions):

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2005 2004 2003

Computer Systems products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,826 $5,854 $6,243Network Storage products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,300 1,501 1,550

Total products revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,126 $7,355 $7,793

Support services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,031 $2,999 $2,844Client solutions and Educational services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 913 831 797

Total services revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,944 $3,830 $3,641

Customer information

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. Our Chairman of the Board of Directors andChief Executive Officer, Scott G. McNealy, was a member of GE’s Board of Directors during part of fiscal 2003, untilhe resigned from GE’s Board of Directors as of January 1, 2003. More than 80% of the revenue attributed to GE wasgenerated through GE subsidiaries acting as either a reseller or financier of our products. The vast majority of thisrevenue is from sales through a single GE subsidiary, comprised 13%, 11% and 9% of net revenues in 2005, 2004 and2003, respectively. This subsidiary acts as a distributor of our products to resellers who in turn sell those products toend-users. No other customer accounted for more than 10% of revenues. The revenues from GE are generated in theProduct Group and Sun Services segments. Accounts receivable from GE and its subsidiaries in the aggregate wasapproximately 14% and 9% of total accounts receivable as of June 30, 2005 and 2004, respectively.

Geographic information (Restated)

Sun’s significant operations outside the U.S. include manufacturing facilities, design centers, and sales offices inEurope, Middle East, and Africa (EMEA), as well as the Asia Pacific (APAC) and Americas-Other (Canada and LatinAmerica) regions. Intercompany transfers between operating segments and geographic areas are primarily accountedfor at prices that approximate arm’s length transactions. In fiscal 2005, 2004 and 2003, sales between segments arerecorded at standard cost. Information regarding geographic areas at June 30, and for each of the years then ended, wasas follows (in millions):

U.S.Americas —

OtherAmericas —

Total EMEA APAC Total

(Restated) (Restated) (Restated) (Restated) (Restated) (Restated)

2005Sales to unaffiliated customers . . . . . . . . . . . . . . $4,392 $590 $4,982 $4,152 $1,936 $11,070Long-lived assets (excluding investments and

deferred tax assets) . . . . . . . . . . . . . . . . . . . . . 2,164 46 2,210 401 94 2,705Net assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (80) (74) (154) 5,836 992 6,6742004Sales to unaffiliated customers . . . . . . . . . . . . . . $4,768 $562 $5,330 $3,942 $1,913 $11,185Long-lived assets (excluding investments and

deferred tax assets) . . . . . . . . . . . . . . . . . . . . . 2,399 19 2,418 502 101 3,021Net assets (as restated) . . . . . . . . . . . . . . . . . . . . 610 (85) 525 4,976 982 6,4832003Sales to unaffiliated customers . . . . . . . . . . . . . . $5,048 $543 $5,591 $3,783 $2,060 $11,434Long-lived assets (excluding investments and

deferred tax assets) . . . . . . . . . . . . . . . . . . . . . 2,549 73 2,622 593 105 3,320Net assets (as restated) . . . . . . . . . . . . . . . . . . . . 556 (39) 517 5,028 991 6,536

17. Related Parties

We conduct transactions with three companies that are or were considered related parties. Time Warner, Inc. wasconsidered a related party until the dissolution of our strategic alliance with Time Warner in fiscal 2002, because JamesL. Barksdale, the former President and Chief Executive Officer of Netscape Communications Corporation is a member

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of the Board of Directors of both Sun and Time Warner. General Electric Company (GE) and its subsidiaries wereconsidered a related party because our Chairman of the Board of Directors and Chief Executive Officer, Scott G.McNealy, was a member of GE’s Board of Directors until January 1, 2003 when he resigned from the GE Board ofDirectors. Therefore, as of fiscal 2004, GE was no longer considered a related party. Stephen Bennett, the Presidentand Chief Executive Officer of Intuit Inc. (Intuit) was appointed a member of the Board of Directors of Sun effectiveJune 28, 2004. The amount of net revenues and expenses recognized for Intuit since Mr. Bennett’s appointment werenot material. The amount of net revenues and expenses recognized for GE and Time Warner were as follows (inmillions):

2005 2004 2003

Net revenues — GE(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . N/A N/A 1,311Net revenues — Time Warner(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . N/A 46 34Expenses — GE(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . N/A N/A 12Expenses — Time Warner(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . N/A — 1

At June 30, accounts receivable and accounts payable balances with, GE and Time Warner were as follows (inmillions):

2005 2004 2003

Accounts receivable from GE(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . N/A N/A $277Accounts receivable from Time Warner(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . N/A 2 7Accounts payable to GE(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . N/A N/A 5Accounts payable to Time Warner(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . N/A — —

(1) As of fiscal 2004, GE is no longer considered a related party.(2) As of fiscal 2005, Time Warner is no longer considered a related party.

At June 30, 2005 and 2004, Sun had a note receivable including accrued interest totaling $3.9 million and $3.6 million,respectively, due from Jonathan I. Schwartz, our President and Chief Operating Officer. The note was made in July2002 prior to the enactment of the Sarbanes-Oxley Act of 2002 and was negotiated at an arms-length basis. The note isdue on June 30, 2006, bears interest at 6.75% per annum and is fully collateralized by Sun common stock owned byMr. Schwartz. Based on fair market value, the number of shares are adjusted every six months as required to fullycollaterize the loan.

18. Subsequent Events

Tarantella

On July 13, 2005, we acquired Tarantella, Inc. (Tarantella), a publicly-held company based in Los Gatos, California,(OTC: TTLA.OB) by means of a merger pursuant to which we paid approximately $25 million in cash for all of theoutstanding shares of capital stock of Tarantella. In addition, all outstanding options to purchase Tarantella commonstock were converted into options to purchase shares of our stock. Tarantella is a leading provider of software thatenables organizations to access and manage information, data and applications across virtually all platforms, networksand devices. We acquired Tarantella to enhance our thin-client product offerings and strengthen our utility computingstrategy. This transaction will be accounted for as a business combination under SFAS 141.

SeeBeyond

On August 25, 2005, we acquired 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 eachSeeBeyond share for an aggregate value of approximately $362 million, plus the fair value of assumed employee stockoptions. In addition, certain SeeBeyond stock option holders received cash equal to the difference between $4.25 pershare and the exercise price of such options. SeeBeyond provides business integration software via its IntegratedComposite Application Network (ICAN) suite, which enables the real-time flow of information within the enterpriseand among customers, suppliers, and partners. This acquisition will strengthen our software portfolio and create acomplete offering for the development, deployment and management of enterprise applications and Service OrientedArchitectures (SOA). This transaction will be accounted for as a business combination under SFAS 141.

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StorageTek

On August 31, 2005, we acquired StorageTek, a publicly-held company based in Louisville, Colorado (NYSE: STK).Under the terms of the agreement, StorageTek stockholders will receive $37 per share in cash for each StorageTekshare for an aggregate value of $4.0 billion, plus the fair value of assumed employee stock options. In addition, certainStorageTek stock option and stock equivalent holders received cash equal to the difference between $37 per share andthe exercise price of such options or equivalents. StorageTek engages in the design, manufacture, sale, andmaintenance 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 oftheir storage infrastructures. We are acquiring StorageTek in order to offer customers the most complete range ofproducts, services and solutions available for securely managing mission-critical data assets. This transaction will beaccounted for as a business combination under SFAS 141.

Restricted stock grant

On July 28, 2005, the compensation committee of the Board of Directors approved a stock grant for a one-time targetedrecognition and retention program, which included the issuance of approximately 18 million shares of restricted stockto certain employees with a purchase price of $0.01 per share. These restricted shares will vest 50% on the firstanniversary of the grant date and 50% six months later. The issuance of these restricted shares will result inapproximately $70 million of stock-based compensation expense which will be recognized over the vesting period.

19. Quarterly Financial Data (unaudited) (Restated)

Our first three quarters in fiscal 2005 ended on September 26, December 26 and March 27 and in fiscal 2004 ended onSeptember 28, December 28 and March 28. Our fourth quarter ends on June 30.

The following tables contain selected unaudited Consolidated Statement of Operations data for each quarter of fiscal2005 and 2004 (in millions, except per share amounts):

Fiscal 2005 Quarter Ended

September 26 December 26 March 27 June 30

(Restated) (Restated) (Restated)

Net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,628 $2,841 $2,627 $2,974Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,073 1,198 1,087 1,231(3)

Operating income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . (121) 1 (142) (115)Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (133) 4 (28)(2) 50Net income (loss) per common share(1):

Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.04) $ 0.00 $ (0.01) $ 0.01Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.04) $ 0.00 $ (0.01) $ 0.01

Weighted average shares outstanding:Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,343 3,360 3,376 3,399Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,343 3,400 3,376 3,410

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Fiscal 2004 Quarter Ended

September 28 December 28 March 28 June 30

(Restated) (Restated) (Restated) (Restated)

Net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,536 $2,888 $2,651 $3,110

Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,016 1,208 1,068 1,224(3)

Operating loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (251) (81) (447) (411)

Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (288) (126) (754) 780(2)

Net income (loss) per common share(1):

Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.09) $ (0.04) $ (0.23) $ 0.23

Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.09) $ (0.04) $ (0.23) $ 0.23

Weighted average shares outstanding:

Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,235 3,262 3,286 3,327

Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,235 3,262 3,286 3,348

(1) Net income (loss) per common share are computed independently for each of the quarters presented. Therefore,the sum of the quarterly per common share information may not equal the annual per common share information.

(2) Fiscal 2005 and 2004 includes $54 million and $1,597 million, respectively, in settlement income related to theMicrosoft settlement.

(3) Gross margin in the fourth quarter of fiscal 2005 was unfavorably impacted by $20 million for adjustmentsprimarily associated with our accounting for the foreign currency impact of spares and fixed asset amortization.

As described in Note 2, we have made corrections to our consolidated statements of operations related to accountingerrors which were identified in the fourth quarter of fiscal 2005. The changes between the first and second quarter offiscal 2005 related to the fiscal 2004 bonus accrual of $12 million, together with a number of other individuallyimmaterial items that impacted SG&A expense by an aggregate of $2 million.

The changes between the third and fourth quarter of fiscal 2005 similarly reflected the adjustment of a number ofindividually immaterial items that impacted SG&A expense by $3 million.

Provision for (benefit from) income taxes have been restated as a result of our identification of errors related to theaccounting for deferred taxes in certain foreign jurisdictions, as well as the aggregate effect of corrections to provisionsfor state and foreign tax returns and withholding taxes.

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Set forth below are the “as restated” amounts as a result of our restatement of the previously issued financial statementsfor the first three quarters of fiscal 2005 and all of the quarters for fiscal 2004 from previously reported informationfiled on Form 10-Q (in millions, except per share amounts):

Fiscal 2005 Quarter Ended

September 26 December 26 March 27

(As reported) (As restated) (As reported) (As restated) (As reported) (As restated)

Operating income (loss) . . . . . . . . . . . . . . $ (135) $ (121) $ 15 $ 1 $ (139) $ (142)

Income (loss) before taxes . . . . . . . . . . . . (108) (94) 57 43 (46) (49)

Provision for (benefit from) incometaxes . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 39 39 39 (43) (21)

Net income (loss) . . . . . . . . . . . . . . . . . . . (147) (133) 18 4 (3) (28)Net income (loss) per common share:

Basic . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.04) $ (0.04) $ 0.01 $ 0.00 $ (0.00) $ (0.01)

Diluted . . . . . . . . . . . . . . . . . . . . . . . $ (0.04) $ (0.04) $ 0.01 $ 0.00 $ (0.00) $ (0.01)Shares used in the calculation of net

income (loss):

Basic . . . . . . . . . . . . . . . . . . . . . . . . . 3,343 3,343 3,360 3,360 3,376 3,376

Diluted . . . . . . . . . . . . . . . . . . . . . . . 3,343 3,343 3,400 3,400 3,376 3,376

Fiscal 2004 Quarter Ended

September 28 December 28 March 28 June 30

(Asreported)

(Asrestated)

(Asreported)

(Asrestated)

(Asreported)

(Asrestated)

(Asreported)

(Asrestated)

Operating loss . . . . . . . . . . . . . . . . . . . . . $ (251) $ (251) $ (81) $ (81) $ (447) $ (447) $ (411) $ (411)

Income (loss) before taxes . . . . . . . . . . . . (255) (255) (97) (97) (421) (421) 1,210 1,210

Provision for (benefit from) incometaxes . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 33 28 29 339 333 427 430

Net income (loss) . . . . . . . . . . . . . . . . . . . (286) (288) (125) (126) (760) (754) 783 780Net income (loss) per common share:

Basic . . . . . . . . . . . . . . . . . . . . . . . . $ (0.09) $ (0.09) $ (0.04) $ (0.04) $ (0.23) $ (0.23) $ 0.24 $ 0.23

Diluted . . . . . . . . . . . . . . . . . . . . . . . $ (0.09) $ (0.09) $ (0.04) $ (0.04) $ (0.23) $ (0.23) $ 0.23 $ 0.23Shares used in the calculation of net

income (loss):

Basic . . . . . . . . . . . . . . . . . . . . . . . . 3,235 3,235 3,262 3,262 3,286 3,286 3,327 3,327

Diluted . . . . . . . . . . . . . . . . . . . . . . . 3,235 3,235 3,262 3,262 3,286 3,286 3,348 3,348

We have not amended our annual reports on Form 10-K or quarterly reports on Form 10-Q for the quarterly periodsaffected by the restatement prior to June 30, 2005. The information that has been previously filed or otherwise reportedfor these periods is superseded by the information in this annual report.

The sum of the quarterly consolidated financial data may not equal the annual consolidated financial data due torounding.

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Report of Independent Registered Public Accounting Firm

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

We have audited the accompanying consolidated balance sheets of Sun Microsystems, Inc. as of June 30, 2005 and2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the threeyears in the period ended June 30, 2005. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (UnitedStates). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well as evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidatedfinancial position of Sun Microsystems, Inc. at June 30, 2005 and 2004, and the consolidated results of their operationsand their cash flows for each of the three years in the period ended June 30, 2005, in conformity with U.S. generallyaccepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (UnitedStates), the effectiveness of Sun Microsystem’s internal control over financial reporting as of June 30, 2005, based oncriteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizationsof the Treadway Commission and our report dated September 12, 2005 expressed an unqualified opinion onmanagement’s assessment and an adverse opinion on the effectiveness of internal control over financial reporting.

As discussed in Note 2 of the consolidated financial statements, the Company has restated its consolidated financialstatements for fiscal 2004 and 2003.

/s/ Ernst & Young LLP

San Jose, CaliforniaSeptember 12, 2005

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Report of Ernst & Young LLP, Independent Registered Public Accounting Firm

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

We have audited management’s assessment, included in Management’s Report on Internal Control Over FinancialReporting in Item 9a, that Sun Microsystems, Inc. did not maintain effective internal control over financial reporting asof June 30, 2005, because of the effect of the material weakness identified in management’s assessment, based oncriteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizationsof the Treadway Commission (the COSO criteria). Sun Microsystems, Inc.’s management is responsible formaintaining effective internal control over financial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (UnitedStates). Those standards require that we plan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in all material respects. Our audit included obtainingan understanding of internal control over financial reporting, evaluating management’s assessment, testing andevaluating the design and operating effectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. A company’s internal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recordedas necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, andthat receipts and expenditures of the company are being made only in accordance with authorizations of management anddirectors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.The following material weakness has been identified and included in management’s assessment:

As of June 30, 2005, the Company identified a material weakness in its internal control over financial reporting whichresulted from deficiencies in the design and operation of the Company’s controls related to the review of accountingfor income tax reserves. Although the Company detected errors affecting the income tax reserves and income taxbenefit and adjusted the consolidated financial statements as of June 30, 2005 to correct the identified errors, theCompany has determined that the ineffective controls with respect to the review processes within the Company’s taxdepartment result in there being a more than remote likelihood that a material misstatement in the Company’s annual orinterim financial statements will not be prevented or detected.

This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our auditof the 2005 consolidated financial statements, and this report does not affect our report dated September 12, 2005 onthose financial statements.

In our opinion, management’s assessment that Sun Microsystems, Inc. did not maintain effective internal control overfinancial reporting as of June 30, 2005, is fairly stated, in all material respects, based on the COSO control criteria.Also, in our opinion, because of the effect of the material weakness described above on the achievement of theobjectives of the control criteria, Sun Microsystems, Inc. has not maintained effective internal control over financialreporting as of June 30, 2005, based on the COSO control criteria.

/s/ Ernst & Young LLP

San Jose, CaliforniaSeptember 12, 2005

107

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ANDFINANCIAL DISCLOSURE

Not applicable.

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Management, with the participation of the Chief Executive Officer and Chief Financial Officer, has performed anevaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the SecuritiesExchange Act of 1934). This evaluation included consideration of the controls, processes and procedures that compriseour internal control over financial reporting. Based on such evaluation, our Chief Executive Officer and ChiefFinancial Officer concluded that, as of June 30, 2005, as a result of the material weakness in internal control overfinancial reporting discussed below, our disclosure controls and procedures were not effective in ensuring thatinformation required to be disclosed by us in the reports that we file under the Securities Exchange Act of 1934 isrecorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and thatsuch information is accumulated and communicated to our management as appropriate to allow timely decisionsregarding required disclosure.

Management’s Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting asdefined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Our internal control overfinancial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance with generally accepted accounting principles.Our internal control over financial reporting includes those policies and procedures that:

(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions anddispositions of our assets;

(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, and that our receipts and expenditures arebeing made only in accordance with authorizations of our management and directors; and

(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use ordisposition of our assets that could have a material effect on the financial statements.

Management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our internalcontrols will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, canprovide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design ofa control system must reflect the fact that there are resource constraints, and the benefits of controls must be consideredrelative to their costs. Because of the inherent limitations in all control systems, no evaluation of internal controls canprovide absolute assurance that all control issues and instances of fraud, if any, have been detected. Also, anyevaluation of the effectiveness of controls in future periods are subject to the risk that those internal controls maybecome inadequate because of changes in business conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

Based on the results of our evaluation, management assessed the effectiveness of our internal control over financialreporting as of June 30, 2005. In conducting its assessment of internal control over financial reporting, managementbased its evaluation on the framework in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (COSO). A “material weakness” is a significant deficiency(within the meaning of Public Company Accounting Oversight Board Auditing Standard No. 2), or combination ofsignificant deficiencies, that results in there being more than a remote likelihood that a material misstatement of theannual or interim financial statements will not be prevented or detected on a timely basis by employees in the normalcourse of their assigned functions. As of June 30, 2005, we have identified one material weakness, as described below.

108

As of June 30, 2005, the Company identified a material weakness in its internal control over financial reporting whichresulted from deficiencies in the design and operation of the Company’s controls related to the review of accountingfor income tax reserves. Although the Company detected errors affecting the income tax reserves and income taxbenefit and adjusted the consolidated financial statements as of June 30, 2005 to correct the identified errors, theCompany has determined that the ineffective controls with respect to the review processes within the Company’s taxdepartment result in there being a more than remote likelihood that a material misstatement in the Company’s annual orinterim financial statements will not be prevented or detected.

Because of the material weakness described above, our management believes that, as of June 30, 2005, we did notmaintain effective internal control over financial reporting based on the COSO criteria.

The attestation report concerning management’s assessment of the effectiveness of our internal control over financialreporting as of June 30, 2005, issued by Ernst & Young, LLP, Independent Registered Public Accounting Firm,appears on page 107 of this Report.

Change in internal Control—Remediation of Material Weakness

Subsequent to discovery of the material weakness, we began taking steps to remediate the deficiencies, includingengaging external tax advisors to assist in the review of our income tax calculations, implementing preventive controlswith respect to the recording of tax reserves, and accelerating the timing of certain tax review activities during thefinancial statement close process. Additionally, management will perform an assessment of its tax organization andrecruit the necessary personnel to improve its internal control and communication processes and the overall level ofexpertise within the group. Management has also determined that the most appropriate organization to perform the taxaccounting going forward is the Corporate Controller’s Group. This change is effective immediately. We believe theseactions will strengthen our internal control over financial reporting and address the material weakness identified above.

There have been no changes in our internal control over financial reporting during the fiscal quarter ended June 30,2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financialreporting.

ITEM 9B. OTHER INFORMATION

Sun Microsystems, Inc. has restated our consolidated financial statements for fiscal 2004 and 2003, quarterly financialdata for each of the quarters within fiscal 2005 and 2004, and selected financial data for fiscal 2004 and 2003 (theRestatement). The determination to restate these financial statements and selected financial data was made by ourmanagement in consultation with the Audit Committee on September 12, 2005, as a result of our identification oferrors related to the accounting for deferred taxes in certain foreign jurisdictions, as well as the aggregate effect ofcorrections to provisions for State and foreign tax returns and withholding taxes. In addition, the determination torestate our quarterly financial statements for fiscal 2005 was the result of evaluating the impact of certain pre-taxaccounting adjustments recorded throughout the year. Our Audit Committee discussed these matters with ourindependent registered public accounting firm. These errors were largely identified through the operation of ourinternal controls over financial reporting. Although we believe such errors were immaterial to our financial statementsand selected financial information for fiscal 2004 and 2003, under relevant Securities and Exchange Commissionaccounting interpretations, a restatement of the financial statements of such prior periods to correct immaterialmisstatements therein is required if the aggregate correcting adjustment related to such errors would be material to thefinancial statements of the current period.

109

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information regarding our directors is incorporated herein by reference to the information contained under the caption“Proposal 1 — Election of Directors” in our 2005 Proxy Statement for the 2005 Annual Meeting of Stockholders.Information regarding current executive officers found under the caption “Executive Officers of the Registrant” in PartI hereof is incorporated by reference into this Item 10. Information regarding Section 16 reporting compliance isincorporated herein by reference to information contained under the caption “Executive Compensation — Section16(a) beneficial ownership reporting compliance” in our 2005 Proxy Statement. The identity of our Audit Committeemembers and information regarding the “audit committee financial expert” on our Audit Committee, as such term isdefined in SEC regulations, is incorporated herein by reference to information contained under the caption “Proposal 1— Election of Directors — About the Board and its committees” in our 2005 Proxy Statement. Finally, the informationcontained under the caption “Corporate Governance — Standards of Business Conduct” in our 2005 Proxy Statement isincorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is incorporated by reference from the information contained under the captions“Proposal 1 — Election of Directors — Director Compensation” and “Executive Compensation” in our 2005 ProxyStatement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ANDRELATED STOCKHOLDER MATTERS

The information required by this item is incorporated by reference from the information contained under the caption“Security Ownership of Certain Beneficial Owners and Management” in our 2005 Proxy Statement.

Equity Compensation Plan Information

The following table presents a summary of outstanding stock options and securities available for future grant under ourstockholder approved and non-stockholder-approved equity compensation plans as of June 30, 2005 (in millions,except per share amounts).

Plan Category

Number of Securitiesto be Issued upon

Exercise ofOutstanding

Options, Warrantsand Rights

Weighted AverageExercise Price of

OutstandingOptions, Warrants

and Rights

Number ofSecurities

Remaining Availablefor Future Issuance

Under EquityCompensation Plans

Equity compensation plans approved by securityholders (excluding ESPP) . . . . . . . . . . . . . . . . . . . . . . 537 $12.17 235

Equity compensation plans not approved by securityholders (excluding ESPP) . . . . . . . . . . . . . . . . . . . . . . 20 $ 5.91 29

Total (excluding ESPP) . . . . . . . . . . . . . . . . . . . . . . . . . . 557 $11.94 264

Equity compensation plans approved by securityholders (ESPP only) . . . . . . . . . . . . . . . . . . . . . . . . . . N/A N/A 132

Equity compensation plans not approved by securityholders (ESPP only) . . . . . . . . . . . . . . . . . . . . . . . . . . N/A N/A N/A

Total (ESPP only) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . N/A N/A 132

All plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 557 $11.94 396

110

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item is incorporated by reference from the information contained under the captions“Proposal 1 — Election of Directors — Compensation committee interlocks and insider participation,” “ExecutiveCompensation — Summary Compensation Table,” “— Executive officer, severance and change-in-controlarrangements,” “— Deferred compensation arrangements” and “— Certain transactions with officers and members ofthe Board” in our 2005 Proxy Statement.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item is incorporated herein by reference to the information contained under thecaption “Audit and Non-Audit Fees” in our 2005 Proxy Statement.

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

The following documents are filed as part of this report:

1. Financial Statements: See Index to Consolidated Financial Statements under Item 8 on Page 61 ofthis report.

2. Financial Statement Schedules have been omitted since they are either not required, not applicable, orthe information is otherwise included.

3. Exhibits:

ExhibitNumber Description

2.1(1) Agreement and Plan of Merger by and among the Registrant, Stanford Acquisition Corporation andStorage Technology Corporation, dated as of June 2, 2005.

2.2 Agreement and Plan of Merger by and among the Registrant, Big Bear Acquisition Corporation andSeeBeyond Technology Corporation, dated as of June 27, 2005.

3.1(2) Registrant’s Restated Certificate of Incorporation, as amended February 11, 1998.3.2(3) Certificate of Amendment of the Restated Certificate of Incorporation of Registrant dated

November 8, 2000.3.3(4) Amended and Restated Certificate of Designations dated December 13, 2000.3.4(15) Bylaws of the Registrant, as amended November 10, 2004.4.1(5) Third Amended and Restated Shares Rights Agreement dated July 25, 2002.4.2(6) Indenture, dated August 1, 1999 (the “Indenture”) between Registrant and The Bank of New York, as

Trustee.4.3(6) Form of Subordinated Indenture.4.4(6) Officers’ Certificate Pursuant to Section 301 of the Indenture, without exhibits, establishing the terms

of Registrant’s Senior Notes.4.5(6) Form of Senior Note.

10.1(8)* Registrant’s 1990 Long-Term Equity Incentive Plan, as amended on September 17, 2002 (the “1990Plan”).

10.2(16)* Representative form of stock option grant agreement under the 1990 Plan.10.3* Representative form of restricted stock grant agreement under the 1990 Plan.10.4(7)* Registrant’s 1988 Directors’ Stock Option Plan, as amended on August 11, 1999 (the “Directors’

Plan”).10.5* Representative form of stock option grant agreement under the Directors’ Plan.10.6(11)* Registrant’s Equity Compensation Acquisition Plan, as amended on July 25, 2002 (the “ECAP”).10.7* Representative form of stock option grant agreement under the ECAP.10.8(10)* Registrant’s Non-Qualified Deferred Compensation Plan, as amended June 30, 2002.

111

ExhibitNumber Description

10.9(10)* Registrant’s Section 162(m) Executive Officer Performance-Based Bonus Plan, as amended andrestated July 1, 2001.

10.10* U.S. Vice President Severance Plan, effective as of July 1, 2005.10.11(12)* Form of Change of Control Agreement executed by each executive officer, other than the Chief

Executive Officer, of Registrant.10.12(12)* Form of Change of Control Agreement executed by Chief Executive Officer of Registrant.10.13(13)* Promissory Notes issued by Jonathan I. Schwartz dated October 29, 2001 (“Note 1”), Promissory Note

issued by Jonathan I. Schwartz dated June 28, 2002 (“Note 2”), cancellation of Notes 1 and 2 datedJuly 18, 2002, and Promissory Note issued by Jonathan I. Schwartz on July 19, 2002.

10.14(11)* Form of Indemnification Agreement executed by each Board member of Registrant.10.15* Chief Executive Officer Bonus Terms for FY06 under the Section 162(m) Executive Officer

Performance-Based Bonus Plan.10.16* Chief Operating Officer Bonus Terms for FY06 under the Section 162(m) Executive Officer

Performance-Based Bonus Plan.10.17* SMX Staff Executive Officer Bonus Terms for FY06 under the Section 162(m) Executive Officer

Performance-Based Bonus Plan.10.18* EMG Staff Executive Officer Bonus Terms for FY06 under the Section 162(m) Executive Officer

Performance-Based Bonus Plan.10.19(14)† Technical Collaboration Agreement dated April 1, 2004 between Microsoft Corporation and the

Registrant, Sun Microsystems International B.V. and Sun Microsystems Technology Ltd.10.20(14)† Limited Patent Covenant and Stand-Still Agreement dated April 1, 2004 between the Registrant and

Microsoft Corporation.10.21(14)† Settlement Agreement dated April 1, 2004 between the Registrant and its subsidiaries and Microsoft

Corporation.21.1 Subsidiaries of Registrant23.1 Consent of Independent Registered Public Accounting Firm31.1 Rule 13a-14(a) Certification of Chief Executive Officer31.2 Rule 13a-14(a) Certification of Chief Financial Officer32.1 Section 1350 Certificate of Chief Executive Officer32.2 Section 1350 Certificate of Chief Financial Officer

* Indicates a management contract or compensatory plan or arrangement.

† Pursuant to a request for confidential treatment, portions of the Exhibit have been redacted from the publiclyfiled document and have been furnished separately to the SEC as required by Rule 406 under the Securities Act.

(1) Incorporated by reference to Registrant’s Current Report on Form 8-K filed on September 6, 2005

(2) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for fiscal quarter ended March 29,1998.

(3) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for fiscal quarter ended December 31,2000.

(4) Incorporated by reference to Registrant’s Form 8-A/A filed December 20, 2000.

(5) Incorporated by reference to Registrant’s Form 8-A/A filed September 26, 2002.

(6) Incorporated by reference to Registrant’s Current Report on Form 8-K filed August 6, 1999.

(7) Incorporated by reference to Registrant’s Annual Report on Form 10-K for the fiscal year ended June 30, 1999.

(8) Incorporated by reference to Registrant’s Registration Statement on Form S-8 filed on November 20, 2002.

(9) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31,2002.

112

(10) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter endedSeptember 30, 2001.

(11) Incorporated by reference to Registrant’s Annual Report on Form 10-K for the fiscal year ended June 30, 2002.

(12) Incorporated by reference to Registrant’s Annual Report on Form 10-K for the fiscal year ended June 30, 2003.

(13) Incorporated by reference to Registrant’s Current Report on Form 8-K filed on August 9, 2002.

(14) Incorporated by reference to Registrant’s Annual Report on Form 10-K for the fiscal year ended June 30, 2004.

(15) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter endedDecember 26, 2004.

(16) Incorporated by reference to Registrant’s Current Report on Form 8-K filed on June 28, 2005.

113

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

September 13, 2005 SUN MICROSYSTEMS, INC.Registrant

By: /s/ STEPHEN T. McGOWAN

(Stephen T. McGowan)Chief Financial Officer and ExecutiveVice President, Corporate Resources

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature Title Date

/s/ SCOTT G. McNEALY

(Scott G. McNealy)

Chairman of the Board of Directors andChief Executive Officer (PrincipalExecutive Officer)

September 13, 2005

/s/ STEPHEN T. McGOWAN

(Stephen T. McGowan)

Chief Financial Officer and ExecutiveVice President, Corporate Resources(Principal Financial Officer)

September 13, 2005

/s/ ROBYN M. DENHOLM

(Robyn M. Denholm)

Senior Vice President, Finance (PrincipalAccounting Officer)

September 13, 2005

/s/ JAMES L. BARKSDALE

(James L. Barksdale)

Director September 13, 2005

/s/ STEPHEN M. BENNETT

(Stephen M. Bennett)

Director September 13, 2005

/s/ L. JOHN DOERR

(L. John Doerr)

Director September 13, 2005

/s/ ROBERT J. FISHER

(Robert J. Fisher)

Director September 13, 2005

/s/ MICHAEL E. LEHMAN

(Michael E. Lehman)

Director September 13, 2005

/s/ M. KENNETH OSHMAN

(M. Kenneth Oshman)

Director September 13, 2005

/s/ NAOMI O. SELIGMAN

(Naomi O. Seligman)

Director September 13, 2005

/s/ LYNN E. TURNER

(Lynn E. Turner)

Director September 13, 2005

114

INDEX TO EXHIBITS

ExhibitNumber Description

2.1(1) Agreement and Plan of Merger by and among the Registrant, Stanford Acquisition Corporation andStorage Technology Corporation, dated as of June 2, 2005.

2.2 Agreement and Plan of Merger by and among the Registrant, Big Bear Acquisition Corporation andSeeBeyond Technology Corporation, dated as of June 27, 2005.

3.1(2) Registrant’s Restated Certificate of Incorporation, as amended February 11, 1998.3.2(3) Certificate of Amendment of the Restated Certificate of Incorporation of Registrant dated November 8,

2000.3.3(4) Amended and Restated Certificate of Designations dated December 13, 2000.3.4(15) Bylaws of the Registrant, as amended November 10, 2004.4.1(5) Third Amended and Restated Shares Rights Agreement dated July 25, 2002.4.2(6) Indenture, dated August 1, 1999 (the “Indenture”) between Registrant and The Bank of New York, as

Trustee.4.3(6) Form of Subordinated Indenture.4.4(6) Officers’ Certificate Pursuant to Section 301 of the Indenture, without exhibits, establishing the terms

of Registrant’s Senior Notes.4.5(6) Form of Senior Note.

10.1(8)* Registrant’s 1990 Long-Term Equity Incentive Plan, as amended on September 17, 2002 (the “1990Plan”).

10.2(16)* Representative form of stock option grant agreement under the 1990 Plan.10.3* Representative form of restricted stock grant agreement under the 1990 Plan.10.4(7)* Registrant’s 1988 Directors’ Stock Option Plan, as amended on August 11, 1999 (the “Directors’

Plan”).10.5* Representative form of stock option grant agreement under the Directors’ Plan.10.6(11)* Registrant’s Equity Compensation Acquisition Plan, as amended on July 25, 2002 (the “ECAP”).10.7* Representative form of stock option grant agreement under the ECAP.10.8(10)* Registrant’s Non-Qualified Deferred Compensation Plan, as amended June 30, 2002.10.9(10)* Registrant’s Section 162(m) Executive Officer Performance-Based Bonus Plan, as amended and

restated July 1, 2001.10.10* U.S. Vice President Severance Plan, effective as of July 1, 2005.10.11(12)* Form of Change of Control Agreement executed by each executive officer, other than the Chief

Executive Officer, of Registrant.10.12(12)* Form of Change of Control Agreement executed by Chief Executive Officer of Registrant.10.13(13)* Promissory Notes issued by Jonathan I. Schwartz dated October 29, 2001 (“Note 1”), Promissory Note

issued by Jonathan I. Schwartz dated June 28, 2002 (“Note 2”), cancellation of Notes 1 and 2 datedJuly 18, 2002, and Promissory Note issued by Jonathan I. Schwartz on July 19, 2002.

10.14(11)* Form of Indemnification Agreement executed by each Board member of Registrant.10.15* Chief Executive Officer Bonus Terms for FY06 under the Section 162(m) Executive Officer

Performance-Based Bonus Plan.10.16* Chief Operating Officer Bonus Terms for FY06 under the Section 162(m) Executive Officer

Performance-Based Bonus Plan.10.17* SMX Staff Executive Officer Bonus Terms for FY06 under the Section 162(m) Executive Officer

Performance-Based Bonus Plan.10.18* EMG Staff Executive Officer Bonus Terms for FY06 under the Section 162(m) Executive Officer

Performance-Based Bonus Plan.10.19(14)† Technical Collaboration Agreement dated April 1, 2004 between Microsoft Corporation and the

Registrant, Sun Microsystems International B.V. and Sun Microsystems Technology Ltd.10.20(14)† Limited Patent Covenant and Stand-Still Agreement dated April 1, 2004 between the Registrant and

Microsoft Corporation.10.21(14)† Settlement Agreement dated April 1, 2004 between the Registrant and its subsidiaries and Microsoft

Corporation.

115

ExhibitNumber Description

21.1 Subsidiaries of Registrant23.1 Consent of Independent Registered Public Accounting Firm31.1 Rule 13a-14(a) Certification of Chief Executive Officer31.2 Rule 13a-14(a) Certification of Chief Financial Officer32.1 Section 1350 Certificate of Chief Executive Officer32.2 Section 1350 Certificate of Chief Financial Officer

* Indicates a management contract or compensatory plan or arrangement.

† Pursuant to a request for confidential treatment, portions of the Exhibit have been redacted from the publiclyfiled document and have been furnished separately to the SEC as required by Rule 406 under the Securities Act.

(1) Incorporated by reference to Registrant’s Current Report on Form 8-K filed on September 6, 2005

(2) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for fiscal quarter ended March 29,1998.

(3) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for fiscal quarter ended December 31,2000.

(4) Incorporated by reference to Registrant’s Form 8-A/A filed December 20, 2000.

(5) Incorporated by reference to Registrant’s Form 8-A/A filed September 26, 2002.

(6) Incorporated by reference to Registrant’s Current Report on Form 8-K filed August 6, 1999.

(7) Incorporated by reference to Registrant’s Annual Report on Form 10-K for the fiscal year ended June 30, 1999.

(8) Incorporated by reference to Registrant’s Registration Statement on Form S-8 filed on November 20, 2002.

(9) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31,2002.

(10) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended September30, 2001.

(11) Incorporated by reference to Registrant’s Annual Report on Form 10-K for the fiscal year ended June 30, 2002.

(12) Incorporated by reference to Registrant’s Annual Report on Form 10-K for the fiscal year ended June 30, 2003.

(13) Incorporated by reference to Registrant’s Current Report on Form 8-K filed on August 9, 2002.

(14) Incorporated by reference to Registrant’s Annual Report on Form 10-K for the fiscal year ended June 30, 2004.

(15) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter endedDecember 26, 2004.

(16) Incorporated by reference to Registrant’s Current Report on Form 8-K filed on June 28, 2005.

116

Exhibit 2.2

EXECUTION COPY

AGREEMENT AND PLAN OF MERGER

BY AND AMONG

SUN MICROSYSTEMS, INC.

BIG BEAR ACQUISITION CORPORATION

AND

SEEBEYOND TECHNOLOGY CORPORATION

Dated as of June 27, 2005

TABLE OF CONTENTS

A-i

Page

ARTICLE I THE MERGER A-1

1.1 The Merger A-1 1.2 Effective Time; Closing A-1 1.3 Effect of the Merger A-2 1.4 Certificate of Incorporation and Bylaws A-2 1.5 Directors and Officers A-2 1.6 Effect on Capital Stock A-2 1.7 Dissenting Shares. A-4 1.8 Surrender of Certificates. A-4 1.9 No Further Ownership Rights in Company Common Stock A-5 1.10 Lost, Stolen or Destroyed Certificates A-5 1.11 Further Action A-5

ARTICLE II REPRESENTATIONS AND WARRANTIES OF THE COMPANY A-6

2.1 Organization; Standing and Power; Charter Documents; Subsidiaries. A-6 2.2 Capital Structure. A-7 2.3 Authority; No Conflict; Necessary Consents. A-8 2.4 SEC Filings; Financial Statements; Internal Controls. A-10 2.5 Absence of Certain Changes or Events A-11 2.6 Taxes. A-13 2.7 Title to Properties. A-14 2.8 Intellectual Property. A-15 2.9 Restrictions on Business Activities A-19 2.10 Governmental Authorizations A-20 2.11 Litigation A-20 2.12 Compliance with Laws A-20 2.13 Environmental Matters. A-20 2.14 Brokers’ and Finders’ Fees A-21 2.15 Transactions with Affiliates A-21 2.16 Employee Benefit Plans and Compensation. A-21 2.17 Contracts. A-25 2.18 Insurance A-27 2.19 Export Control Laws A-27 2.20 Foreign Corrupt Practices Act A-27 2.21 Information Supplied A-27 2.22 Fairness Opinion A-28 2.23 Takeover Statutes and Rights Plans A-28

ARTICLE III REPRESENTATIONS AND WARRANTIES OF PARENT AND MERGER SUB A-28

3.1 Organization A-28 3.2 Authority; No Conflict; Necessary Consents. A-28 3.3 Capital Resources A-29 3.4 Information Supplied A-29 3.5 Operations of Merger Sub A-29 3.6 Ownership of Shares A-29

A-ii

Page

ARTICLE IV CONDUCT BY THE COMPANY PRIOR TO THE EFFECTIVE TIME A-29

4.1 Conduct of Business by the Company. A-29 4.2 Procedures for Requesting Parent Consent A-33

ARTICLE V ADDITIONAL AGREEMENTS A-33

5.1 Proxy Statement A-33 5.2 Meeting of Company Stockholders; Board Recommendation. A-33 5.3 Acquisition Proposals. A-34 5.4 Confidentiality; Access to Information; No Modification of Representations, Warranties or Covenants. A-37 5.5 Public Disclosure A-38 5.6 Regulatory Filings; Reasonable Efforts. A-38 5.7 Notification of Certain Matters. A-39 5.8 Third-Party Consents A-39 5.9 Equity Awards and Employee Matters. A-40 5.10 Form S-8 A-41 5.11 Indemnification. A-41 5.12 Section 16 Matters A-42 5.13 Insurance Approval A-42 5.14 FIRPTA Compliance A-43 5.15 Immigration-Related Liabilities A-43

ARTICLE VI CONDITIONS TO THE MERGER A-43

6.1 Conditions to the Obligations of Each Party to Effect the Merger A-43 6.2 Additional Conditions to the Obligations of Parent A-43 6.3 Additional Conditions to the Obligations of the Company A-44

ARTICLE VII TERMINATION, AMENDMENT AND WAIVER A-44

7.1 Termination A-44 7.2 Notice of Termination; Effect of Termination A-46 7.3 Fees and Expenses. A-46 7.4 Amendment A-47 7.5 Extension; Waiver A-47

ARTICLE VIII GENERAL PROVISIONS A-48

8.1 Non-Survival of Representations and Warranties A-48 8.2 Notices A-48 8.3 Interpretation; Knowledge. A-49 8.4 Counterparts A-49 8.5 Entire Agreement; Third-Party Beneficiaries A-49 8.6 Severability A-50 8.7 Other Remedies. A-50 8.8 Governing Law A-50 8.9 Rules of Construction A-50 8.10 Assignment A-50 8.11 Waiver of Jury Trial A-50

Exhibit A Forms of Voting AgreementExhibit B Form of Non-Competition AgreementExhibit C Foreign Antitrust Approvals

INDEX OF DEFINED TERMS

A-iii

Defined Term

Section

Acquisition Proposal 5.3(g)(i)Acquisition 7.3(b)(iii)Action of Divestiture 5.6(d)Agreement Preamblethe business of 8.3(a)Business Day 1.2Cashed-Out Options 1.6(b)(ii)Certificate of Merger 1.2Certificates 1.8(c)Change of Recommendation Notice 5.3(d)(iii)Change of Recommendation 5.3(d)Closing 1.2Closing Date 1.2COBRA 2.16(a)Code 1.8(d)Company PreambleCompany Balance Sheet 2.4(b)Company Charter Documents 2.1(b)Company Common Stock 1.6(a)Company Disclosure Letter Article IICompany Employee Plan 2.16(a)Company Environmental Permits 2.13(c)Company Financials 2.4(b)Company Intellectual Property 2.8(a)Company Material Contract 2.17(a)Company Options 2.2(b)Company Preferred Stock 2.2(a)Company Products 2.8(a)Company Purchase Plan 1.6(e)Company Registered Intellectual Property 2.8(a)Company SEC Reports 2.4(a)Company Stock Option Plans 2.2(b)Company Warrants 1.6(b)(i)Company PreambleConfidentiality Agreement 5.4(a)Contaminants 2.8(k)Contract 2.1(a)Customer Information 2.8(o)Delaware Law RecitalsDissenting Shares 1.7(a)DOJ 2.3(c)DOL 2.16(a)Effect 8.3(d)Effective Time 1.2Employee Agreement 2.16(a)Employee 2.16(a)End Date 7.1(b)Environmental Laws 2.13(a)ERISA Affiliate 2.16(a)

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Defined Term

Section

ERISA 2.16(a)Exchange Act 2.3(c)Exchange Agent 1.8(a)Exchange Fund 1.8(b)Export Approvals 2.19(a)FCPA 2.20FTC 2.3(c)GAAP 2.4(b)Governmental Authorizations 2.10Governmental Entity 2.3(c)Hazardous Material 2.13(a)Hazardous Materials Activities 2.13(b)HSR Act 2.3(c)Include, Includes, Including 8.3(a)Indemnified Parties 5.11(a)Intellectual Property Rights 2.8(a)Intellectual Property 2.8(a)International Employee Plan 2.16(a)IRS 2.16(a)Knowledge 8.3(b)Lease Documents 2.7(b)Leased Real Property 2.7(a)Legal Requirements 2.2(d)Liens 2.1(c)Made Available 8.3(c)Material Adverse Effect 8.3(d)Merger Consideration 1.6(a)Merger Sub Common Stock 1.6(d)Merger Sub PreambleMerger 1.1Necessary Consents 2.3(c)Non-Competition Agreements RecitalsOpen Source 2.8(i)Option Ratio 5.9(a)Parent Common Stock 5.10Parent PreamblePension Plan 2.16(a)Person 8.3(e)Proxy Statement 2.21Returns 2.6(b)(i)SEC 2.3(c)Securities Acts 2.4(a)Service Engagement Orders 2.8(m)Shrink-Wrapped Code 2.8(a)Source Code 2.8(a)Specified Company Representations 6.2(a)Stockholders’ Meeting 5.2(a)Subsidiary Charter Documents 2.1(b)Subsidiary 2.1(a)Superior Offer 5.3(g)(ii)Surviving Corporation 1.1

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Defined Term

Section

Tax 2.6(a)Taxes 2.6(a)Termination Fee 7.3(b)(i)Trade Secrets 2.8(a)Triggering Event 7.1Voting Agreements RecitalsVoting Debt 2.2(c)WARN 2.16(a)

AGREEMENT AND PLAN OF MERGER

This AGREEMENT AND PLAN OF MERGER (this “Agreement”) is made and entered into as of June 27, 2005, by and among Sun Microsystems, Inc., a Delaware corporation (“Parent”), Big Bear Acquisition Corporation, a Delaware corporation and direct wholly owned subsidiary of Parent (“Merger Sub”), and SeeBeyond Technology Corporation, a Delaware corporation (the “Company”).

RECITALS

A. The respective Boards of Directors of Parent, Merger Sub and the Company have deemed it advisable and in the best interests of their respective corporations and stockholders that Parent and the Company consummate the business combination and other transactions provided for herein.

B. The respective Boards of Directors of Merger Sub and the Company have approved, in accordance with the Delaware General Corporation Law (“Delaware Law”), this Agreement and the transactions contemplated hereby, including the Merger.

C. Concurrently with the execution of this Agreement, and as a condition and inducement to Parent’s willingness to enter into this Agreement, all executive officers and members of the Board of Directors of the Company are entering into a Voting Agreement and irrevocable proxy in substantially the form attached hereto as Exhibit A (the “Voting Agreements”).

D. Concurrently with the execution of this Agreement, and as a condition and inducement to Parent’s willingness to enter into this Agreement, certain senior executives of the Company are entering into Non-Competition and Non-Solicitation Agreements in substantially the form attached hereto as Exhibit B (the “Non-Competition Agreements”)

E. The Board of Directors of the Company has resolved to recommend to its stockholders approval and adoption of this Agreement and approval of the Merger subject to the terms and conditions hereof.

F. Following the execution of this Agreement, Parent, as the sole stockholder of Merger Sub, will approve and adopt this Agreement and approve the Merger.

G. Parent, Merger Sub and the Company desire to make certain representations, warranties and agreements in connection with the Merger and also to prescribe certain conditions to the Merger.

NOW, THEREFORE, in consideration of the covenants, promises and representations set forth herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows:

ARTICLE I

THE MERGER

1.1 The Merger. At the Effective Time and subject to and upon the terms and conditions of this Agreement and the applicable provisions of Delaware Law, Merger Sub shall be merged with and into the Company (the “Merger”), the separate corporate existence of Merger Sub shall cease and the Company shall continue as the surviving corporation and as a wholly owned subsidiary of Parent. The surviving corporation after the Merger is hereinafter sometimes referred to as the “Surviving Corporation.”

1.2 Effective Time; Closing. Subject to the provisions of this Agreement, the parties hereto shall cause the Merger to be consummated by filing a Certificate of Merger with the Secretary of State of the State of Delaware in accordance with the relevant provisions of Delaware Law (the “Certificate of Merger”) (the time of such

filing with the Secretary of State of the State of Delaware (or such later time as may be agreed in writing by the Company and Parent and specified in the Certificate of Merger) being the “Effective Time”) as soon as practicable on or after the Closing Date. The closing of the Merger (the “Closing”) shall take place at the offices of Latham & Watkins, located at 633 W. Fifth St., Suite 4000, Los Angeles, California, at a time and date to be specified by the parties, which shall be no later than the second Business Day after the satisfaction or waiver of the conditions set forth in Article VI (other than those that by their terms are to be satisfied or waived at the Closing), or at such other time, date and location as the parties hereto agree in writing; provided, however, that if Parent has complied with its obligations set forth in the first and sixth sentences in Section 5.1, then without the prior written consent of Parent, the Closing shall not occur on a date that is during the last 15 Business Days prior to the last Business Day of a fiscal quarter of Parent. The date on which the Closing occurs is referred to herein as the “Closing Date.” “Business Day” shall mean each day that is not a Saturday, Sunday or other day on which Parent is closed for business or banking institutions located in San Francisco, California are authorized or obligated by law or executive order to close.

1.3 Effect of the Merger. At the Effective Time, the effect of the Merger shall be as provided in this Agreement and the applicable provisions of Delaware Law. Without limiting the generality of the foregoing, and subject thereto, at the Effective Time all the property, rights, privileges, powers and franchises of Company and Merger Sub shall vest in the Surviving Corporation, and all debts, liabilities and duties of Company and Merger Sub shall become the debts, liabilities and duties of the Surviving Corporation.

1.4 Certificate of Incorporation and Bylaws. Unless otherwise determined by Parent prior to the Effective Time, at the Effective Time, the Certificate of Incorporation of the Company shall be amended and restated in its entirety to be identical to the Certificate of Incorporation of Merger Sub, as in effect immediately prior to the Effective Time, until thereafter amended in accordance with Delaware Law and as provided in such Certificate of Incorporation; provided, however, that at the Effective Time, Article I of the Certificate of Incorporation of the Surviving Corporation shall be amended and restated in its entirety to read as follows: “The name of the corporation is See Beyond Technology Corporation”. Unless otherwise determined by Parent prior to the Effective Time, at the Effective Time, the Bylaws of the Company shall be amended and restated in their entirety to be identical to the Bylaws of Merger Sub, as in effect immediately prior to the Effective Time, until thereafter amended in accordance with Delaware Law and as provided in such Bylaws.

1.5 Directors and Officers. Unless otherwise determined by Parent prior to the Effective Time, the initial directors of the Surviving Corporation shall be the directors of Merger Sub immediately prior to the Effective Time, until their respective successors are duly elected or appointed and qualified. Unless otherwise determined by Parent prior to the Effective Time, the initial officers of the Surviving Corporation shall be the officers of Merger Sub immediately prior to the Effective Time, until their respective successors are duly appointed. In addition, unless otherwise determined by Parent prior to the Effective Time, Parent, the Company and the Surviving Corporation shall cause the directors and officers of Merger Sub immediately prior to the Effective Time to be the directors and officers, respectively, of each of the Company’s Subsidiaries immediately after the Effective Time, each to hold office as a director or officer of each such Subsidiary in accordance with the provisions of the laws of the respective jurisdiction of organization and the respective bylaws or equivalent organizational documents of each such Subsidiary.

1.6 Effect on Capital Stock. Subject to the terms and conditions of this Agreement, at the Effective Time, by virtue of the Merger and without any action on the part of Parent, Merger Sub, the Company or the holders of any shares of capital stock of the Company, the following shall occur:

(a) Company Common Stock. Each share of the Common Stock, par value $0.0001 per share, of the Company (“Company Common Stock”) issued and outstanding immediately prior to the Effective Time, other than any shares of Company Common Stock to be canceled pursuant to Section 1.6(c) and any Dissenting Shares, will be canceled and extinguished and automatically converted (subject to Section 1.7) into the right to receive an amount of cash equal to $4.25, without interest (such amount of cash hereinafter

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referred to as the “Merger Consideration”) upon surrender of the certificate representing such share of Company Common Stock in the manner provided in Section 1.8 (or in the case of a lost, stolen or destroyed certificate, upon delivery of an affidavit (and bond, if required) in the manner provided in Section 1.10).

(b) Company Warrants and Cashed-Out Options.

(i) Following the Effective Time, all warrants to purchase Company Common Stock issued by the Company

(“Company Warrants”) shall represent only the right, upon the valid exercise thereof, if any, to receive the Merger Consideration payable upon the shares of Company Common Stock previously issuable upon exercise of such Company Warrants and shall in no event be exercisable for any equity securities of Parent, the Company or any of their Subsidiaries. In addition, the Company shall use commercially reasonable efforts to have all holders of Company Warrants either fully exercise such Company Warrants prior to the Effective Time or agree that such Company Warrants shall be terminated upon the Effective Time; provided, however, that the holder of any such terminated Company Warrant shall be entitled to receive following the Effective Time, upon surrender of the certificate representing such Company Warrant, only an amount equal to the product of (x) the number of shares of Company Common Stock issuable upon exercise of such Company Warrant multiplied by (y) the excess, if any, of the per share Merger Consideration over the per share exercise price in effect for such Company Warrant.

(ii) At the Effective Time, each Company Option (A) granted under the 1997 Stock Option Plan, (B) held by any

Person other than an employee of the Company or any of its Subsidiaries or (C) (x) granted under the 1998 Stock Plan (as amended and restated) and (y) that was vested as of the Closing Date (including any such Company Options that vest solely by reason of the consummation of the Merger) other than, in the case of any Company Option referenced in clause (C), any Company Option that has a per share exercise price equal to or greater than the Merger Consideration (each such Company Option referred to in clauses (A), (B) or (C), a “Cashed-Out Option”) that is unexpired, unexercised and outstanding immediately prior to the Effective Time shall, on the terms and subject to the conditions set forth in this Agreement, terminate in its entirety at the Effective Time, and the holder of each Cashed-Out Option shall, be entitled to receive therefor an amount of cash (rounded down to the nearest whole cent) equal to the product of (i) the number of shares of Company Common Stock as to which such Company Option was vested and exercisable immediately prior to the Effective Time (giving effect to any acceleration of vesting resulting from the Merger), and (ii) the excess, if any, of the per share Merger Consideration over the exercise price of such Company Option immediately prior to the Effective Time.

(iii) Any materials to be submitted to the holders of Company Warrants or Cashed-Out Options shall be subject to

review and reasonable and timely approval by Parent.

(c) Cancellation of Treasury and Parent Owned Stock. Each share of Company Common Stock held by the Company or Parent or any direct or indirect wholly-owned Subsidiary of the Company or of Parent immediately prior to the Effective Time shall be canceled and extinguished without any conversion thereof.

(d) Capital Stock of Merger Sub. Each share of common stock, no par value, of Merger Sub (the “Merger Sub Common

Stock”) issued and outstanding immediately prior to the Effective Time shall be converted into one validly issued, fully paid and nonassessable share of common stock, no par value, of the Surviving Corporation. Each certificate evidencing ownership of shares of Merger Sub Common Stock shall evidence ownership of such shares of capital stock of the Surviving Corporation.

(e) Employee Stock Options; Employee Stock Purchase Plan. At the Effective Time, all Company Options, other than

Cashed-Out Options, outstanding under each Company Stock Option Plan shall be assumed by Parent in accordance with Section 5.9. Rights outstanding under the Company’s 2000 Employee Stock Purchase Plan (the “Company Purchase Plan”) shall be treated as set forth in Section 5.9(c).

(f) Adjustments to Merger Consideration. The Merger Consideration shall be adjusted to reflect fully the appropriate

effect of any stock split, reverse stock split, stock dividend (including any dividend or

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distribution of securities convertible into Company Common Stock), reorganization, recapitalization, reclassification or other like change with respect to Company Common Stock having a record date on or after the date hereof and prior to the Effective Time.

1.7 Dissenting Shares.

(a) Notwithstanding any other provisions of this Agreement to the contrary, any shares of Company Common Stock held

by a holder who: (i) has not voted in favor of the Merger or consented thereto in writing, (ii) has demanded its rights to appraisal in accordance with Section 262 of Delaware Law, and (iii) has not effectively withdrawn or lost such holder’s appraisal rights (collectively, the “Dissenting Shares”), shall not be converted into or represent a right to receive the applicable consideration for Company Common Stock set forth in Section 1.6, but the holder thereof shall only be entitled to such rights as are provided by Delaware Law, including the right to receive payment of the fair value of such holder’s Dissenting Shares in accordance with the provisions of Section 262 of Delaware Law.

(b) Notwithstanding the provisions of Section 1.7(a), if any holder of Dissenting Shares shall effectively withdraw or lose

(through failure to perfect or otherwise) such holder’s appraisal rights under Delaware Law, then, as of the later of the Effective Time and the occurrence of such event, such holder’s shares shall automatically be converted into and represent only the right to receive the consideration for Company Common Stock, as applicable, set forth in Section 1.6, without interest thereon, upon surrender of the certificate representing such shares.

(c) The Company shall give Parent (i) prompt notice of any written demand for appraisal received by the Company

pursuant to the applicable provisions of Delaware Law, and (ii) the opportunity to participate in any negotiations and proceedings with respect to such demands. The Company shall not, except with the prior written consent of Parent, make any payment with respect to any such demands or offer to settle or settle any such demands. Any communication to be made by the Company to any holder of Company Common Stock with respect to such demands shall be submitted to Parent in advance and shall not be presented to any holder of Company Common Stock prior to the Company receiving Parent’s consent, which shall not be unreasonably delayed or withheld.

1.8 Surrender of Certificates.

(a) Exchange Agent. Parent shall select an institution reasonably satisfactory to the Company to act as the exchange agent

(the “Exchange Agent”) for the Merger.

(b) Parent to Provide Cash. On the Closing Date, Parent shall initiate a wire transfer to the Exchange Agent of the aggregate Merger Consideration in cash payable pursuant to Section 1.6(a) in exchange for outstanding shares of Company Common Stock. Any cash deposited with the Exchange Agent shall hereinafter be referred to as the “Exchange Fund.”

(c) Exchange Procedures. As soon as reasonably practicable following the Effective Time, Parent shall cause the

Exchange Agent to mail to each holder of record (as of the Effective Time) of a certificate or certificates (the “Certificates”) which immediately prior to the Effective Time represented outstanding shares of Company Common Stock whose shares were converted into the right to receive the Merger Consideration set forth in Section 1.6(a): (i) a letter of transmittal (which shall specify that delivery shall be effected, and risk of loss and title to the Certificates shall pass, only upon delivery of the Certificates to the Exchange Agent and shall be in such form and have such other provisions as Parent may reasonably specify) and (ii) instructions for use in effecting the surrender of the Certificates in exchange for cash constituting the Merger Consideration. Upon surrender of Certificates for cancellation to the Exchange Agent or to such other agent or agents as may be appointed by Parent, together with such letter of transmittal, duly completed and validly executed in accordance with the instructions thereto and such other documents as may reasonably be required by the Exchange Agent, the holder of record of such Certificates shall be entitled to receive in exchange therefor the cash constituting the Merger Consideration, and the Certificates so surrendered shall forthwith be canceled. Until so surrendered, outstanding Certificates will be deemed from

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and after the Effective Time, for all corporate purposes, to evidence the ownership of the Merger Consideration into which such shares of Company Common Stock shall have been so converted.

(d) Required Withholding. Each of the Exchange Agent and the Surviving Corporation shall be entitled to deduct and

withhold from any consideration payable or otherwise deliverable pursuant to this Agreement to any holder or former holder of Company Common Stock, Company Warrants or Company Options such amounts as may be required to be deducted or withheld therefrom under the Internal Revenue Code of 1986, as amended (the “Code”) or under any provision of state, local or foreign Tax law or under any other applicable Legal Requirement. To the extent such amounts are so deducted or withheld, the amount of such consideration shall be treated for all purposes under this Agreement as having been paid to the Person to whom such consideration would otherwise have been paid.

(e) No Liability. Notwithstanding anything to the contrary in this Section 1.8, neither the Exchange Agent, the Surviving

Corporation nor any party hereto shall be liable to a holder of shares of Company Common Stock for any amount paid to a public official pursuant to any applicable abandoned property, escheat or similar law.

(f) Investment of Exchange Fund. The Exchange Agent shall invest the cash included in the Exchange Fund as directed

by Parent on a daily basis; provided, however, that no such investment or loss thereon shall affect the amounts payable to Company stockholders pursuant to this Article I and, if necessary, Parent shall deposit such additional funds as become necessary to pay the aggregate Merger Consideration payable to the Company stockholders due to losses incurred on any investment of the Exchange Fund. Any interest and other income resulting from such investment shall become a part of the Exchange Fund, and any amounts in excess of the amounts payable to Company stockholders pursuant to this Article I shall promptly be paid to Parent.

(g) Termination of Exchange Fund. Any portion of the Exchange Fund which remains undistributed to the holders of

Certificates six months after the Effective Time shall, at the request of the Surviving Corporation, be delivered to the Surviving Corporation or otherwise according to the instruction of the Surviving Corporation, and any holders of the Certificates who have not surrendered such Certificates in compliance with this Section 1.8 shall after such delivery to the Surviving Corporation, subject to Section 1.8(e), look only to the Surviving Corporation solely as general creditors for the cash constituting the Merger Consideration (which shall not accrue interest) pursuant to Section 1.6(a) with respect to the shares of Company Common Stock formerly represented thereby.

1.9 No Further Ownership Rights in Company Common Stock. All Merger Consideration paid upon the surrender for

exchange of shares of Company Common Stock in accordance with the terms hereof shall be deemed to have been paid in full satisfaction of all rights pertaining to such shares of Company Common Stock, and there shall be no further registration of transfers on the records of the Surviving Corporation of shares of Company Common Stock which were outstanding immediately prior to the Effective Time. If, after the Effective Time, Certificates are presented to the Surviving Corporation for any reason, they shall be canceled and exchanged as provided in this Article I.

1.10 Lost, Stolen or Destroyed Certificates. In the event any Certificates shall have been lost, stolen or destroyed, the Exchange Agent shall issue in exchange for such lost, stolen or destroyed Certificates, upon the making of an affidavit of that fact by the holder thereof, such cash constituting the Merger Consideration; provided, however, that Parent may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed Certificates to deliver a bond in such sum as it may reasonably direct as indemnity against any claim that may be made against Parent, the Company or the Exchange Agent with respect to the Certificates alleged to have been lost, stolen or destroyed.

1.11 Further Action. At and after the Effective Time, the officers and directors of Parent and the Surviving Corporation will be authorized to execute and deliver, in the name and on behalf of the Company and Merger Sub, any deeds, bills of sale, assignments or assurances and to take and do, in the name and on behalf of

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Company and Merger Sub, any other actions and things to vest, perfect or confirm of record or otherwise in the Surviving Corporation any and all right, title and interest in, to and under any of the rights, properties or assets acquired or to be acquired by the Surviving Corporation as a result of, or in connection with, the Merger.

ARTICLE II

REPRESENTATIONS AND WARRANTIES OF THE COMPANY

The Company represents and warrants to Parent and Merger Sub, subject to the exceptions specifically disclosed in writing in the disclosure letter (referencing the appropriate section or subsection; provided, however, that any information set forth in one section of the disclosure letter shall be deemed to apply to each other section or subsection thereof to which its relevance is reasonably apparent on its face) supplied by the Company to Parent dated as of the date hereof (the “Company Disclosure Letter”), as follows:

2.1 Organization; Standing and Power; Charter Documents; Subsidiaries.

(a) Organization; Standing and Power. The Company and each of its Subsidiaries is a corporation or other organization duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or organization (except, in the case of good standing, for entities organized under the laws of any jurisdiction that does not recognize such concept) and has the requisite corporate power and authority to own, lease and operate its properties and to carry on its business as currently conducted and as currently contemplated to be conducted over the next twelve months, except where the failure to be so organized, validly existing and in good standing would not reasonably be expected to have, individually or in the aggregate, a Material Adverse Effect on the Company. For purposes of this Agreement, “Subsidiary,” when used with respect to any party, shall mean any corporation, association, business entity, partnership, limited liability company or other Person of which such party, either alone or together with one or more Subsidiaries or by one or more Subsidiaries (i) directly or indirectly owns or controls securities or other interests representing more than 50% of the voting power of such Person, or (ii) is entitled, by Contract or otherwise, to elect, appoint or designate directors constituting a majority of the members of such Person’s board of directors or other governing body. For purposes of this Agreement, “Contract” shall mean any written, oral or other agreement, contract, subcontract, settlement agreement, lease, legally binding understanding, instrument, note, option, warranty, purchase order, license, sublicense, insurance policy or legally binding commitment, arrangement or undertaking of any nature, as in effect as of the date hereof or as may hereinafter be in effect, but shall not include any Company Employee Plan, International Employee Plan or Employee Agreement entered into with any employee of the Company or any of its Subsidiaries the primary purpose of which is to provide compensation, employee welfare or fringe benefits or severance or termination benefits.

(b) Charter Documents. The Company has Made Available to Parent (i) a true and correct copy of the certificate of

incorporation and bylaws of the Company, each as amended to date (collectively, the “Company Charter Documents”) and (ii) the certificate of incorporation and bylaws, or like organizational documents (collectively, “Subsidiary Charter Documents”), of each of its Subsidiaries, and each such instrument is in full force and effect. The Company is not in violation of any of the provisions of the Company Charter Documents and each Subsidiary is not in material violation of its respective Subsidiary Charter Documents.

(c) Subsidiaries. Section 2.1(c) of the Company Disclosure Letter sets forth each Subsidiary of the Company. The

Company is the owner of all of the outstanding shares of capital stock of, or other equity or voting interests in, each such Subsidiary and all such shares have been duly authorized, validly issued and are fully paid and nonassessable, free and clear of all pledges, claims, liens, charges, encumbrances, options and security interests of any kind or nature whatsoever (collectively, “Liens”), including any restriction on the right to vote, sell or otherwise dispose of such capital stock or other ownership interests, except for restrictions imposed by applicable securities laws. Other than the Subsidiaries of the Company, neither the

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Company nor any of its Subsidiaries owns any capital stock of, or other equity or voting interests of any nature in, or any interest convertible, exchangeable or exercisable for, capital stock of, or other equity or voting interests of any nature in, any other Person.

2.2 Capital Structure.

(a) Capital Stock. The authorized capital stock of Company consists of: (i) 200,000,000 shares of Company Common

Stock and (ii) 10,000,000 shares of undesignated preferred stock, par value $0.0001 per share (the “Company Preferred Stock”). As of the close of business on June 24, 2005: (i) 88,629,973 and 84,910,721 shares of Company Common Stock were issued and outstanding, respectively, (ii) 3,719,252 shares of Company Common Stock were issued and held by the Company in its treasury and (iii) no shares of Company Preferred Stock were issued or outstanding. Except as set forth in the preceding sentence, since the close of business on June 24, 2005 to the close of business on the date hereof, the Company has not issued any shares of Company Common Stock or Company Preferred Stock other than: (A) issuances of Company Common Stock upon the exercise of Company Options existing on June 24, 2005 in accordance with their terms on such date, (B) issuance of shares of Company Common Stock to participants in the Common Purchase Plan pursuant to its present terms and (C) issuances of Company Common Stock upon the exercise of Company Warrants existing on June 24, 2005 in accordance with their terms on such date. No shares of Company Common Stock are owned or held by any Subsidiary of the Company. All outstanding shares of Company Common Stock are duly authorized, validly issued, fully paid and non-assessable and are not subject to preemptive rights created by statute, the Company Charter Documents, or any agreement to which the Company is a party or by which it is bound, and none of such shares are subject to forfeiture or to any right entitling or obligating the Company to repurchase such shares.

(b) Company Options and Company Warrants. As of the close of business on June 24, 2005: (i) 18,765,366 shares of

Company Common Stock are issuable upon the exercise of outstanding options to purchase Company Common Stock under the Company’s Amended and Restated 1998 Stock Plan and the Company’s 1997 Stock Option Plan (the “Company Stock Option Plans”) (such options and any other options to purchase Company Common Stock, whether payable in cash, shares or otherwise, granted under or pursuant to the Company Stock Option Plans are referred to in this Agreement as “Company Options”), and 13,388,778 such Company Options are vested and exercisable; (ii) 12,082,587 shares of Company Common Stock are available for future grant under the Company Stock Option Plans; (iii) 2,099,687 shares of Company Common Stock are issuable under the Company Purchase Plan; and (iv) 625,000 shares of Company Common Stock are issuable upon the exercise of Company Warrants. Section 2.2(b)(i) of the Company Disclosure Letter sets forth a list of each Company Option outstanding as of June 24, 2005 and each Company Warrant outstanding as of the date hereof: (a) the name of the holder of such Company Option or Company Warrant, (b) the number of shares of Company Common Stock subject to such Company Option or Company Warrant, (c) the exercise price of such Company Option or Company Warrant, (d) the date on which such Company Option or Company Warrant was granted or issued, (e) the Company Stock Option Plan under which such Company Option was issued and (f) for each Company Option, whether such Company Option is held by a Person who is not an employee of the Company or any of its Subsidiaries. The Company has Made Available with respect to each Company Option outstanding as of June 24, 2005 and each Company Warrant outstanding as of the date hereof, (a) the applicable vesting schedule, if any, and the extent to which such Company Option or Company Warrant is vested and exercisable as of the date hereof and (b) the date on which such Company Option or Company Warrant expires. All shares of Company Common Stock subject to issuance under the Company Stock Option Plans, the Company Purchase Plans and the Company Warrants, upon issuance on the terms and conditions specified in the instruments pursuant to which they are issuable, would be duly authorized, validly issued, fully paid and nonassessable. Except as set forth in Section 2.2(b)(i) of the Company Disclosure Letter, since the close of business on June 24, 2005 to the close of business on the date hereof, the Company has not issued any Company Options other than grants of Company Options as would be permitted under Section 4.1(b)(iv)(C) after the date hereof. Except as set forth in Section 2.2(b)(ii) of the Company Disclosure Letter, there are no commitments or agreements of any character to which the Company is bound

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obligating the Company to accelerate the vesting of any Company Option or Company Warrant as a result of the Merger (whether alone or upon the occurrence of any additional or subsequent events). As of the end of the most recent bi-weekly payroll period ending prior to the date hereof, the aggregate amount credited to the accounts of participants in the Company Purchase Plan was $83,000 and the aggregate amount credited to such accounts for such bi-weekly payroll period for U.S. payroll was $21,000. There are no outstanding or authorized stock appreciation, phantom stock, profit participation or other similar rights with respect to the Company.

(c) Voting Debt. No bonds, debentures, notes or other indebtedness of the Company or any of its Subsidiaries (i) having the

right to vote on any matters on which stockholders may vote (or which is convertible into, or exchangeable for, securities having such right) or (ii) the value of which is any way based upon or derived from capital or voting stock of the Company, are issued or outstanding as of the date hereof (collectively, “Voting Debt”).

(d) Other Securities. Except as otherwise set forth in Section 2.2(b)(i) above or Section 2.2(b)(i) or Section 2.2(d) of the

Company Disclosure Letter, as of the date hereof, there are no securities, options, warrants, calls, rights, contracts, commitments, agreements, instruments, arrangements, understandings, obligations or undertakings of any kind to which the Company or any of its Subsidiaries is a party or by which any of them is bound obligating the Company or any of its Subsidiaries to (including on a deferred basis) issue, deliver or sell, or cause to be issued, delivered or sold, additional shares of capital stock, Voting Debt, other voting securities or any securities convertible into shares of capital stock, Voting Debt or other voting securities of the Company or any of its Subsidiaries, or obligating the Company or any of its Subsidiaries to issue, grant, extend or enter into any such security, option, warrant, call, right, commitment, agreement, instrument, arrangement, understanding, obligation or undertaking. There are no outstanding Contracts or Company Employee Plans to which the Company or any of its Subsidiaries is a party or by which any of them is bound obligating the Company or any of its Subsidiaries to (i) repurchase, redeem or otherwise acquire any shares of capital stock of, or other equity or voting interests in, the Company or any of its Subsidiaries or (ii) dispose of any shares of the capital stock of, or other equity or voting interests in, any of its Subsidiaries. The Company is not a party to any voting agreement, other than the Voting Agreements, with respect to shares of the capital stock of, or other equity or voting interests in, the Company or any of its Subsidiaries and, to the Knowledge of the Company, other than the Voting Agreements and the irrevocable proxies granted pursuant to the Voting Agreements, there are no irrevocable proxies and no voting agreements, voting trusts, rights plans, anti-takeover plans or registration rights agreements with respect to any shares of the capital stock of, or other equity or voting interests in, the Company or any of its Subsidiaries. For purposes of this Agreement, “Legal Requirements” shall mean any federal, state, local, municipal, foreign or other law, statute, constitution, principle of common law, resolution, ordinance, code, order, edict, decree, directive, rule, regulation, ruling or requirement issued, enacted, adopted, promulgated, implemented or otherwise put into effect by or under the authority of any Governmental Entity.

2.3 Authority; No Conflict; Necessary Consents.

(a) Authority. The Company has all requisite corporate power and authority to enter into this Agreement and to

consummate the transactions contemplated hereby, subject, in the case of consummation of the Merger, to obtaining the approval and adoption of this Agreement and the approval of the Merger by the Company’s stockholders as contemplated in Section 5.2. The execution and delivery by the Company of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by all necessary corporate action on the part of the Company and no further action is required on the part of the Company to authorize the execution and delivery of this Agreement or to consummate the Merger and the other transactions contemplated hereby, subject only to the approval and adoption of this Agreement and the approval of the Merger by the Company’s stockholders as contemplated by Section 5.2 and the filing of the Certificate of Merger pursuant to Delaware Law. The affirmative vote of the holders of a majority of the outstanding shares of Company Common Stock is the only vote of the holders of any class or series of Company capital stock necessary to approve or adopt this Agreement, approve the Merger and consummate

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the Merger and the other transactions contemplated hereby. The Board of Directors of the Company has, by resolution adopted by unanimous vote at a meeting of all Directors duly called and held and not subsequently rescinded or modified in any way (except as is permitted pursuant to Section 5.3(d) hereof) duly (i) determined that the Merger is fair to, and in the best interest of, the Company and its stockholders and declared the Merger to be advisable, (ii) approved this Agreement and the transactions contemplated thereby, including the Merger, and (iii) recommended that the stockholders of the Company approve and adopt this Agreement and approve the Merger and directed that such matter be submitted to the Company’s stockholders at the Company Stockholders’ Meeting. This Agreement has been duly executed and delivered by the Company and assuming due authorization, execution and delivery by Parent and Merger Sub, constitutes the valid and binding obligation of the Company, enforceable against the Company in accordance with its terms, subject to applicable bankruptcy, insolvency, reorganization, moratorium or other laws relating to or affecting the rights and remedies of creditors generally and to general principles of equity.

(b) No Conflict. The execution and delivery by the Company of this Agreement and the consummation of the transactions

contemplated hereby, will not (i) conflict with or violate any provision of the Company Charter Documents or any Subsidiary Charter Documents of any Subsidiary of the Company, (ii) subject to obtaining the approval and adoption of this Agreement and the approval of the Merger by the Company’s stockholders as contemplated in Section 5.2 and compliance with the requirements set forth in Section 2.3(c), conflict with or violate any Legal Requirement applicable to the Company or any of its Subsidiaries or by which the Company or any of its Subsidiaries or any of their respective properties or assets (whether tangible or intangible) is bound or affected, except for such conflicts or violations that would not reasonably be expected to be material to the Company and its Subsidiaries, taken as a whole, or (iii) result in any material breach of or constitute a material default (or an event that with notice or lapse of time or both would become a material default) under, or materially impair the Company’s rights or alter the rights or obligations of any third party under, or give to others any rights of termination, amendment, acceleration or cancellation of any Company Material Contract, Lease Document, material Employee Agreement, Company Employee Plan or International Employee Plan, or result in the creation of a Lien on any of the properties or assets of the Company or any of its Subsidiaries. Section 2.3(b) of the Company Disclosure Letter lists all consents, waivers and approvals required to be obtained in connection with the consummation of the transactions contemplated hereby under any Contract, Company Employee Plan or International Employee Plan, to which the Company or any of its Subsidiaries is a party or by which the Company or any of its Subsidiaries is bound or any of their properties or assets is bound or affected, which, if individually or in the aggregate, not obtained, would reasonably be expected to have a Material Adverse Effect on the Company.

(c) Necessary Consents. No consent, waiver, approval, order or authorization of, or registration, declaration or filing with

any supranational, national, state, municipal, local or foreign government, any instrumentality, subdivision, court, arbitral body, administrative agency or commission or other governmental authority or instrumentality, or any quasi-governmental or private body exercising any regulatory, taxing, importing or other governmental or quasi-governmental authority (a “Governmental Entity”) is required to be obtained or made by the Company in connection with the execution and delivery of this Agreement by the Company or the consummation of the Merger and other transactions contemplated hereby and thereby, except for (i) the filing of the Certificate of Merger with the Secretary of State of the State of Delaware and appropriate documents with the relevant authorities of other states in which the Company or Parent are qualified to do business, (ii) the filing of the Proxy Statement with the United States Securities and Exchange Commission (the “SEC”) in accordance with the requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the rules and regulations promulgated thereunder, (iii) the filing of the Notification and Report Forms with the United States Federal Trade Commission (“FTC”) and the Antitrust Division of the United States Department of Justice (“DOJ”) required by the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (“HSR Act”) and the expiration or termination of the applicable waiting period under the HSR Act and such consents, waivers, approvals, orders, authorizations, registrations, declarations and filings as may be required under the foreign

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merger control regulations identified in Section 2.3(c) of the Company Disclosure Letter, and (iv) such other consents, waivers, approvals, orders, authorizations, registrations, declarations and filings which if not obtained or made would reasonably be expected to be material to the Company and its Subsidiaries, taken as a whole, or to Parent and its Subsidiaries, taken as a whole or would reasonably be expected to materially and adversely affect the ability of the parties hereto to consummate the Merger within the time frame contemplated by this Agreement. The consents, approvals, orders, authorizations, registrations, declarations and filings set forth in (i) through (iv) are referred to herein as the “Necessary Consents.”

2.4 SEC Filings; Financial Statements; Internal Controls.

(a) SEC Filings. The Company has filed all required registration statements, prospectuses, reports, schedules, forms,

statements and other documents (including exhibits and all other information incorporated by reference) required to be filed by it with the SEC since January 1, 2002. All such required registration statements, prospectuses, reports, schedules, forms, statements and other documents (including those that the Company may file subsequent to the date hereof) in each case as they have been amended since the time of their filing and prior to the date hereof are referred to herein as the “Company SEC Reports.” As of their respective dates, the Company SEC Reports (i) were prepared in accordance with, and complied in all material respects with, the requirements of the Securities Act of 1933, as amended (the “Securities Act”), or the Exchange Act, as the case may be, and, in each case, the rules and regulations promulgated thereunder applicable to such Company SEC Reports and (ii) did not at the time they were filed (or if amended or superseded by a filing prior to the date of this Agreement then on the date of such filing) contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. None of the Company’s Subsidiaries is required to file any forms, reports or other documents with the SEC. The Company has Made Available to Parent true, correct and complete copies of all material correspondence between the SEC, on the one hand, and the Company and any of its Subsidiaries, on the other, since January 1, 2002, including all SEC comment letters and responses to such comment letters by or on behalf of the Company, and, since January 1, 2002, the SEC has not advised the Company that any final responses are inadequate, insufficient, or otherwise non-responsive. To the Company’s Knowledge, as of the date hereof, none of the Company SEC Documents is the subject of ongoing SEC review or outstanding SEC comment. The Company and, to the Knowledge of the Company, each of its officers and directors are in compliance with, and have complied, in each case in all material respects with (i) the applicable provisions of the Sarbanes-Oxley Act of 2002 and the related rules and regulations promulgated under or pursuant to such act and (ii) the applicable listing and corporate governance rules and regulations of the Nasdaq Stock Market.

(b) Financial Statements. Each of the consolidated financial statements (including, in each case, any related notes thereto)

contained in the Company SEC Reports (the “Company Financials”), including each Company SEC Report filed after the date hereof until the Closing: (i) complied as to form in all material respects with the published rules and regulations of the SEC with respect thereto, (ii) was prepared in accordance with United States generally accepted accounting principles (“GAAP”) applied on a consistent basis throughout the periods involved (except as may be indicated in the notes thereto or, in the case of unaudited interim financial statements, as may be permitted by the SEC on Form 10-Q, 8-K or any successor form under the Exchange Act), and (iii) present fairly and in all material respects the consolidated financial position of the Company and its consolidated Subsidiaries as at the respective dates thereof and the consolidated results of the Company’s operations and cash flows for the periods indicated (subject, in the case of unaudited quarterly statements, to normal year-end audit adjustments). The Company does not intend to correct or restate, and there is not any basis to correct or restate, any of the Company Financials. The consolidated balance sheet of the Company and its consolidated subsidiaries as of March 31, 2005 contained in the Company SEC Reports is hereinafter referred to as the “Company Balance Sheet.” Except as disclosed in the Company Financials, since the date of the Company Balance Sheet, neither the Company nor any of its Subsidiaries has any liabilities (absolute, accrued, contingent or otherwise) of a nature required to be disclosed on a consolidated balance sheet or in the related notes to the consolidated financial

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statement prepared in accordance with GAAP, except for (i) liabilities incurred since the date of the Company Balance Sheet in the ordinary course of business consistent with past practice and (ii) liabilities that would not reasonably be expected to be material to the Company and its Subsidiaries, taken as a whole. The Company has not had any dispute with any of its auditors regarding accounting matters or policies during any of its past three full fiscal years or during the current fiscal year-to-date which was required to be reported to the Company’s Board of Directors. The books and records of the Company and each Subsidiary have been, and are being maintained in all material respects in accordance with applicable legal and accounting requirements and the Financial Statements are consistent with such books and records. Neither the Company nor any of its Subsidiaries is a party to, or has any commitment to become a party to, any “off-balance sheet arrangements” (as defined in Item 303(a) of Regulation S-K of the SEC).

(c) Internal Controls. The Company and each of its Subsidiaries has established and maintains, adheres to and enforces a

system of internal controls which are effective in providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements (including the Company Financials) for external purposes in accordance with GAAP, including policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company and its Subsidiaries; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company and its Subsidiaries are being made only in accordance with appropriate authorizations of management and the Board of Directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements of the Company and its Subsidiaries. None of the Company, any of its Subsidiaries or, to the Company’s Knowledge, any of their respective employees or the Company’s independent auditors has identified or been made aware of (i) since the adoption of rules promulgated by the SEC pursuant to the Section 404 of the Sarbanes-Oxley Act of 2002, any significant deficiency or material weakness in the system of internal controls utilized by the Company and its Subsidiaries, (ii) any fraud, whether or not material, that involves the Company’s management or other Employees who have a role in the preparation of financial statements or the internal controls utilized by the Company and its Subsidiaries or (iii) any claim or allegation regarding any of the foregoing.

2.5 Absence of Certain Changes or Events. Since the date of the Company Balance Sheet through the date hereof, there has not

been, accrued or arisen:

(a) any Effect that, individually or when taken together with all other Effects that have occurred since the date of the Company Balance Sheet through the date hereof, that has or would reasonably be expected to have a Material Adverse Effect on the Company;

(b) any acquisition by the Company or any Subsidiary of, or agreement by the Company or any Subsidiary to acquire by

merging or consolidating with, or by purchasing any assets or equity securities of, or by any other manner, any business or corporation, partnership, association or other business organization or division thereof, or other acquisition or agreement to acquire any assets or any equity securities that are material, individually or in the aggregate, to the business of the Company and its Subsidiaries, taken as a whole;

(c) any entry into, amendment or termination by the Company or any of its subsidiaries of any Contract, agreement in

principle, letter of intent, memorandum of understanding or similar agreement with respect to any joint venture, strategic partnership or alliance, (in each case, other than reseller and licensing agreements entered into in the ordinary course of business consistent with past practice) material to the Company and its Subsidiaries, taken as a whole;

(d) any declaration, setting aside or payment of any dividend on, or other distribution (whether in cash, stock or property)

in respect of, any of the Company’s or any of its Subsidiaries’ capital stock, or any purchase, redemption or other acquisition by the Company or any of its Subsidiaries of any of the Company’s capital stock or any other securities of the Company or its Subsidiaries or any options, warrants,

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calls or rights to acquire any such shares or other securities except for repurchases from Employees following their termination pursuant to the terms of their pre-existing stock option or purchase agreements and the repurchase of 1,025,300 shares of Company Common Stock pursuant to the Company’s stock repurchase program announced on May 5, 2005;

(e) any split, combination or reclassification of any of the Company’s or any of its Subsidiaries’ capital stock;

(f) except to the extent such grant, payment, change or entry would not exceed $10,000 per individual, (i) any granting by

the Company or any of its Subsidiaries, whether orally or in writing, of any increase in compensation or fringe benefits (except for normal increases of cash compensation to current non-officer employees in the ordinary course of business consistent with past practice), (ii) any payment by the Company or any of its Subsidiaries of any bonus (except for bonuses made to current non-officer employees in the ordinary course of business consistent with past practice), (iii) any change by the Company or any of its Subsidiaries that materially increases the value of, or accelerates the timing of payment of any severance, termination or bonus policies or practices or (iv) any entry by the Company or any of its Subsidiaries into any currently effective Employee Agreement that is (A) an employment, severance, termination or indemnification agreement or (B) any agreement the benefits of which are contingent or the terms of which are materially altered upon the occurrence of a transaction involving the Company of the nature contemplated hereby (either alone or upon the occurrence of additional or subsequent events), in any case as disclosed in Section 2.5(f) of the Company Disclosure Letter;

(g) any amendment, termination or consent with respect to any Company Material Contract, Lease Document or Company

Employee Plan entered into outside the ordinary course of business;

(h) entry into any customer Contract that contains any material non-standard provisions for unpaid future deliverables or future royalty payments (other than current royalty product offerings as set forth in the Company’s current price list) other than in the ordinary course of business consistent with past practice;

(i) any material change by the Company in its accounting methods, principles or practices, except as required by

concurrent changes in GAAP;

(j) any debt, capital lease or other debt or equity financing transaction by the Company or any of its Subsidiaries or entry into any agreement by the Company or any of its Subsidiaries in connection with any such transaction, except for capital leases entered into in the ordinary course of business consistent with past practice which are not, individually or in the aggregate, material to the Company and its Subsidiaries, taken as a whole;

(k) any grants of any material refunds, credits, rebates or other allowances by the Company or any of its Subsidiaries to any

end user, customer, reseller or distributor, in each case, other than in the ordinary course of business consistent with past practice or otherwise previously accrued in the Company Balance Sheet;

(l) any material change in the level of product returns, bad debts or rights to accounts receivable which, individually or in

the aggregate, have had or are reasonably likely to have a material effect on accounts receivable reserves or other reserves maintained by the Company and its Subsidiaries (other than historical seasonal changes or factors);

(m) any material reductions in force, lease terminations, restructuring of contracts or similar actions;

(n) any sale, lease, license, encumbrance or other disposition of any properties or assets except the sale, lease, license or

disposition of property or assets which are not material, individually or in the aggregate, to the business of the Company and any of its Subsidiaries, taken as a whole, or the licenses of current Company Products, in each case, in the ordinary course of business consistent with past practice;

(o) any loan, extension of credit or financing or grant of extended payment terms by the Company or any of its Subsidiaries

to any Person other than in the ordinary course of business consistent with past practice;

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(p) any material purchases of fixed assets or other long-term assets other than in the ordinary course of business consistent with past practice;

(q) any adoption of or change in any material election in respect of Taxes, adoption or change in any accounting method in

respect of Taxes, agreement or settlement of any claim or assessment in respect of Taxes, or extension or waiver of the limitation period applicable to any claim or assessment in respect of Taxes;

(r) any material revaluation, or any indication that such a revaluation is required under GAAP, by the Company of any of

its assets, including, without limitation, writing down the value of long term or short-term investments, fixed assets, goodwill, intangible assets, deferred tax assets, or writing off notes or accounts receivable other than in the ordinary course of business consistent with past practice; or

(s) any significant deficiency or material weakness identified in the system of internal controls utilized by the Company

and its Subsidiaries.

2.6 Taxes.

(a) Definition of Taxes. For the purposes of this Agreement, “Tax” or “Taxes” shall mean any and all federal, state, local and foreign taxes, assessments and other governmental charges, duties, impositions and liabilities relating to taxes, including taxes based upon or measured by gross receipts, income, profits, sales, use and occupation, and value added, ad valorem, transfer, franchise, withholding, payroll, recapture, employment, excise and property taxes as well as public imposts, fees and social security charges (including health, unemployment, workers’ compensation and pension insurance), together with all interest, penalties and additions imposed with respect to such amounts.

(b) Tax Returns and Audits.

(i) The Company and each of its Subsidiaries have (a) timely filed or caused to be filed all federal, state, local and

foreign returns, estimates, information statements and reports (“Returns”) relating to material Taxes required to be filed by the Company or any of its Subsidiaries, and such Returns are true, correct, and complete and have been completed in accordance with applicable Legal Requirements in all material respects and (b) timely paid or withheld (and timely paid over any withheld amounts to the appropriate Governmental Entity) all Taxes required to be paid or withheld whether or not shown as due on any Return, other than Taxes (i) for which payment is not yet due or (ii) which are being challenged in good faith by appropriate means, promptly instituted and diligently pursued, and for which an adequate reserve has been accrued or established on the Company Financials.

(ii) Neither the Company nor any of its Subsidiaries has any material Tax deficiency outstanding, assessed or

proposed in writing against the Company or any of its Subsidiaries, nor has the Company or any of its Subsidiaries executed any waiver of any statute of limitations on or extending the period for the assessment or collection of any Tax.

(iii) No audit or other examination of any Return of the Company or any of its Subsidiaries relating to any material

Tax is presently in progress, nor has the Company or any of its Subsidiaries been notified in writing of any request for such an audit or other examination.

(iv) No material adjustment relating to any Return filed by the Company or any of its Subsidiaries has been proposed

by any Tax authority to the Company or any of its Subsidiaries or any representative thereof that remains unpaid.

(v) Neither the Company nor any of its Subsidiaries has constituted either a “distributing corporation” or a “controlled corporation” in a distribution of stock within the past three years intended to qualify for tax-free treatment under Section 355 of the Code.

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(vi) None of the Company or any of its Subsidiaries has engaged in a transaction that is the same as or substantially similar to one of the types of transactions that the Internal Revenue Service has identified by notice, regulation, or other form of published guidance as a listed transaction, as set forth in Treasury Regulation Section 1.6011-4(b)(2).

(vii) The Company and its Subsidiaries are in compliance in all material respects with all terms and conditions of any

material Tax exemption, Tax holiday or other Tax reduction agreement or order of a territorial or non-U.S. government, and the consummation of the transactions contemplated by this Agreement will not have any adverse effect on the continued validity and effectiveness of any such Tax exemption, Tax holiday or other Tax reduction agreement or order.

(viii) Neither the Company nor any of its Subsidiaries has any material liability for unpaid Taxes arising from or

relating to any period ending on or prior to the close of business on the date of the Company Financials which has not been accrued or reserved on the particular Company Financials for the period to which such liabilities arises from or relates, whether asserted or unasserted, contingent or otherwise, and neither the Company nor any of its Subsidiaries has incurred any liability for Taxes since the date of the Company Balance Sheet other than in the ordinary course of business consistent with past practice.

(ix) Neither the Company nor any of its Subsidiaries (a) has ever been a member of an affiliated group (within the

meaning of Code Section 1504(a)) filing a consolidated federal income Tax Return (other than a group the common parent of which was Company), (b) has ever been a party to any Tax sharing, indemnification or allocation agreement, (c) has any liability for the Taxes of any person (other than Company or any of its Subsidiaries), under Treasury Regulation Section 1.1502-6 (or any similar provision of state, local or foreign law including any arrangement for group or consortium Tax relief or similar arrangement), as a transferee or successor, by contract or agreement, or otherwise, (d) has an obligation to make any payment determined by reference to the Tax liability of a third party, or (e) is presently a party to any joint venture or partnership in respect of which there exists a negative capital account or any other circumstance giving rise to a deferred Tax liability materially in excess of reserves set forth on the Company Financials.

(x) Neither the Company nor its Subsidiaries will be required to include any income or gain or exclude any deduction

or loss from taxable income as a result of any (a) change in method of accounting under Section 481(c) of the Code, (b) closing agreement under Section 7121 of the Code, (c) deferred intercompany gain or excess loss account under Treasury Regulations under Section 1502 of the Code materially in excess of specifically identified reserves as indicated on the Company Financials (or in the case of each of (a), (b) and (c)), under any similar provision of applicable law), or (d) installment sale or open transaction disposition or prepaid amount materially in excess of reserves set forth on the Company Financials.

2.7 Title to Properties.

(a) Properties. Neither the Company nor any of its Subsidiaries owns or has owned any real property. Section 2.7(a)(i) of

the Company Disclosure Letter sets forth a list of all real property currently leased, licensed or subleased by the Company or any of its Subsidiaries or otherwise used or occupied by the Company or any of its Subsidiaries (the “Leased Real Property”), and each Leased Real Property that is material to the Company and its Subsidiaries, taken as a whole, is marked by an asterisk. All such current leases which are material to the Company and its Subsidiaries, taken as a whole, are in full force and effect, are valid and effective in accordance with their respective terms, and there is not, under any of such leases, any existing breach, default or event of default (or event which with notice or lapse of time, or both, would constitute a default). Except as set forth in Section 2.7(a)(ii) of the Company Disclosure Letter, no parties other than the Company or any of its Subsidiaries have a right to occupy any material Leased Real Property and the Leased Real Property is used in all material respects only for the operation of the business of the Company and its Subsidiaries. The Leased Real Property and the physical assets of the Company and the Subsidiaries are, in all material respects, in good condition and repair and regularly maintained, in all

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material respects, in accordance with standard industry practice and the Leased Real Property is in compliance, in all material respects, with Legal Requirements in light of the purposes for which such Leased Real Property and assets are used, subject to reasonable wear and tear. Neither the Company nor any of its Subsidiaries will be required to incur any material cost or expense for any restoration or surrender obligations, or any other material costs otherwise qualifying as asset retirement obligations under Financial Accounting Standards Board Statement of Financial Accounting Standard No. 143 “Accounting for Asset Retirement Obligations,” upon the expiration or earlier termination of any leases or other occupancy agreements for the Leased Real Property. The Company and each of its Subsidiaries has performed in all material respects its obligations under any material termination agreements pursuant to which it has terminated any leases of real property that are no longer in effect and has no material continuing liability with respect to such terminated real property leases.

(b) Documents. The Company has Made Available to Parent true, correct and complete copies of all leases, lease

guaranties, agreements for the leasing, use or occupancy of, or otherwise granting a right in or relating to the Leased Real Property that are material to the Company and its Subsidiaries, taken as a whole, including all amendments, terminations and modifications thereof (“Lease Documents”); and there are no other leases, lease guaranties, agreements for the leasing use or occupancy of, or otherwise granting a right in or relating to or affecting any Leased Real Property to which the Company or any of its Subsidiaries is bound, other than those identified in Section 2.7(b) of the Company Disclosure Letter.

(c) Valid Title. The Company and each of its Subsidiaries has good and valid title to, or, in the case of leased properties

and assets, valid leasehold interests in, all of its material tangible properties and assets, real, personal and mixed, used or held for use in its business, free and clear of any Liens except (i) as reflected in the Company Balance Sheet, statutory landlord Liens or Liens arising under equipment leases entered into in the ordinary course of business consistent with past practice, (ii) Liens for Taxes not yet due and payable, and (iii) such imperfections of title and encumbrances, if any, which do not in any material respect detract from the value or interfere with the present use of the property subject thereto or affected thereby. The rights, properties and assets presently owned, leased or licensed by the Company and its Subsidiaries include all rights, properties and assets necessary to permit the Company and its Subsidiaries to conduct their business in all material respects in the same manner as their businesses have been conducted prior to the date hereof.

2.8 Intellectual Property.

(a) Definitions. For all purposes of this Agreement, the following terms shall have the following respective meanings:

“Company Intellectual Property” shall mean any and all Intellectual Property and Intellectual Property Rights that

are owned by or exclusively licensed to, the Company or its Subsidiaries.

“Company Products” shall mean all products, technologies and services developed (including products, technologies and services under development), owned, made, provided, distributed, imported, sold or licensed by or on behalf of the Company and any of its Subsidiaries.

“Company Registered Intellectual Property” shall mean the applications, registrations and filings for Intellectual

Property Rights that have been registered, filed, certified or otherwise perfected or recorded, and that have not been abandoned prior to January 1, 2005, with or by any Governmental Entity by or in the name of the Company or any of its Subsidiaries.

“Intellectual Property” shall mean any or all of the following (i) original works of authorship fixed in a tangible

medium of expression including computer programs, source code, and executable code, whether embodied in software, firmware or otherwise, architecture, documentation, designs, files, records, and data, (ii) inventions (whether or not patentable), discoveries, improvements, and technology, (iii) proprietary and confidential information, trade secrets and know how, (iv) databases, data compilations and collections and technical data, (v) logos, trade names, trade dress, trademarks and service marks, (vi) domain names, web addresses and sites, (vii) tools, methods and processes,

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(viii) devices, prototypes, schematics, breadboards, netlists, maskworks, test methodologies, verilog files, emulation and simulation reports, test vectors and hardware development tools, and (ix) any and all instantiations of the foregoing in any form and embodied in any media.

“Intellectual Property Rights” shall mean worldwide common law and statutory rights associated with (i) patents,

patent applications and inventors’ certificates, (ii) copyrights, copyright registrations and copyright applications, “moral” rights and mask work rights, (iii) trade and industrial secrets and confidential information (“Trade Secrets”), (iv) other proprietary rights relating to intangible intellectual property, (v) trademarks, trade names and service marks, (vi) divisions, continuations, renewals, reissuances and extensions of the foregoing (as applicable) and (vii) analogous rights to those set forth above, including the right to enforce and recover remedies for any of the foregoing.

“Shrink-Wrapped Code” means generally commercially available software code (other than development tools and

development environments) where available for a cost of not more than U.S. $10,000 for a perpetual license for a single user or work station (or $75,000 in the aggregate for all users and work stations).

“Source Code” shall mean computer software and code, in form other than object code form, including related

programmer comments and annotations, help text, data and data structures, instructions and procedural, object-oriented and other code, which may be printed out or displayed in human readable form.

(b) No Default/No Conflict. All Contracts constituting either (i) a license of (or covenant not to sue related to) Intellectual

Property that is material to the business of the Company or any of its Subsidiaries by the Company or any of its Subsidiaries to a third Person, or (ii) a license of Intellectual Property or Intellectual Property Rights of a third Person to the Company or any of its Subsidiaries that is material to the business of the Company (in each case that have not, prior to the date hereof, expired or been terminated pursuant to their terms or operation of law) are in full force and effect, and enforceable in accordance with their terms, subject to applicable bankruptcy, insolvency, reorganization or other laws relating to or affecting the rights and remedies of creditors generally and to general principles of equity. The consummation of the transactions contemplated by this Agreement will not result in the material breach, modification, cancellation, termination, suspension of, or acceleration of any payments with respect to, such Contracts. Each of the Company and its Subsidiaries is in material compliance with, and has not materially breached any term of any such Contracts and, to the Knowledge of the Company, all other parties to such Contracts are in compliance with, and have not materially breached any term of, such Contracts. Following the Closing Date, the Surviving Corporation will be permitted to exercise all of the Company’s and its Subsidiaries’ material rights under such Contracts to the same extent the Company and its Subsidiaries would have been able to had the transactions contemplated by this Agreement not occurred and without the payment of any additional amounts or consideration other than ongoing fees, royalties or payments which the Company or any of its Subsidiaries would otherwise be required to pay.

(c) No Infringement. The operation of the business of the Company and its Subsidiaries as currently conducted by the

Company, including the design, development, use, import, branding, advertising, promotion, marketing, manufacture and sale of any Company Product does not infringe or misappropriate any Intellectual Property Rights of any Person, violate any right to privacy or publicity, or constitute unfair competition or trade practices under the laws of any jurisdiction to which the Company or its Subsidiaries are subject.

(d) Notice. Except as set forth in Section 2.8(d) of the Company Disclosure Letter, neither the Company nor any of its

Subsidiaries has received in the last two years written notice from any Person claiming that the Company, any of its Subsidiaries, any Company Product or Company Intellectual Property infringes or misappropriates any Intellectual Property Rights of any Person, violates any rights to privacy or publicity or constitutes unfair competition or trade practices under the laws of any jurisdiction (nor does the Company have Knowledge of any basis therefor).

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(e) No Third Party Infringers. To the Knowledge of the Company, no Person is infringing, misappropriating or otherwise violating any Company Intellectual Property. Within the past two years, the Company or any of its Subsidiaries has not asserted or threatened any claim against any Person alleging any infringement, misappropriation or violation of any Company Intellectual Property.

(f) Transaction. Neither this Agreement nor the transactions contemplated by this Agreement, will result in the Surviving

Corporation or, to the Knowledge of the Company, Parent or any of its subsidiaries: (i) granting to any third party any incremental right to or with respect to any material Intellectual Property Rights owned by, or licensed to, any of them, (ii) being bound by, or subject to, any incremental non-compete or other incremental material restriction on the operation or scope of their respective businesses, or (iii) being obligated to pay any incremental royalties or other material amounts, or offer any incremental discounts, to any third party. As used in this Section 2.8(f), an “incremental” right, non-compete, restriction, royalty or discount refers to a right, non-compete, restriction, royalty or discount, as applicable, in excess of the rights, non-competes, restrictions, royalties or discounts payable that would have been required to be offered or granted, as applicable, had the parties not entered into this Agreement or consummated the transactions contemplated hereby.

(g) Intellectual Property. Each of the Company and its Subsidiaries has taken commercially reasonable steps to obtain,

maintain and protect the Company Intellectual Property. Without limiting the foregoing, each of the Company and its Subsidiaries has, and enforces, and since January 1, 2001 has had and enforced, a policy requiring each employee, consultant and contractor to execute work-for-hire, invention assignment, proprietary information, and confidentiality agreements (as applicable) to protect Company Intellectual Property. Without limiting the foregoing, in the past two years, all current or former employees, consultants and contractors of the Company or any Subsidiary that have created any material Intellectual Property used or held for use by the Company or any of its Subsidiaries have executed such agreements in which they have assigned all of their rights in and to such Intellectual Property to the Company. To the Knowledge of the Company, no party to any such agreement is in material breach thereof. To the Knowledge of the Company, no current or former employees, consultants or contractors of the Company or any Subsidiary own any material Intellectual Property used or held for use by the Company or any of its Subsidiaries.

(h) No Order. There are no extant forbearances to sue, consents, settlement agreements, judgments, orders or similar

litigation-related, inter partes or adversarial-related, or government-imposed obligations to which the Company or a Subsidiary is a party or are otherwise bound, other than licenses of Company Intellectual Property to third Persons and licenses of Intellectual Property to the Company, that (i) restrict the rights of the Company or any of its Subsidiaries to use, transfer, license or enforce any of its Intellectual Property Rights; (ii) restrict the conduct of the business of the Company or any of its Subsidiaries in order to accommodate a third party’s Intellectual Property Rights; or (iii) grant any third party any right with respect to any Company Intellectual Property Rights.

(i) Open Source. Except as has been Made Available to Parent, to the Knowledge of the Company no Intellectual Property

or Intellectual Property Rights of the Company or any of its Subsidiaries, of a third party or in the public domain, that constitutes open source, public source or freeware Intellectual Property, or any modification or derivative thereof, including any version of any software licensed pursuant to any GNU general public license or GNU lesser general public license or other software that is licensed pursuant to a license that purports to require the distribution of or access to Source Code or purports to restrict one’s ability to charge for distribution of or to use software for commercial purposes (collectively “Open Source”), has been used in, incorporated into, integrated or bundled with, or used in the development or compilation of, any current Company Products. Each of the Company and its Subsidiaries takes commercially reasonable steps and has implemented commercially reasonable procedures (in each case in light of the Company’s and its Subsidiaries’ size and business) intended to: (i) identify such Open Source; and (ii) to avoid the release of the Source Code of the Company Intellectual Property. To the Knowledge of the Company, there has been no material deviation from such efforts and procedures of Company and its Subsidiaries with respect to Open Source.

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(j) Source Code. To the Knowledge of the Company, the execution of this Agreement or any of the other transactions contemplated by this Agreement, will not result in a release from escrow of any Source Code that is Company Intellectual Property or the grant of incremental rights to a Person with regard to such Source Code. No event has occurred, and no circumstance or condition exists, that (with or without notice or lapse of time, or both) will, or would reasonably be expected to, result in the disclosure or delivery by the Company, any of its Subsidiaries or any Person acting on their behalf to any Person of any Source Code that is Company Intellectual Property under any Contract, and no material portions of such Source Code has been disclosed, delivered or licensed to a third party (other than deposits of Source Code with escrow agents pursuant to escrow agreements in the ordinary course of business consistent with past practice, which deposits have not been released from escrow).

(k) Software. To the Knowledge of the Company, all Company Products and Company Intellectual Property (and all parts

thereof) are free of: (i) any critical defects, including without limitation any critical error or critical omission in the processing of any transactions; and (ii) any disabling codes or instructions and any “back door,” “time bomb,” “Trojan horse,” “worm,” “drop dead device,” “virus” or other software routines or hardware components that permit unauthorized access or the unauthorized disruption, impairment, disablement or erasure of such Company Product or Company Intellectual Property (or all parts thereof) or data or other software of users (“Contaminants”), in each case that reasonably would be expected to materially impact the business of the Company and its Subsidiaries taken as a whole.

(l) Information Technology. The Company and its Subsidiaries have taken commercially reasonable steps and

implemented commercially reasonable procedures intended to ensure that information technology systems used in connection with the operation of the Company and its Subsidiaries are free from Contaminants that would reasonably be expected to be material to the Company and its Subsidiaries, taken as a whole. The Company and its Subsidiaries have appropriate disaster recovery plans procedures and facilities for the business and have taken commercially reasonable steps to safeguard the information technology systems utilized in the operation of the business of the Company and its Subsidiaries as it is currently conducted. To the Knowledge of the Company, since January 1, 2002, there have been no unauthorized intrusions or breaches of the security of the information technology systems. The Company and its Subsidiaries have implemented security patches or upgrades that are generally available for the Company’s information technology systems where, in the Company’s reasonable judgment, such patches or upgrades are required.

(m) Licenses-In. Other than (i) licenses to Shrink-Wrapped Code, (ii) non-disclosure agreements entered into in the

ordinary course of business consistent with past practice, and (iii) service engagement orders pursuant to which the Company or any of its subsidiaries customizes software related to Company Products, in each case, used by customers of the Company or any of its Subsidiaries entered into in the ordinary course of business consistent with past practices (“Service Engagement Orders”) (provided, however, that the term “Service Engagement Orders” shall not include the Contracts under which such service engagement orders are provided), Section 2.8(m) of the Company Disclosure Letter lists all Contracts that are material to the business of the Company to which the Company or any of its Subsidiaries is a party and under which the Company or any of its Subsidiaries has been granted or provided any rights to Intellectual Property or Intellectual Property Rights by a third party and sets forth, for each such Contract, any minimum purchase obligations and any per unit royalty charges required of the Company or any of its Subsidiaries thereunder.

(n) Licenses-Out. Other than (i) written non-disclosure agreements, (ii) non-exclusive licenses and related agreements with

respect thereto (including software and maintenance and support agreements) of Company Products to end-users, (iii) any non-exclusive dealer, distributor, or joint marketing agreement with any customers of the Company or its Subsidiaries (in each case, pursuant to written agreements that have been entered into in the ordinary course of business consistent with past practice), and (iv) Service Engagement Orders, Section 2.8(n) of the Company Disclosure Letter lists each contract, license and agreement by which the Company or any Subsidiary grants to any third Person rights in any Intellectual Property or Company Products.

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(o) Trade Secrets. The Company and each of its Subsidiaries has the right to use, or has ownership of, free and clear of any pledges, mortgages, liens and security interests, all customer lists, customer contact information, customer correspondence and customer licensing and purchasing histories relating to its current and former customers (the “Customer Information”). No Person other than the Company, its wholly owned Subsidiaries, Persons distributing Company Products through channels (whether by way of sales, licensing, leasing or otherwise), or Persons to which such Customer Information refers, possess any claims or rights with respect to use of the Customer Information. Except as set forth on Section 2.8(o) of the Company Disclosure Letter, the Company and its Subsidiaries have taken commercially reasonable steps to protect their trade secrets, and any trade secrets of third parties provided thereto, according to the laws of the applicable jurisdictions where such trade secrets are developed, practiced or disclosed.

(p) Privacy. To the Knowledge of the Company, the Company and its Subsidiaries have complied with all applicable laws

and their respective internal privacy policies and guidelines, if any, relating to privacy, data protection, and the collection and use of personal information collected, used, or held for use by the Company and its Subsidiaries in the conduct of their business. The Company and its Subsidiaries take reasonable measures to ensure that such information is protected against unauthorized access, use, modification, or other misuse. To the Knowledge of the Company, the execution, delivery and performance of this Agreement complies with all applicable laws relating to privacy and the Company’s and its Subsidiaries’ applicable privacy policies in each case in all material respects (and in each case, except as otherwise required or permitted by this Agreement). All applicable privacy policies and guidelines are listed in Section 2.5(p) of the Company Disclosure Letter (true and correct copies in all material respects of which have been Made Available to Parent) and, to the Knowledge of the Company, the Company and its Subsidiaries have at all times made all disclosures to users or customers required by applicable laws and none of such disclosures have been inaccurate in any material respect or materially misleading or deceptive or in violation of any applicable laws.

(q) Ownership of Intellectual Property Rights. Section 2.8(q) of Company Disclosure Letter lists all Company Registered

Intellectual Property, identifying in each case the inventors/authors, status, filing date, and issuance/registration/grant date, and prosecution status thereof. The Company or its Subsidiaries own all right, title, and interest (including the sole right to enforce) free and clear of all pledges, mortgages, liens and security interests in and to all Company Intellectual Property, and with respect to Company Registered Intellectual Property is listed in the records of the appropriate United States, state or foreign authority as the sole owner for each item thereof. No Service Engagement Order restricts the rights of the Company or any of its Subsidiaries to use, transfer, license or enforce any of its Intellectual Property Rights in or to any of the Company’s or its Subsidiaries’ core software products (excluding custom eWay adaptors) or grants any third Person any exclusive or ownership rights in or to any of the Company’s or its Subsidiaries’ core software products (excluding custom eWay adaptors).

(r) Validity and Enforceability. To the Knowledge of the Company and its Subsidiaries: (i) the material Company

Registered Intellectual Property and Intellectual Property owned by Company is subsisting, in full force and effect, is valid and enforceable, and (in the case of Company Registered Intellectual Property) has not expired or been cancelled or abandoned, except where such expiration, cancellation or abandonment is consistent with the exercise of reasonable business judgment, and (ii) all necessary registration, maintenance and renewal fees currently due have been made, and all necessary documents, recordations and certificates have been filed, for the purposes of maintaining such Company Registered Intellectual Property.

2.9 Restrictions on Business Activities. Neither the Company nor any of its Subsidiaries is party to or bound by any Contract

containing any covenant (a) limiting in any material respect the right of the Company or any of its Subsidiaries to engage or compete in any line of business, to make use of any material Company Intellectual Property or to compete with any Person, (b) granting any exclusive distribution rights, (c) providing “most favored nations” clauses other than such clauses that are based on volume and restricted to “similarly situated customers” for any future purchases of Company Products, or (d) which otherwise adversely affects or would reasonably be expected to adversely affect the right of the Company and its Subsidiaries to sell, distribute or

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manufacture any Company Products or material Company Intellectual Property or to purchase or otherwise obtain any material software, components, parts or subassemblies.

2.10 Governmental Authorizations. Each material consent, license, permit, grant or other authorization (i) pursuant to which the Company or any of its Subsidiaries currently operates or holds any material interest in any of their respective properties, or (ii) which is required for the operation of the Company’s or any of its Subsidiaries’ business as currently conducted or currently contemplated to be conducted during the next twelve months or the holding of any such interest (collectively, “Governmental Authorizations”) has been issued or granted to the Company or any of its Subsidiaries, as the case may be, and are in full force and effect. As of the date hereof, no suspension or cancellation of any of the Governmental Authorizations is pending or, to the Knowledge of the Company, threatened and the Company and its Subsidiaries are in compliance in all material respects with the terms of the Governmental Authorizations.

2.11 Litigation. There is no material action, suit, claim or proceeding pending or, to the Knowledge of the Company, threatened against the Company, any of its Subsidiaries or any of their respective properties (tangible or intangible). There is no material investigation or other proceeding pending or, to the Knowledge of the Company, threatened against the Company, any of its Subsidiaries or any of their respective properties (tangible or intangible) by or before any Governmental Entity. Since January 1, 2002 to the date hereof, there have not been any internal investigations or inquiries being conducted by the Company, the Company’s Board of Directors (or any committee thereof) or any third party at the request of any of the foregoing concerning any financial, accounting, tax, conflict of interest, illegal activity, fraudulent or deceptive conduct or other misfeasance or malfeasance issues.

2.12 Compliance with Laws. The Company and its Subsidiaries are in compliance in all material respects with the Legal Requirements applicable to the Company or any of its Subsidiaries or by which the Company or any of its Subsidiaries is bound or any of their respective properties is bound or affected. There is no agreement, judgment, injunction, order or decree binding upon the Company or any of its Subsidiaries which has or would reasonably be expected to have the effect of prohibiting or impairing any business practice of the Company or any of its Subsidiaries in such a way as to be material and adverse to the Company and its Subsidiaries, taken as a whole.

2.13 Environmental Matters.

(a) Hazardous Material. Except as would not be reasonably likely to result in a material liability to the Company and its Subsidiaries, taken as a whole, neither the Company nor any of its Subsidiaries has: (i) operated any underground storage tanks at any property that the Company or any of its Subsidiaries has at any time owned, operated, occupied or leased, or (ii) released any amount of any substance that has been designated, defined, or classified by any Governmental Entity or by any Legal Requirement relating to pollution or protection of human health or the environment (collectively, “Environmental Laws”) as radioactive, toxic, hazardous or otherwise a danger to health or the environment, including, without limitation, PCBs, asbestos, petroleum and petroleum products, toxic mold and biological materials, urea-formaldehyde, radon and all “hazardous substances” pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, and all “hazardous wastes” pursuant to the United States Resource Conservation and Recovery Act of 1976, as amended, but excluding customary and unregulated amounts of office and janitorial supplies (a “Hazardous Material”). Except as would not be reasonably likely to result in a material liability to the Company or any of its Subsidiaries, no Hazardous Materials are present as a result of the actions of the Company or any of its Subsidiaries or, to the Company’s Knowledge, as a result of any actions of any affiliate of the Company or any third party or otherwise, in, on or under any property, including the land and the improvements, soil, ground water and surface water thereof, that the Company or any of its Subsidiaries has at any time owned, operated, occupied or leased.

(b) Hazardous Materials Activities. Neither the Company nor any of its Subsidiaries has transported, managed, stored,

used, recycled, manufactured, disposed of, released, removed or exposed its Employees or

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others to Hazardous Materials or manufactured or distributed for sale any product containing a Hazardous Material (collectively “Hazardous Materials Activities”) in violation in any material respect of any Legal Requirement or in a manner which has caused or would reasonably be expected to cause a material adverse health effect to any such person or result in any material liabilities under Environmental Laws.

(c) Environmental Compliance. The Company and its Subsidiaries are in material compliance with Environmental Laws

and, to the Knowledge of the Company, there are no conditions or circumstances that could reasonably be expected to prevent or interfere with such material compliance in the future. The Company and its Subsidiaries currently hold all Governmental Authorizations necessary under Environmental Laws for their business, operations and Hazardous Material Activities as such operations, activities and businesses are currently being conducted (the “Company Environmental Permits”), and are in compliance with the terms and conditions thereof, except for Governmental Authorizations, the absence of which could not reasonably be expected to result in a material liability for the Company or any of its Subsidiaries.

(d) Environmental Liabilities. No material legal action, governmental proceeding or investigation, order, permit

revocation proceeding, permit amendment procedure, writ, injunction or claim is pending, or, to the Company’s Knowledge, threatened against the Company or any of its Subsidiaries or, to the Company’s Knowledge, against any person for whom they may be responsible by law or contract concerning any Environmental Law, Company Environmental Permit, Hazardous Material or any Hazardous Materials Activity. The Company has no knowledge of any facts or circumstances which could result in any liability for the Company or its Subsidiaries (or any person for whom they may be responsible by law or contract) under Environmental Laws, or related to any Company Environmental Permit, Hazardous Material or Hazardous Material Activity which could reasonably be expected to be material to the Company and its Subsidiaries, taken as a whole. Except as would not be reasonably be likely to result in a material liability to the Company and its Subsidiaries, taken as a whole, neither the Company nor any of its Subsidiaries have entered into any agreement that would require it to guarantee, reimburse, pledge, defend, hold harmless or indemnify any other Person with respect to liabilities arising out of the Hazardous Materials Activities or environmental liabilities of the Company, any of its Subsidiaries or of any other Person.

(e) Environmental Information. The Company has Made Available to Parent all material assessments, reports, data,

results of investigations or audits, and other material information that is in the possession of the Company regarding environmental matters pertaining to or the environmental condition of the business of the Company and its Subsidiaries, or the compliance (or noncompliance) by the Company and its Subsidiaries with any Environmental Laws.

2.14 Brokers’ and Finders’ Fees. Except for fees payable to SG Cowen & Co., LLC pursuant to an engagement letter dated

February 3, 2005, and fees payable Houlihan Lokey Howard & Zukin Financial Advisers, Inc. pursuant to an engagement letter dated June 22, 2005, copies of which has been provided to Parent, neither the Company nor any of its Subsidiaries has incurred, nor will it incur, directly or indirectly, any liability for brokerage or finders’ fees or agents’ commissions, fees related to investment banking or similar advisory services or any similar charges in connection with this Agreement or any transaction contemplated hereby, nor has the Company or any of its Subsidiaries entered into any indemnification agreement or arrangement with any Person in connection with this Agreement and the transactions contemplated hereby.

2.15 Transactions with Affiliates. Except as set forth in the Company SEC Reports, the date of the Company’s last proxy statement filed with the SEC, no event has occurred as of the date hereof that would be required to be reported by the Company pursuant to Item 404 of Regulation S-K promulgated by the SEC.

2.16 Employee Benefit Plans and Compensation.

(a) Definitions. For all purposes of this Agreement, the following terms shall have the following respective meanings:

“Company Employee Plan” shall mean any plan, program, policy, practice, contract, agreement or other arrangement providing for compensation, severance, termination pay, deferred compensation,

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performance awards, stock or stock-related awards, welfare benefits, retirement benefits, fringe benefits or other employee benefits or remuneration of any kind, whether written, unwritten or otherwise, funded or unfunded, including each “employee benefit plan,” within the meaning of Section 3(3) of ERISA which (i) is or has been maintained, contributed to, or required to be contributed to, by the Company, any of its Subsidiaries or any ERISA Affiliate for the benefit of any Employee, and (ii) with respect to which the Company, any of its Subsidiaries or any ERISA Affiliate has or may have any liability or obligation, but excluding any International Employee Plan.

“COBRA” shall mean the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended.

“DOL” shall mean the United States Department of Labor.

“Employee” shall mean any current or former employee, consultant, independent contractor or director of the

Company, any of its Subsidiaries or any ERISA Affiliate, excluding consultants and independent contractors who are not individuals.

“Employee Agreement” shall mean each management, employment, severance, separation, settlement, consulting,

contractor, relocation, repatriation, expatriation, loan, visa, work permit or other agreement, or contract (including, any offer letter which provides for any term of employment other than employment at will or any agreement providing for acceleration of Company Options, or any other agreement providing for compensation or benefits) between the Company, any of its Subsidiaries or any ERISA Affiliate and any director or any Employee pursuant to which the Company or any of its Subsidiaries has or may have any current or future liabilities or obligations, but excluding any International Employee Plan.

“ERISA” shall mean the Employee Retirement Income Security Act of 1974, as amended.

“ERISA Affiliate” shall mean any other Person under common control with the Company or any of its Subsidiaries

within the meaning of Section 414(b), (c), (m) or (o) of the Code, and the regulations issued thereunder.

“HIPAA” shall mean the Health Insurance Portability and Accountability Act of 1996, as amended.

“International Employee Plan” shall mean each Company Employee Plan or Employee Agreement that has been adopted or maintained by the Company, any of its Subsidiaries or any ERISA Affiliate, whether formally or informally, or with respect to which the Company, any of its Subsidiaries or any ERISA Affiliate will or may have any liability, for the benefit of Employees who perform services outside the United States.

“IRS” shall mean the United States Internal Revenue Service.

“Pension Plan” shall mean each Company Employee Plan that is an “employee pension benefit plan,” within the

meaning of Section 3(2) of ERISA.

“WARN” shall mean the Worker Adjustment and Retraining Notification Act.

(b) Schedule. Section 2.16(b)(i) of the Company Disclosure Letter contains an accurate and complete list of each Company Employee Plan and each material Employee Agreement. Section 2.16(b)(ii) of the Company Disclosure Letter sets forth, as of the date hereof, the name and salary of each employee of the Company and each of its Subsidiaries whose base salary currently exceeds $150,000 per year. To the Knowledge of the Company, as of the date of this Agreement, no employee listed on Section 2.16(b)(ii) of the Company Disclosure Letter intends to terminate his or her employment. Section 2.16(b)(iii) of the Company Disclosure Letter contains an accurate and complete list of all Persons that have a consulting or advisory relationship (other than pursuant to an Employee Agreement) with the Company or any of its Subsidiaries that is subject to ongoing obligations in excess of $50,000 per year.

(c) Documents. The Company and each of its Subsidiaries has Made Available to Parent (i) correct and complete copies of

all documents embodying each Company Employee Plan and each Employee Agreement

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including all amendments thereto and all related trust documents, (ii) the three most recent annual reports (Form Series 5500 and all schedules and financial statements attached thereto), if any, required under ERISA or the Code in connection with each Company Employee Plan, (iii) if the most recent summary plan description together with the summary(ies) of material modifications thereto, if any, required under ERISA with respect to each Company Employee Plan, (iv) all material written agreements and contracts relating to each Company Employee Plan, including administrative service agreements and group insurance contracts, (v) all communications material to any Employee or Employees relating to any Company Employee Plan and any proposed Company Employee Plan, in each case, relating to any amendments, terminations, establishments, increases or decreases in benefits, acceleration of payments or vesting schedules or other events which would result in any material liability to the Company or any of its Subsidiaries, (vi) all material correspondence to or from any governmental agency relating to any Company Employee Plan, (vii) all policies pertaining to fiduciary liability insurance covering the fiduciaries for each Company Employee Plan, (viii) to the extent applicable, all discrimination tests for each Company Employee Plan for the three most recent plan years, (ix) all prospectuses prepared in connection with each Company Employee Plan, and (x) the most recent IRS determination issued with respect to each Company Employee Plan to the extent applicable.

(d) Employee Plan Compliance.

(i) The Company and each of its Subsidiaries have performed all material obligations required to be performed by

them under, are not in default or violation in any material respect of, and the Company and each of its Subsidiaries have no Knowledge of any material default or violation by any other party to, any Company Employee Plan or Employee Agreement, and each Company Employee Plan and Employee Agreement has been established and maintained in accordance with its terms and in material compliance with all applicable laws, statutes, orders, rules and regulations, including ERISA or the Code. Any Company Employee Plan intended to be qualified under Section 401(a) of the Code has obtained a current favorable determination letter as to its qualified status under the Code. To the Knowledge of the Company, no “prohibited transaction,” within the meaning of Section 4975 of the Code or Sections 406 and 407 of ERISA, and not otherwise exempt under Section 408 of ERISA, has occurred with respect to any Company Employee Plan.

(ii) There are no actions, suits or claims pending or, to the Knowledge of the Company, threatened or reasonably

anticipated (other than routine claims for benefits) against any Company Employee Plan or against the assets of any Company Employee Plan. Each Company Employee Plan that is not (A) an Employee Agreement or (B) an employee welfare benefit plan can be amended, terminated or otherwise discontinued after the Effective Time in accordance with its terms, without liability to Parent, the Company, any of its Subsidiaries or any ERISA Affiliate (other than ordinary administration expenses or with respect to benefits previously earned, vested or accrued thereunder).

(iii) There are no audits, inquiries or proceedings pending or to the Knowledge of the Company, threatened by the

IRS, DOL, or any other Governmental Entity with respect to any Company Employee Plan. None of the Company, any of its Subsidiaries or any ERISA Affiliate is currently or, to the Knowledge of the Company, will be subject to any penalty or Tax with respect to any Company Employee Plan under Section 502(i) of ERISA or Sections 4975 through 4980 (including 4980B) of the Code.

(iv) The Company and each of its Subsidiaries have timely made all contributions and other payments required by

and due under the terms of each Company Employee Plan.

(e) No Pension Plan. Neither the Company, any of its Subsidiaries nor any current or former ERISA Affiliate has ever maintained, established, sponsored, participated in, or contributed to, any Pension Plan subject to Part 3 of Subtitle B of Title I of ERISA, Title IV of ERISA or Section 412 of the Code.

(f) No Self-Insured Plan. Except as disclosed in Section 2.16(f) of the Company Disclosure Letter, neither the Company,

any of its Subsidiaries nor any ERISA Affiliate currently maintains or has any

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obligation, whether fixed or contingent, to contribute to any self-insured plan that provides benefits to Employees (including any such plan pursuant to which a stop-loss policy or contract applies).

(g) Collectively Bargained, Multiemployer and Multiple-Employer Plan. At no time has the Company, any of its

Subsidiaries or any ERISA Affiliate contributed to or been obligated to contribute to any multiemployer plan (as defined in Section 3(37) of ERISA). Neither the Company, any of its Subsidiaries nor any ERISA Affiliate has at any time ever maintained, established, sponsored, participated in or contributed to any multiple employer plan or any plan described in Section 413 of the Code.

(h) No Post-Employment Obligations. No Company Employee Plan or Employee Agreement provides post-termination or

retiree life insurance, health or other employee welfare benefits to any person for any reason, except as may be required by COBRA or other applicable statute or other law, and neither the Company nor any of its Subsidiaries has ever represented, promised or contracted (whether in oral or written form) to any Employee (either individually or to Employees as a group) or any other person that such Employee(s) or other person would be provided with post-termination or retiree life insurance, health or other employee welfare benefits, except to the extent required by statute or other law.

(i) Effect of Transaction. Except as set forth in Section 2.16(i) of the Company Disclosure Letter, neither the execution

and delivery of this Agreement nor the consummation of the transactions contemplated hereby or any termination of employment or service in connection therewith will (i) result in any payment (including severance, golden parachute, retention payment, bonus or otherwise), becoming due to any Employee or in the funding of any such payment, (ii) result in any forgiveness of indebtedness, (iii) materially increase any benefits otherwise payable by the Company or any Subsidiary or (iv) result in the acceleration of the time of payment or vesting of any such benefits (including with regard to Company Options) except as required under Section 411(d)(3) of the Code.

(j) Parachute Payments. Neither this Agreement nor any other agreement, plan, arrangement or other contract covering

any Employee that, considered individually or considered collectively with any other such agreements, plans, arrangements or other contracts, could reasonably be expected to, give rise directly or indirectly to the payment of any amount that would be characterized as a “parachute payment” within the meaning of Section 280G(b)(2) of the Code. There is no agreement, plan, arrangement or other contract by which the Company or any of its Subsidiaries is bound to compensate any Employee for excise taxes paid pursuant to Section 4999 of the Code. Section 2.16(j) of the Company Disclosure Letter lists all persons who the Company reasonably believes are “disqualified individuals” (within the meaning of Section 280G of the Code and the regulations promulgated thereunder) as determined as of the date hereof. Prior to the date of this Agreement, the Company has not undergone a change in ownership or effective control as defined in Section 280G of the Code and the regulations promulgated thereunder that has, or could reasonably be expected to give rise directly or indirectly to the payment of any amount that would be characterized as a “parachute payment” within the meaning of Section 280G(b)(2) of the Code.

(k) Executive Compensation Tax. There is no contract, agreement, plan or arrangement to which the Company or any of

its Subsidiaries is a party, including the provisions of this Agreement, covering any Employee of the Company or any of its Subsidiaries, which, individually or collectively, could give rise to the payment of any amount that would not be deductible pursuant to Sections 404 or 162(m) of the Code.

(l) Employment Matters. The Company and each of its Subsidiaries are in compliance in all material respects with all

applicable Legal Requirements respecting employment, employment practices, terms, conditions and classifications of employment, employee safety and health, immigration status and wages and hours, and in each case, with respect to Employees (i) are not liable for any arrears of wages, severance pay or any Taxes or any penalty for failure to comply with any of the foregoing, and (ii) are not liable for any payment to any trust or other fund governed by or maintained by or on behalf of any governmental authority, with respect to unemployment compensation benefits, social security or other benefits or obligations for Employees (in each case, other than routine payments to be made in the normal course of business and consistent with past practice). There are no material actions, investigations, suits, claims or administrative matters pending, or, to the Knowledge of the Company, threatened or reasonably anticipated

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against the Company, any of its Subsidiaries, or any of their Employees relating to any Employee, Employee Agreement or Company Employee Plan. Except as provided under any Employee Agreements listed in Section 2.16(b)(i) of the Company Disclosure Letter, the services provided by each of the Company’s, each Subsidiary’s and their ERISA Affiliates’ Employees are terminable at the will of the Company and its ERISA Affiliates.

(m) Works Council. There are no foreign works’ councils or collective bargaining agreements to which the Company or

any of its Subsidiaries are subject. The consummation of the Merger and the other transactions contemplated by this Agreement will not entitle any third party (including any labor union or labor organization) to any payments under any collective bargaining agreement or any labor agreement that would be material to the Company or any of its Subsidiaries.

(n) Labor. No work stoppage, slowdown, lockout or labor strike against the Company or any of its Subsidiaries is pending,

or to the Knowledge of the Company threatened nor has there been any such occurrence for the past three years. The Company has no Knowledge of any activities or proceedings of any labor union to organize any Employees located in the United States. There are no material actions, suits, claims, labor disputes or grievances pending or, to the Knowledge of the Company, threatened relating to any labor matters involving any Employee, including charges of unfair labor practices. Neither the Company nor any of its Subsidiaries is presently, nor has it been in the past, a party to, or bound by, any collective bargaining agreement or union contract with respect to Employees and no collective bargaining agreement is being negotiated by the Company or any of its Subsidiaries with respect to employees located in the United States. Within the past year, neither the Company nor any of its Subsidiaries has incurred any liability or obligation under WARN or any similar state or local law that remains unsatisfied.

(o) International Employee Plan. To the Knowledge of the Company except as (i) is not reasonably likely to result in a

material liability to the Company; (ii) is required under any Legal Requirements; or (iii) otherwise set forth in Section 2.16(o)(i) of the Company Disclosure Letter, the foregoing representations contained in Sections 2.16(c) through 2.16(n), to the extent applicable, are accurate with respect to Employees located outside the United States and International Employee Plans. Each International Employee Plan has been established, maintained and administered in material compliance with its terms and conditions and with the requirements prescribed by all statutory or regulatory laws that are applicable to such International Employee Plan. No International Employee Plan has unfunded liabilities, that as of the Effective Time, will not be offset by insurance or fully accrued. Except as required by law, no condition exists that would prevent the Company or Parent from terminating or amending any International Employee Plan at any time for any reason.

(p) With respect to those Company Employee Plans that may be subject to Code Section 409A, the Company has taken or

intends to take such timely actions as may be necessary or appropriate to comply with Code Section 409A.

2.17 Contracts.

(a) Material Contracts. For purposes of this Agreement, “Company Material Contract” shall mean any of the following to which the Company or any of its Subsidiaries is a party or by which it or its assets are bound, but shall not include any Company Employee Plan, International Employee Plan or any Employee Agreement:

(i) any “material contract” (as such term is defined in Item 601(b)(10) of Regulation S-K of the SEC) with respect to

the Company and its Subsidiaries;

(ii) any agreement of indemnification or any guaranty (other than any agreement of indemnification entered into in connection with the sale or license of Company Products in the ordinary course of business consistent with past practice or any guaranty of obligations of a wholly-owned Subsidiary);

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(iii) any Contract relating to the disposition or acquisition by the Company or any of its Subsidiaries of a material amount of assets or any interest in any other Person or business enterprise other than in the ordinary course of business consistent with past practice;

(iv) any mortgages, indentures, guarantees, loans or credit agreements, security agreements or other Contracts relating

to the borrowing of money or extension of credit, other than accounts receivable and payable in the ordinary course of business consistent with past practice;

(v) any material settlement agreement entered into within three years prior to the date of this Agreement or which

otherwise contains continuing obligations of the Company or any of its Subsidiaries;

(vi) (A) any dealer, distributor, joint marketing or end-user license agreement with any of the top 25 customers of the Company and its Subsidiaries, taken as a whole, as measured by sales during the twelve months ended March 31, 2005, (B) any development agreement under which the Company or any of its Subsidiaries has continuing material obligations to jointly market any product, technology or service and which may not be canceled without penalty to the Company or any of its Subsidiaries upon notice of 30 days or less, or (C) any material agreement pursuant to which the Company or any of its Subsidiaries has continuing material obligations to jointly develop any Intellectual Property or Intellectual Property Rights that will not be owned, in whole or in part, by the Company or any of its Subsidiaries and which may not be terminated without penalty to the Company or any of its Subsidiaries upon notice of 30 days or less, excluding in the case of each of Clause (B) and (C), Service Engagement Orders;

(vii) (A) any Contract required to be disclosed in Section 2.8(n) of the Company Disclosure Letter or any subsection

thereof and (B) Contracts (other than (i) licenses to Shrink-Wrapped Code, (ii) non-disclosure agreements entered into in the ordinary course of business consistent with past practice and (iii) Service Engagement Orders) that are material to the business of the Company to which the Company or any of its Subsidiaries is a party and under which the Company or any of its Subsidiaries has been granted or provided any rights to Intellectual Property or Intellectual Property Rights by a third party;

(viii) (A) any Contract containing any support or maintenance obligation on the part of the Company or any of its

Subsidiaries with any of the top 25 customers of the Company and its Subsidiaries as measured by support and maintenance revenues earned during the period from January 1, 2005 through April 30, 2005, and (B) any Contract containing material service obligations on the part of the Company or any of its Subsidiaries, other than those obligations that are terminable by the Company or any of its Subsidiaries on no more than 90 days notice without liability or financial obligation to the Company or its Subsidiaries;

(ix) any Contract, or group of Contracts with a Person (or group of affiliated Persons), the termination or breach of

which, individually or in the aggregate, could reasonably be expected to have a Material Adverse Effect on the Company; or

(x) any other Contract with any continuing obligations to make payments or entitlement to receive payments on

behalf of the Company or any of its Subsidiaries of $2,000,000 or more.

(b) Schedule. Section 2.17(b) of the Company Disclosure Letter sets forth a list of all Company Material Contracts to which the Company or any of its Subsidiaries is a party or by which the Company or any of its Subsidiaries is bound or by which any of their respective properties is bound or affected as of the date hereof, setting forth for each such Company Material Contract, the subsections of Section 2.17(a) that are applicable to such Company Material Contract.

(c) No Breach. All Company Material Contracts are valid and in full force and effect except to the extent they have

previously expired in accordance with their terms or if the failure to be in full force and effect, individually or in the aggregate, would not reasonably be expected to be material to the Company and its Subsidiaries, taken as a whole. Neither the Company nor any of its Subsidiaries has violated any

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provision of, or committed or failed to perform any act which, with or without notice, lapse of time or both would constitute a default under the provisions of, any Company Material Contract, except in each case for those violations and defaults which, individually or in the aggregate, would not reasonably be expected to be material to the Company and its Subsidiaries, taken as a whole.

2.18 Insurance. The Company has Made Available to Parent true, correct and accurate copies of all insurance policies and

fidelity bonds material to the business of the Company that are in effect as of the date hereof. There is no material claim by the Company or any of its Subsidiaries pending under any of the insurance policies and fidelity bonds covering the assets, business, equipment, properties, operations, employees, officers and directors of the Company and its Subsidiaries as to which coverage has been questioned, denied or disputed by the underwriters of such policies or bonds.

2.19 Export Control Laws. The Company and each of its Subsidiaries has at all times conducted its export transactions materially in accordance with (i) all applicable U.S. export and reexport control laws and (ii) to the Company’s Knowledge, all other applicable import/export controls in other countries in which the Company conducts business. Without limiting the foregoing:

(a) The Company and each of its Subsidiaries has obtained, and is in material compliance with, all export licenses, license exceptions and other consents, notices, waivers, approvals, orders, authorizations, registrations, declarations, classifications and filings with any Governmental Entity required for (i) the export and reexport of products, services, software and technologies and (ii) releases of technologies and software to foreign nationals located in the United States and abroad (“Export Approvals”);

(b) There are no pending or, to the Company’s Knowledge, threatened claims or legal actions against the Company or any

Subsidiary with respect to such Export Approvals or with respect to the export control laws of any Governmental Entity;

(c) To the Company’s Knowledge, there are no actions, conditions or circumstances pertaining to the Company’s or any Subsidiary’s export transactions that would give rise to any future claims or legal actions; and

(d) No Export Approvals for the transfer of export licenses to Parent or the Surviving Corporation are required by the

consummation of the Merger, or such Export Approvals can be obtained in a reasonable timely manner without material cost.

2.20 Foreign Corrupt Practices Act. Neither the Company nor any of its Subsidiaries (including any of their officers, directors, agents, distributors, employees or other Person associated with or acting on their behalf) has, directly or indirectly, taken any action which would cause the Company to be in material violation of the Foreign Corrupt Practices Act of 1977, as amended, or any rules or regulations thereunder or any similar anti-corruption or anti-bribery Legal Requirements applicable to the Company or to the Company’s Knowledge, any of its Subsidiaries in any jurisdiction other than the United States (in each case, as in effect at the time of such action) (collectively, the “FCPA”), and, to the Company’s Knowledge, none of them has used any corporate funds for unlawful contributions, gifts, entertainment or other unlawful expenses relating to political activity, made, offered or authorized any unlawful payment to foreign or domestic government officials or employees, whether directly or indirectly, or made, offered or authorized any unlawful bribe, rebate, payoff, influence payment, kickback or other similar unlawful payment, whether directly or indirectly. The Company has established reasonable internal controls and procedures intended to ensure compliance with the FCPA.

2.21 Information Supplied. None of the information supplied or to be supplied by or on behalf of the Company for inclusion or incorporation by reference in the preliminary and definitive proxy statements to be filed by the Company with the SEC in connection with the Merger (collectively, the “Proxy Statement”) will, on each relevant filing date, on the date of mailing to the Company’s stockholders and at the time of the Stockholders’ Meeting, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they are made, not misleading. The Proxy Statement will comply as to form in all material respects with

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the provisions of the Exchange Act and the rules and regulations promulgated thereunder. If at any time prior to the Effective Time any event relating to the Company or any of its Affiliates, officers or directors should be discovered by the Company which is required to be set forth in a supplement to the Proxy Statement, the Company shall promptly inform Parent. Notwithstanding the foregoing, the Company makes no representation or warranty with respect to any information supplied by Parent or Merger Sub for inclusion or incorporation by reference in the Proxy Statement.

2.22 Fairness Opinion. The Company’s Board of Directors has received opinions from each of SG Cowen & Co., LLC, dated as of June 27, 2005 and Houlihan Lokey Howard & Zukin Financial Advisors, Inc., dated as of June 27, 2005, copies of which has been Made Available to Parent, to the effect that, as of such date and subject to the qualifications contained in such opinion, the Merger Consideration to be received by the holders of the Company Common Stock pursuant to this Agreement is fair from a financial point of view to the holders of Company Common Stock.

2.23 Takeover Statutes and Rights Plans. The Board of Directors of the Company has taken all actions so that the restrictions contained in Section 203 of Delaware Law applicable to a “business combination” (as defined in such Section 203), and any other similar Legal Requirement, will not apply to Parent with respect to the Merger, including the execution, delivery or performance of this Agreement and the consummation of the Merger and the other transactions contemplated hereby. The Company does not have in effect any “poison pill” or similar plan or agreement which would reasonably be expected to have a dilutive or otherwise adverse effect on the capitalization of Parent as a result of consummation of the transactions contemplated hereby.

ARTICLE III

REPRESENTATIONS AND WARRANTIES OF PARENT AND MERGER SUB

Parent and Merger Sub represent and warrant to the Company as follows:

3.1 Organization. Parent is a corporation duly organized, validly existing and in good standing under the laws of the State of

Delaware. Merger Sub is a corporation duly organized, validly existing and in good standing under the laws of Delaware.

3.2 Authority; No Conflict; Necessary Consents.

(a) Authority. Each of Parent and Merger Sub has all requisite corporate power and authority to enter into this Agreement and to consummate the transactions contemplated hereby subject, in the case of the consummation by Merger Sub of the transactions contemplated hereby, to obtaining the approval and adoption of this Agreement by Parent, as the sole stockholder of Merger Sub. The execution and delivery by each of Parent and Merger Sub of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by all necessary corporate action on the part of Parent and Merger Sub and no other action is required on the part of Parent and Merger Sub to authorize the execution and delivery of this Agreement or to consummate the Merger and the other transactions contemplated hereby, subject only to the approval and adoption of this Agreement by Parent, as the sole stockholder of Merger Sub, and the filing of the Certificate of Merger pursuant to Delaware Law. Immediately after the execution of this Agreement, Parent shall have approved and adopted this Agreement as sole stockholder of Merger Sub. This Agreement has been duly executed and delivered by Parent and Merger Sub and, assuming due execution and delivery of this Agreement by the Company, constitutes the valid and binding obligations of Parent, enforceable against each of Parent and Merger Sub in accordance with its terms, subject to applicable bankruptcy, insolvency, reorganization, moratorium or other laws relating to or affecting the rights and remedies of creditors generally and to general principles of equity.

(b) No Conflict. The execution and delivery by Parent and Merger Sub of this Agreement and the consummation of the

transactions contemplated hereby, will not (i) conflict with or violate any provision of

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their respective certificates of incorporation or bylaws, (ii) subject to compliance with the requirements set forth in Section 3.2(c), conflict with or violate any material Legal Requirement applicable to Parent or Merger Sub or by which Parent or Merger Sub or any of their respective properties or assets (whether tangible or intangible) is bound or affected, or (iii) result in any breach of or constitute a default (or an event that with notice or lapse of time or both would become a default) under, or materially impair Parent’s or Merger Sub’s rights or alter the rights or obligations of any third party under, or give to others any rights of termination, amendment, acceleration or cancellation of, any Contract to which Parent or any of its Subsidiaries is a party or result in the creation of a Lien on any of the properties or assets of Parent or Merger Sub; except, in the case of each of the preceding clauses (ii) and (iii) for any conflict, violation, beach, default, impairment, alteration, giving of rights or Lien which would not materially adversely affect the ability of the parties hereto to consummate the Merger within the time frame contemplated by this Agreement.

(c) Necessary Consents. No consent, waiver, approval, order, authorization, registration, declaration or filing with any

Governmental Entity is required to be made or obtained by Parent or Merger Sub in connection with the execution and delivery of this Agreement by Parent and Merger Sub or the consummation of the Merger and the transactions contemplated hereby, except for (i) the Necessary Consents; and (ii) such consents, waivers, approvals, orders, authorizations, registrations, declarations and filings which, if not obtained or made, would not materially adversely affect the ability of Parent and Merger Sub to consummate the Merger within the time frame in which the Merger would otherwise be consummated in the absence of the need for such consent, waiver, approval, order, authorization, registration, declaration or filing.

3.3 Capital Resources. Parent has, and will have available to it upon the consummation of the Merger, sufficient capital

resources to pay the Merger Consideration and to consummate all of the transactions contemplated by this Agreement.

3.4 Information Supplied. None of the information supplied or to be supplied by or on behalf of Parent and Merger Sub for inclusion or incorporation by reference in the Proxy Statement, will contain, on each relevant filing date, on the date of the mailing to the Company’s stockholders and at the time of the Stockholders’ Meeting, any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they are made, not misleading. If at any time prior to the Effective Time, any event relating to Parent, Merger Sub or any of their respective Affiliates, officers or directors should be discovered by Parent which is required to be set forth in a supplement to the Proxy Statement, Parent shall promptly inform the Company. Notwithstanding the foregoing, Parent makes no representation or warranty with respect to any information supplied by or on behalf of the Company which is contained in the Proxy Statement.

3.5 Operations of Merger Sub. Merger Sub was formed solely for the purpose of engaging in the transactions contemplated hereby, has engaged in no other business activities and has conducted and will conduct its operations prior to the Effective Time only as contemplated hereby. Parent is the sole stockholder of Merger Sub.

3.6 Ownership of Shares. As of the date hereof, Parent and its Subsidiaries beneficially own no shares of Company Common Stock, other than by virtue of the Voting Agreements.

ARTICLE IV

CONDUCT BY THE COMPANY PRIOR TO THE EFFECTIVE TIME

4.1 Conduct of Business by the Company.

(a) Ordinary Course. During the period from the date hereof and continuing until the earlier of the termination of this Agreement pursuant to its terms or the Effective Time, the Company and each of its Subsidiaries shall, except as otherwise expressly contemplated by this Agreement or to the extent that Parent

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shall otherwise consent in writing, (i) carry on its business in the usual, regular and ordinary course, in substantially the same manner as heretofore conducted and in compliance with all applicable laws and regulations, (ii) pay its material debts and Taxes when due, pay or perform other material obligations when due, and (iii) use commercially reasonable efforts consistent with past practice to (x) preserve intact its present business organization, (y) keep available the services of its present executive officers and Employees, and (z) preserve its relationships with customers, suppliers, licensors, licensees, and others with which it has business dealings (it being understood that announcement of the Merger may have an adverse impact on the relationship of the Company and its Subsidiaries with such Persons). In addition, the Company shall promptly notify in writing Parent of any material adverse event involving its business or operations.

(b) Required Consent. Without limiting the generality of Section 4.1(a), except as permitted by the terms of this

Agreement, and except as provided in Section 4.1(b) of the Company Disclosure Letter, without the prior written consent of Parent, during the period from the date hereof and continuing until the earlier of the termination of this Agreement pursuant to its terms or the Effective Time, the Company shall not do any of the following, and shall not permit any of its Subsidiaries to do any of the following:

(i) Enter into any new line of business;

(ii) Declare, set aside or pay any dividends on or make any other distributions (whether in cash, stock, equity

securities or property) in respect of any capital stock or split, combine or reclassify any capital stock or issue or authorize the issuance of any other securities in respect of, in lieu of or in substitution for any capital stock, other than any such transaction by a wholly-owned Subsidiary of it that remains a wholly-owned Subsidiary of it after consummation of such transaction, in the ordinary course of business consistent with past practice and except as permitted under Section 4.1(b)(iv);

(iii) Purchase, redeem or otherwise acquire, directly or indirectly, any shares of its capital stock or the capital stock of

its Subsidiaries;

(iv) Issue, deliver, sell, authorize, pledge or otherwise encumber any shares of capital stock, Voting Debt, other voting securities or any securities convertible into shares of capital stock, Voting Debt or other voting securities, or subscriptions, rights (including stock appreciation rights whether settled in cash or shares of Company Common Stock), warrants or options to acquire any shares of capital stock, Voting Debt, other voting securities or any securities convertible into shares of capital stock, Voting Debt or other voting securities, or enter into other agreements or commitments of any character obligating it to issue any such securities or rights, other than: (A) issuances of Company Common Stock upon the exercise of Company Options existing on the date hereof in accordance with their present terms or granted pursuant to clause (C) hereof in accordance with their terms at the time of grant and the requirements of clause (C) hereof; (B) issuance of shares of Company Common Stock to participants in the Company Purchase Plan pursuant to its present terms (or as it may be modified in accordance with Section 5.9(c)); (C) grants of stock options or other stock based awards to employees of the Company or its Subsidiaries (other than executive officers and members of senior management) to acquire, individually, up to 50,000 shares (as adjusted for stock splits and the like and taking into account any Company Options granted since June 24, 2005) of Company Common Stock and, in the aggregate, up to 1,000,000 shares (as adjusted for stock splits and the like and taking into account any Company Options granted since June 24, 2005) of Company Common Stock in any 30-day period, granted under the Company Stock Option Plans, in each case in the ordinary course of business consistent with past practice in connection with ordinary course promotions or to new hires and which options or stock based awards have a vesting schedule no more favorable than ratable monthly installments that vest over not less than four years and do not accelerate, or become subject to acceleration, directly or indirectly, as a result of this Agreement, the approval or consummation of the Merger and/or termination of employment following or in connection with the Merger; (D) issuances of Company Common Stock upon the exercise of Company Warrants existing on the date hereof; and (E) issuances by a wholly-owned Subsidiary of the Company to the Company or its wholly-owned Subsidiaries;

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(v) Cause, permit or propose any amendments to the Company Charter Documents or adopt any amendments to any of the Subsidiary Charter Documents of the Company’s Subsidiaries;

(vi) Acquire or agree to acquire by merging or consolidating with, or by purchasing any equity or voting interest in or

a portion of the assets of, or by any other manner, any business or any Person or division thereof, or otherwise acquire or agree to acquire any assets which are material, individually or in the aggregate, to the business of the Company and its Subsidiaries, taken as a whole;

(vii) Enter into any binding agreement, agreement in principle, letter of intent, memorandum of understanding or

similar agreement with respect to any joint venture, strategic partnership or alliance (in each case, other than reseller and licensing agreements entered into in the ordinary course of business consistent with past practice) that would reasonably be expected to be material to the business of the Company and its Subsidiaries, taken as a whole;

(viii) Sell, lease, license, encumber or otherwise dispose of any properties or assets except the sale, lease, license,

encumbrance or disposition of property or assets which are not material, individually or in the aggregate, to the business of Company and its Subsidiaries, taken as a whole, or the licenses of current Company Products, in each case, in the ordinary course of business consistent with past practice;

(ix) Any material reductions in force, lease terminations, restructuring of contracts or similar actions;

(x) Make any loans, extensions of credit or financing, advances or capital contributions to, or investments in, or grant

extended payment terms to any other Person, other than: (a) loans or investments by the Company or a wholly-owned Subsidiary of the Company to or in the Company or any wholly-owned Subsidiary of the Company, (b) employee loans or advances for travel and entertainment expenses made in the ordinary course of business consistent with past practice, or (c) extensions of credit or financing to, or extended payment terms for, customers made in the ordinary course of business consistent with past practice;

(xi) Except as required by concurrent changes in GAAP or the SEC as concurred in by its independent auditors, make

any change in its methods or principles of accounting or revalue any of its assets;

(xii) Make or change any material election in respect of Taxes, adopt or change any accounting method in respect of Taxes, enter into any agreement or settle any claim or assessment in respect of Taxes or consent to any extension or waiver of the limitation period applicable to any claim or assessment in respect of Taxes;

(xiii) Except in the ordinary course of business consistent with past practice, enter into any licensing, distribution,

supply, procurement, manufacturing, marketing, OEM, VAR, system integrator, system outsourcer or other similar contracts, agreements, or obligations which either (a) may not be canceled without penalty by the Company or its Subsidiaries upon notice of 30 days or less and which provide for express payments by or to the Company or its Subsidiaries in an amount in excess of $1,000,000 in any one year or (b) which involve any exclusive terms of any kind which are binding on the Company or any of its Subsidiaries;

(xiv) Cancel or terminate or allow to lapse without reasonable substitute policy therefor, or amend in any material

respect or enter into, any material insurance policy, other than the renewal of existing insurance policies on substantially the same terms as in effect on the date hereof;

(xv) Commence or settle any lawsuit, threat of any lawsuit or proceeding or other investigation by or against the

Company or any Subsidiary or relating to any of their businesses, properties or assets, other than settlements with prejudice entered into in the ordinary course of business consistent with past practice and requiring of the Company and its Subsidiaries only the payment of monetary damages not exceeding $250,000 net of any insurance payments received by the Company;

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(xvi) Except as required by Legal Requirements, Company Employee Plans or Employee Agreements currently binding on the Company or its Subsidiaries, (1) increase in any manner the amount of compensation or fringe benefits of, pay or grant any bonus, change of control, severance or termination pay to any Employee or director of the Company or any Subsidiary of the Company other than annual increases in pay in connection with annual performance reviews to current non-officer Employees granted in the ordinary course of business consistent with past practice, (2) adopt or amend any Employee Agreement, Company Employee Plan or International Employee Plan or make any contribution, other than regularly scheduled contributions, to any Employee Agreement, Company Employee Plan or International Employee Plan, (3) waive any stock repurchase rights, accelerate, amend or change the period of exercisability of Company Options or Company Warrants, reprice any Company Options or Company Warrants or authorize cash payments in exchange for any Company Options or Company Warrants, or (4) enter into, modify or amend any Employee Agreement (other than offer letters and letter agreements entered into in the ordinary course of business consistent with past practice with employees who are terminable “at will”) or any indemnification agreement with any Employee or enter into any collective bargaining agreement;

(xvii) Enter into any Contract containing, or otherwise subject the Surviving Corporation or Parent to, any terms

providing for non-competition, exclusivity, “most favored nations”, unpaid future deliverables, service requirements outside the ordinary course of business or future royalty payments (other than current royalty product offerings as set forth on the Company’s current price list), or other material restrictions on the Company or the Surviving Corporation or Parent, or any of their respective businesses, following the Closing;

(xviii) Provide any material refund, credit, rebate or other allowance to any end user, customer, reseller or distributor,

in each case, other than in the ordinary course of business consistent with past practice;

(xix) Hire any non-officer employees other than in the ordinary course of business consistent with past practice or hire, elect or appoint any officers or directors;

(xx) Incur any indebtedness for borrowed money or guarantee any indebtedness of another Person, issue or sell any

debt securities or options, warrants, calls or other rights to acquire any debt securities of the Company or any of its Subsidiaries, guarantee any debt securities of another Person, enter into any “keep well” or other agreement to maintain any financial statement condition of any other Person (other than any wholly-owned Subsidiary) or enter into any arrangement having the economic effect of any of the foregoing, other than (i) any guarantee by the Company of the obligations of its wholly-owned Subsidiary in the ordinary course of business consistent with past practice or (ii) in connection with the financing of trade payables in the ordinary course of business consistent with past practice;

(xxi) Enter into any agreement to purchase or sell any interest in real property, grant any security interest in any real

property, enter into any lease, sublease, license or other occupancy agreement with respect to any real property or alter, amend, modify or terminate any of the terms of any lease, in each case that is material to the business of the Company and its Subsidiaries, taken as a whole;

(xxii) Enter into, modify or amend in a manner adverse in any material respect to the Company or any of its

Subsidiaries, or terminate any Company Material Contract, or waive, release or assign any material rights or claims thereunder, in each case, in a manner adverse in any material respect to the Company and its Subsidiaries, taken as a whole, other than any entry into, modification, amendment or termination of any such Company Material Contract in the ordinary course of business consistent with past practice;

(xxiii) Make any material purchase of fixed assets or other long-term assets other than in the ordinary course of

business consistent with past practice;

(xxiv) Enter into, modify or amend any Service Engagement Order in a manner that restricts the rights of the Company or any of its Subsidiaries to use, transfer, license or enforce any of its

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Intellectual Property Rights in or to any of the Company’s or its Subsidiaries’ core software products or grants any third Person any exclusive or ownership rights in or to any of the Company’s or its Subsidiaries’ core software products; or

(xxv) Take, commit, or agree (in writing or otherwise) or announce the intention to take, any of the actions described

in Sections 4.1(b)(i) through 4.1(b)(xxiv) hereof, or any other action that would reasonably be expected to prevent the Company from performing, or cause the Company not to perform, its obligations hereunder or otherwise prevent or materially delay the consummation of the transactions contemplated hereby.

4.2 Procedures for Requesting Parent Consent. Notwithstanding Section 8.2, if the Company desires to take any action which

would be prohibited pursuant to Section 4.1(b) hereof without the written consent of Parent, prior to taking such action the Company may request such written consent by sending an e-mail or facsimile to the individuals identified on Schedule 4.2 hereof, and may not take such action until such consent in writing has been received from one of such individuals. Parent shall use commercially reasonable efforts to respond to all such requests as promptly as practicable.

ARTICLE V

ADDITIONAL AGREEMENTS

5.1 Proxy Statement. As promptly as reasonably practicable after the execution of this Agreement, the Company, in consultation with Parent (who shall provide comments, if any, to the Company’s Proxy Statement no later than three Business Days of Parent’s receipt thereof), will prepare and file with the SEC preliminary proxy materials that will constitute the Proxy Statement. The Proxy Statement shall include the notice to stockholders required by Section 262(d)(1) of Delaware Law that appraisal rights will be available. As promptly as reasonably practicable after any comments are received from the SEC thereon (or upon notice from the SEC that no such comments will be made), the Company shall, in consultation with Parent, prepare and file any required amendments to, and the definitive, Proxy Statement with the SEC. The Company will notify Parent promptly upon the receipt of any comments from the SEC or its staff in connection with the filing of, or amendments or supplements to, the Proxy Statement. Whenever any event occurs which is required to be set forth in an amendment or supplement to the Proxy Statement, the Company will promptly inform Parent of such occurrence and will, in consultation with Parent, file with the SEC or its staff, and/or mail to stockholders of the Company, such amendment or supplement. The Company shall provide Parent (and its counsel) with a reasonable opportunity to review and comment on the preliminary Proxy Statement and any amendment or supplement thereto prior to filing such with the SEC (and Parent shall provide comments, if any, no later than three Business Days of Parent’s receipt thereof), and will provide Parent with a copy of all such filings made with the SEC. The Company will cause the Proxy Statement to be mailed to its stockholders at the earliest practicable time after the definitive Proxy Statement is filed with the SEC.

5.2 Meeting of Company Stockholders; Board Recommendation.

(a) Meeting of Company Stockholders. The Company will take all action necessary in accordance with Delaware Law and its certificate of incorporation and bylaws to call, hold and convene a meeting of its stockholders, promptly following the mailing of the Proxy Statement to such stockholders, to consider adoption and approval of this Agreement and approval of the Merger (the “Stockholders’ Meeting”) to be held as promptly as reasonably practicable, and in any event (to the extent permissible under applicable law) within 45 days after the mailing of the Proxy Statement to the Company’s stockholders. Subject to Section 5.3(d), the Company will use commercially reasonable efforts to solicit from its stockholders proxies in favor of the adoption and approval of this Agreement and the approval of the Merger and will take all other action necessary or advisable to secure the vote or consent of its stockholders required by the rules of the Nasdaq Stock Market or Delaware Law or any other applicable Legal Requirements to obtain such approvals. Notwithstanding anything to the contrary contained in this Agreement, the Company may

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adjourn or postpone the Stockholders’ Meeting to the extent necessary to ensure that any necessary supplement or amendment to the Proxy Statement is provided to its stockholders in advance of a vote on the Merger and this Agreement or, if as of the time for which the Stockholders’ Meeting is scheduled (as set forth in the Proxy Statement), there are insufficient shares of Company Common Stock represented (either in person or by proxy) to constitute a quorum necessary to conduct the business of such Stockholders’ Meeting or the Board of Directors of the Company reasonably requires additional time to satisfy its fiduciary duties in compliance with Section 5.3. The Company shall ensure that any Stockholders’ Meeting is called, noticed, convened, held and conducted, and that all proxies solicited by it in connection with the Stockholders’ Meeting are solicited in compliance with Delaware Law, its certificate of incorporation and bylaws, the rules of the Nasdaq Stock Market and all other applicable Legal Requirements.

(b) Board Recommendation. Except to the extent expressly permitted by Section 5.3(d): (i) the Board of Directors of the

Company shall recommend that its stockholders vote in favor of adoption and approval of this Agreement and approval of the Merger at the Stockholders’ Meeting, (ii) the Proxy Statement shall include a statement to the effect that the Board of Directors of the Company has recommended that the Company’s stockholders vote in favor of adoption and approval of this Agreement and approval of the Merger at the Stockholders’ Meeting, and (iii) neither the Board of Directors of the Company nor any committee thereof shall withdraw, amend or modify, or propose or resolve to withdraw, amend or modify in a manner adverse to Parent, the recommendation of its Board of Directors that the Company’s stockholders vote in favor of adoption and approval of this Agreement and approval of the Merger.

5.3 Acquisition Proposals.

(a) No Solicitation. The Company agrees that none of the Company, any of its Subsidiaries or any of the Company’s or

any of its Subsidiaries’ officers and directors shall, and that it shall use all reasonable efforts to cause the Company’s and its Subsidiaries’ other employees, agents and representatives (including any investment banker, attorney or accountant retained by the Company or any of its Subsidiaries) not to (and shall not authorize or permit any of them to), directly or indirectly: (i) solicit, initiate, encourage, knowingly induce any inquiry with respect to, or the making, submission or announcement of, any Acquisition Proposal, (ii) participate or engage in any discussions or negotiations regarding, or furnish to any Person any nonpublic information with respect to, or take any other action that is intended to facilitate or encourage any inquiries concerning or the making of any proposal that constitutes or would reasonably be expected to lead to, any Acquisition Proposal, (iii) approve, endorse, recommend or make or authorize any public statement, recommendation or solicitation in support of any Acquisition Proposal (except to the extent specifically permitted pursuant to Section 5.3(d)), or (iv) execute or enter into, or publicly propose to execute or enter into, any letter of intent or similar document or any contract, agreement or commitment contemplating or otherwise relating to any Acquisition Proposal or transaction contemplated thereby. The Company and its Subsidiaries will immediately cease and cause to be terminated any and all existing activities, discussions or negotiations (including, without limitation, any such activities, discussions or negotiations conducted by affiliates, directors, officers, employees, agents and representatives (including any investment banker, financial advisor, attorney, accountant or other representative) of the Company or any of its Subsidiaries) with any third parties conducted heretofore with respect to consideration of any Acquisition Proposal.

(b) Notification of Unsolicited Acquisition Proposals. No later than 48 hours after receipt of any Acquisition Proposal or

any request for nonpublic information or inquiry that would reasonably be expected to lead to an Acquisition Proposal or from any Person seeking to have discussions or negotiations with the Company relating to a possible Acquisition Proposal, the Company shall provide Parent with notice of the material terms and conditions of such Acquisition Proposal, request or inquiry; the identity of the Person or group making any such Acquisition Proposal, request or inquiry and a copy of all written materials provided by or on behalf of such Person or group in connection with such Acquisition Proposal, request or inquiry. The Company shall provide Parent with 48 hours prior notice (or such lesser prior notice as is provided to the members of its Board of Directors) of any meeting of its Board of Directors at which its Board of Directors could reasonably be expected to consider any Acquisition Proposal or any such inquiry or to

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consider providing nonpublic information to any Person. The Company shall notify Parent, in writing, of any decision of its Board of Directors as to whether to consider such Acquisition Proposal, request or inquiry or to enter into discussions or negotiations concerning any Acquisition Proposal or to provide nonpublic information or data to any person, which notice shall be given no later than 24 hours after such determination was reached. The Company agrees that it shall promptly provide Parent with oral and written notice setting forth all such information as is reasonably necessary to keep Parent currently informed in all material respects of the status and details (including material amendments or proposed material amendments) of any such Acquisition Proposal, request or inquiry (including any negotiations contemplated by Section 5.3(c)) and shall promptly provide Parent a copy of all written materials that are subsequently provided to, by or on behalf of such Person or group in connection with such Acquisition Proposal that either contain material information about the Company or such Person or discuss the material terms and conditions of any Acquisition Proposal, request or inquiry; provided, however, that, in the case of such an Acquisition Proposal in which the consideration payable to the Company’s Stockholders consists primarily of shares of common stock of the Person making such Acquisition Proposal, confidential information related to such Person’s business that is contained in such written materials that is unrelated to such Acquisition Proposal may be redacted.

(c) Superior Offers. Notwithstanding anything to the contrary contained in Section 5.3(a), in the event that the Company

receives prior to the adoption of this Agreement by the Stockholders of the Company in accordance with applicable law an unsolicited, bona fide written Acquisition Proposal from a third party that did not result from a breach of this Section 5.3 (including, without limitation, the notification requirements of Section 5.3(b)) and that the Company’s Board of Directors has in good faith concluded (following consultation with its outside legal counsel and its financial advisor), is, or is reasonably likely to result in, a Superior Offer, the Company may then (1) furnish nonpublic information to the third party making such Acquisition Proposal and (2) engage in negotiations with the third party with respect to such Acquisition Proposal; provided, however, that prior to furnishing any nonpublic information or entering into any negotiations or discussions with such third party, (1) the Company receives from such third party an executed confidentiality agreement containing customary limitations on the use and disclosure of all nonpublic written and oral information furnished to such third party on the Company’s behalf that is no less restrictive to such third party than the Confidentiality Agreement is with respect to Parent and (2) contemporaneously with furnishing any such nonpublic information to such third party, the Company furnishes such nonpublic information to Parent (to the extent such nonpublic information has not been previously so furnished).

(d) Change of Recommendation. Notwithstanding anything to the contrary contained in Section 5.3(a), in response to the

receipt of a Superior Offer, (x) the Board of Directors of the Company may withhold, withdraw, amend or modify its recommendation in favor of the Merger, and, in the case of a Superior Offer that is a tender or exchange offer made directly to the stockholders of the Company, may recommend that the stockholders of the Company accept the tender or exchange offer (any of the foregoing actions, whether by the Board of Directors of the Company or a committee thereof, a “Change of Recommendation”), (y) the Board of Directors of the Company, the Company or its Subsidiaries (including each of their respective directors, officers, employees, agents or other representatives) may approve, endorse, recommend any Superior Offer or recommend a Superior Offer, or (z) the Company or any of its Subsidiaries may execute or enter into, or propose to execute or enter into, any letter of intent of similar document or any contract, agreement or commitment (which may be conditioned on the termination of this Agreement) contemplating or otherwise relating to any Superior Offer or transaction contemplated thereby, if all of the following conditions in clauses (i) through (vi) are met:

(i) the Board of Directors of the Company determines in good faith after consultation with the Company’s financial

advisors and outside legal counsel, that a Superior Offer has been made and not withdrawn;

(ii) The stockholders of the Company have not approved this agreement in accordance with applicable law;

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(iii) The Company shall have delivered to Parent written notice (a “Change of Recommendation Notice”) at least five calendar days prior to publicly effecting such Change of Recommendation which shall state expressly (A) that the Company has received a Superior Offer, (B) the final terms and conditions of the Superior Offer and the identity of the Person or group making the Superior Offer, and (C) that the Company intends to effect a Change of Recommendation;

(iv) After delivering the Change of Recommendation Notice, the Company shall provide Parent with a reasonable

opportunity to make such adjustments in the terms and conditions of this Agreement during such five calendar day period, and negotiate in good faith with respect thereto during such five calendar day period, as would enable the Company to proceed with its recommendation to stockholders in favor of approval and adoption of this Agreement and approval of the Merger without making a Change of Recommendation;

(v) the Board of Directors of the Company shall have determined (A) after consultation with its financial advisor, that

the terms of the Superior Offer is more favorable to the stockholders of the Company than the Merger (as it may be adjusted pursuant to paragraph (iv) above) and (B) after consultation with outside legal counsel, the failure to effect a Change of Recommendation would reasonably be expected to result in a breach of the Board of Directors’ fiduciary duties to the stockholders of the Company under applicable law; and

(vi) The Company shall not have breached any of the provisions set forth in Section 5.2 or this Section 5.3.

(e) Compliance with Disclosure Obligations. Nothing contained in this Agreement shall prohibit the Company or its Board

of Directors from complying with Rules 14-a-9, 14d-9 and 14e-2(a) promulgated under the Exchange Act. Without limiting the foregoing, the Company shall not effect a Change of Recommendation unless specifically permitted pursuant to the terms of Section 5.3(d).

(f) State Takeover Statute. The Board of Directors of the Company shall not, in connection with any Change of

Recommendation, take any action to change the approval of the Board of Directors of the Company for purposes of causing any state takeover statute or other state law to be applicable to the transactions contemplated hereby. For the avoidance of doubt, this Section 5.3(f) shall not prohibit the Company from effecting a Change of Recommendation under the circumstances and subject to the conditions set forth in this Section 5.3.

(g) Certain Definitions. For purposes of this Agreement, the following terms shall have the following meanings:

(i) “Acquisition Proposal,” with respect to the Company, shall mean any offer or proposal, relating to any

transaction or series of related transactions involving: (a) any purchase from such party or acquisition by any Person or “group” (as defined under Section 13(d) of the Exchange Act and the rules and regulations thereunder) of more than a 20% interest in the total outstanding voting securities of the Company or any of its Subsidiaries or any tender offer or exchange offer that if consummated would result in any Person or group beneficially owning 20% or more of the total outstanding voting securities of the Company or any of its Subsidiaries, (b) any merger, consolidation, business combination or similar transaction involving the Company or any of its Subsidiaries, (c) any sale, lease (other than in the ordinary course of business consistent with past practice), exchange, transfer, license (other than in the ordinary course of business consistent with past practice), acquisition or disposition of more than 20% of the assets of the Company (including its Subsidiaries taken as a whole), or (d) any liquidation or dissolution of the Company (provided, however, that the transactions between Parent and the Company contemplated by this Agreement shall not be deemed an Acquisition Proposal); and

(ii) “Superior Offer,” with respect to the Company, shall mean an unsolicited, bona fide written offer made by a

third party to acquire, directly or indirectly, pursuant to a tender offer, exchange offer, merger, consolidation or other business combination, all or substantially all of the assets of the Company or all of the outstanding voting securities of the Company as a result of which the stockholders of the Company immediately preceding such transaction would hold less than 50% of the

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equity interests in the surviving or resulting entity of such transaction and any direct or indirect parent or subsidiary thereof, on terms that the Board of Directors of the Company has in good faith concluded (following consultation with its outside legal counsel and its financial adviser), taking into account, among other things, all legal, financial, regulatory and other aspects of the offer and the Person making the offer, to be more favorable, from a financial point of view, to the Company’s stockholders (in their capacities as stockholders) than the terms of the Merger and is reasonably capable of being consummated.

(h) Specific Performance. The parties hereto agree that irreparable damage would occur in the event that the provisions of

this Section 5.3 were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed by the parties hereto that Parent shall be entitled to an immediate injunction or injunctions, without the necessity of proving the inadequacy of money damages as a remedy and without the necessity of posting any bond or other security, to prevent breaches of the provisions of this Section 5.3 and to enforce specifically the terms and provisions hereof in any court of the United States or any state having jurisdiction, this being in addition to any other remedy to which Parent may be entitled at law or in equity.

5.4 Confidentiality; Access to Information; No Modification of Representations, Warranties or Covenants.

(a) Confidentiality. The parties acknowledge that the Company and Parent have previously executed a Confidentiality

Agreement dated February 24, 2005 (the “Confidentiality Agreement”), which Confidentiality Agreement will continue in full force and effect in accordance with its terms and each of Parent and the Company will hold, and will cause its respective directors, officers, Employees, agents and advisors (including attorneys, accountants, consultants, bankers and financial advisors) to hold, any “Evaluation Material” (as defined in the Confidentiality Agreement) confidential in accordance with the terms of the Confidentiality Agreement.

(b) Access to Information. Subject to applicable law, the Company shall afford Parent and its accountants, counsel and

other representatives, reasonable access (during regular business hours upon reasonable notice) during the period from the date hereof and prior to the Effective Time to: (i) all of the properties, books, contracts, commitments and records of the Company and its Subsidiaries, including all Company Intellectual Property (including access to source code, but not to detailed information concerning design processes, design specifications, product roadmaps or similar highly sensitive Company Intellectual Property; provided, however, that (1) access to source code shall only occur on the premises of the Company in Monrovia, California on Company computers designated by the Company for such purposes and, at the Company’s election, under the supervision of a representative or representatives of the Company; (2) Parent shall provide at least forty-eight hours written notice of its request for such access, including in such notice whether Parent desires to have Company engineering personnel available, as provided in subpart 4; (3) Parent and its representatives shall be permitted to take notes during such access provided that (A) on each day such notes are taken, Company shall be provided with such notes in order to make and retain copies thereof and (B) such notes and the contents of such notes may not be disclosed by Parent or its representatives other than to Parent personnel and representatives who have a need to know the contents of such notes for purposes of preparing to integrate the Company Products with Parent offerings as of the Effective Time; and (4) such access shall be permitted for up to fifteen days (which need not be consecutive) selected by Parent in accordance with the requirements hereof (provided, however, that for up to five of the fifteen days selected by Parent, Company engineering personnel with knowledge of those product components and/or topics designated by Parent in its notice shall be required to be on hand to answer questions, unless Company notifies Parent prior to such day that such engineering personnel are unavailable, in which case the parties shall work in good faith to schedule another day that is mutually agreeable)), and all capitalization and equity compensation information that is necessary for Parent to promptly comply with the requirements of Statement of Financial Accounting Standards 123 (revised 2004) “Share-Based Payments” promulgated by the Financial Accounting Standards Board, (ii) all other information concerning the business, properties and personnel (subject to restrictions imposed by applicable

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law) of the Company and its Subsidiaries as Parent may reasonably request, and (iii) all Employees of the Company and its Subsidiaries as reasonably requested by Parent. The Company agrees to promptly provide to Parent and its accountants, counsel and other representatives copies of such internal financial statements (including Tax Returns and supporting documentation) as may be reasonably requested.

(c) No Modification of Representations and Warranties or Covenants. No information or knowledge obtained in any

investigation or notification pursuant to this Section 5.4, Section 5.6 or Section 5.7 or otherwise shall affect or be deemed to modify any representation or warranty contained herein, the covenants or agreements of the parties hereto or the conditions to the obligations of the parties hereto under this Agreement.

5.5 Public Disclosure. Without limiting any other provision of this Agreement, Parent and the Company will consult with each

other before issuing, and provide each other the opportunity to review, comment upon and concur with, and use all reasonable efforts to agree on any press release or public statement with respect to this Agreement and the transactions contemplated hereby, including the Merger, and any Acquisition Proposal and will not issue any such press release or make any such public statement prior to such consultation and (to the extent practicable) agreement, except as may be required by law or any listing agreement with the Nasdaq Stock Market, or any other applicable national or regional securities exchange or market. The parties have agreed to the text of the joint press release announcing the signing of this Agreement.

5.6 Regulatory Filings; Reasonable Efforts.

(a) Regulatory Filings. Each of Parent, Merger Sub and the Company shall coordinate and cooperate with one another and shall each use all reasonable efforts to comply with, and shall each refrain from taking any action that would impede compliance with, all Legal Requirements, and as promptly as practicable after the date hereof, each of Parent, Merger Sub and the Company shall make all filings, notices, petitions, statements, registrations, submissions of information, application or submission of other documents required by any Governmental Entity in connection with the Merger and the transactions contemplated hereby, including, without limitation: (i) Notification and Report Forms with the FTC and the DOJ as required by the HSR Act, (ii) filings under any other comparable pre-merger notification forms reasonably determined by Parent and the Company to be required by the merger notification or control laws of any applicable jurisdiction, as agreed by the parties hereto, and (iii) any filings required under the Securities Act, the Exchange Act, any applicable state or securities or “blue sky” laws and the securities laws of any foreign country, or any other Legal Requirement relating to the Merger. Each of Parent and the Company will cause all documents that it is responsible for filing with any Governmental Entity under this Section 5.6(a) to comply in all material respects with all applicable Legal Requirements. Parent, Merger Sub and the Company each shall promptly supply the other with any information that may be required in order to effectuate any filings or application pursuant to this Section 5.6(a).

(b) Notification. Each of Parent, Merger Sub and the Company will notify the other promptly upon the receipt of: (i) any

comments from any officials of any Governmental Entity in connection with any filings made pursuant hereto and (ii) any request by any officials of any Governmental Entity for amendments or supplements to any filings made pursuant to, or information provided to comply in all material respects with, any Legal Requirements. Whenever any event occurs that is required to be set forth in an amendment or supplement to any filing made pursuant to Section 5.6(a), Parent, Merger Sub or the Company, as the case may be, will promptly inform the other of such occurrence and cooperate in filing with the applicable Governmental Entity such amendment or supplement.

(c) Reasonable Efforts. Subject to the express provisions of Section 5.2 and Section 5.3 hereof and upon the terms and

subject to the conditions set forth herein, each of the parties agrees to use commercially reasonable efforts to take, or cause to be taken, all actions, and to do, or cause to be done, and to assist and cooperate with the other parties in doing, all things necessary, proper or advisable to consummate and make effective, in the most expeditious manner practicable, the Merger and the other transactions contemplated by this Agreement, including using commercially reasonable efforts to accomplish the following: (i) the taking

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of all reasonable acts necessary to cause the conditions precedent set forth in Article VI to be satisfied, (ii) the obtaining of all necessary actions or nonactions, waivers, consents, approvals, orders and authorizations from Governmental Entities and the making of all necessary registrations, declarations, submissions and filings (including registrations, declarations, and filings with Governmental Entities, if any) and the taking of all reasonable steps as may be necessary to avoid any suit, claim, action, investigation or proceeding by any Governmental Entity, (iii) the obtaining of all necessary consents, approvals or waivers from third parties, (iv) the defending of any suits, claims, actions, investigations or proceedings, whether judicial or administrative, challenging this Agreement or the consummation of the transactions contemplated hereby and (v) the execution or delivery of any additional instruments necessary to consummate the transactions contemplated by, and to fully carry out the purposes of, this Agreement. In connection with and without limiting the foregoing, the Company and its Board of Directors shall, if any takeover statute or similar Legal Requirement is or becomes applicable to the Merger, this Agreement or any of the transactions contemplated by this Agreement, use all reasonable efforts to ensure that the Merger and the other transactions contemplated by this Agreement may be consummated as promptly as practicable on the terms contemplated by this Agreement and otherwise to minimize the effect of such Legal Requirement on the Merger, this Agreement and the transactions contemplated hereby.

(d) Limitation on Divestiture. Notwithstanding anything in this Agreement to the contrary, nothing contained in this

Agreement shall be deemed to require Parent or any Subsidiary or affiliate thereof to agree to any Action of Divestiture other than any Action of Divestiture that would have an immaterial consequence on Parent or the Company. The Company shall not, without the prior written consent of Parent, take or agree to take any Action of Divestiture. For purposes of this Agreement, an “Action of Divestiture” shall mean (i) any license, sale or other disposition or holding separate (through establishment of a trust or otherwise) of any shares of capital stock or of any business, assets or properties of Parent, its subsidiaries or affiliates, or of the Company or its Subsidiaries, (ii) the imposition of any limitation on the ability of Parent, its subsidiaries or affiliates, or the Company or its Subsidiaries to conduct their respective businesses or own any capital stock or assets or to acquire, hold or exercise full rights of ownership of their respective businesses and, in the case of Parent, the businesses of the Company and its Subsidiaries, or (iii) the imposition of any impediment on Parent, its subsidiaries or affiliates, or the Company or its Subsidiaries under any statute, rule, regulation, executive order, decree, order or other legal restraint governing competition, monopolies or restrictive trade practices.

5.7 Notification of Certain Matters.

(a) By the Company. The Company shall give prompt notice to Parent and Merger Sub of any representation or warranty

made by it contained in this Agreement becoming untrue or inaccurate, or any failure of the Company to comply with or satisfy in any material respect any covenant, condition or agreement to be complied with or satisfied by it under this Agreement, in each case such that the condition set forth in Sections 6.2(a) or 6.2(b) would not be satisfied.

(b) By Parent. Parent and Merger Sub shall give prompt notice to the Company of any representation or warranty made by

it contained in this Agreement becoming untrue or inaccurate, or any failure of Parent to comply with or satisfy in any material respect any covenant, condition or agreement to be complied with or satisfied by it under this Agreement in each case such that the conditions set forth in Sections 6.3(a) or 6.3(b) would not be satisfied.

5.8 Third-Party Consents. As soon as practicable following the date hereof, the Company will use commercially reasonable

efforts to seek such material consents, waivers and approvals under any of its or its Subsidiaries’ respective Contracts required to be obtained in connection with the consummation of the transactions contemplated hereby as may be reasonably requested by Parent after consultation with the Company, including all consents, waivers and approvals set forth in Section 2.3(b) of the Company Disclosure Letter. For the avoidance of doubt, the Company’s failure to obtain any consent set forth in Section 2.3(b) of the Company Disclosure Letter or which is otherwise reasonably requested to be obtained by Parent pursuant to this Section 5.8, in each case, provided that the Company has used all reasonable efforts to seek such consent, shall not give

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rise to a failure to satisfy the condition to closing set forth in Section 6.2(b). If the consent required under the Company’s Loan and Security Agreement with Comerica Bank-California, dated as of December 4, 2000, as amended, and its related documents is not received prior to Closing, then, if requested by Parent, the Company will repay all amounts outstanding under and terminate such loan and security agreement and the related documents effective as of the Closing Date. In connection with seeking such consents, waivers and approvals, the Company shall keep Parent informed of all material developments and, shall at Parent’s request, include Parent in any discussions or communications with any parties whose consent, waiver or approval is sought hereunder. Such consents, waivers and approvals shall be in a form reasonably acceptable to Parent. In the event the Merger does not close for any reason, Parent shall not have any liability to the Company, its stockholders or any other Person for any costs, claims, liabilities or damages resulting from the Company seeking to obtain such consents, waivers and approvals, except if Parent has breached this Agreement such that the Company would have the right to terminate this Agreement pursuant to Section 7.1(f).

5.9 Equity Awards and Employee Matters.

(a) Assumption of Employee Stock Options. At the Effective Time, each then outstanding Company Option other than Cashed-Out Options, whether or not exercisable at the Effective Time and regardless of the respective exercise prices thereof, will be assumed by Parent. Each Company Option other than Cashed-Out Options so assumed by Parent under this Agreement will continue to have, and be subject to, the same terms and conditions set forth in the applicable Company Option documents (including any applicable stock option agreement or other document evidencing such Company Option) immediately prior to the Effective Time (including any repurchase rights or vesting provisions), except that (i) each such Company Option will be exercisable (or will become exercisable in accordance with its terms) for that number of whole shares of Parent Common Stock equal to the product of the number of shares of Company Common Stock that were issuable upon exercise of such Company Option immediately prior to the Effective Time multiplied by the ratio of the value of the per share Merger Consideration to the average of the closing prices for a share of Parent Common Stock on the ten trading days ended one trading day prior to the Closing Date (such ratio, the “Option Ratio”), rounded down to the nearest whole number of shares of Parent Common Stock and (ii) the per share exercise price for the shares of Parent Common Stock issuable upon exercise of such assumed Company Option will be equal to the quotient determined by dividing the exercise price per share of Company Common Stock at which such Company Option was exercisable immediately prior to the Effective Time by the Option Ratio, rounded up to the nearest whole cent. Each assumed Company Option shall be vested immediately following the Effective Time as to the same percentage of the total number of shares subject thereto as to which it was vested immediately prior to the Effective Time, except to the extent such Company Option by its terms (including by the terms of any applicable Employee Agreement) as of the Effective Time provides for acceleration of vesting upon the Effective Time. As soon as reasonably practicable, Parent will use all reasonable efforts to issue to each Person who holds an assumed Company Option a document evidencing the foregoing assumption of such Company Option by Parent and, as a condition to such assumption, each former holder of a Company Option so assumed by Parent shall acknowledge the receipt of the same in exchange for such holder’s Company Option.

(b) Incentive Stock Options. The conversion of Company Options provided for in Section 5.9(a), with respect to any

options which are intended to be “incentive stock options” (as defined in Section 422 of the Code) shall be effected in a manner consistent with Section 424(a) of the Code.

(c) Termination of Company Employee Stock Purchase Plan. Prior to the Effective Time, the Company Purchase Plan

shall be terminated. The rights of participants in the Company Purchase Plan with respect to any offering period then underway under the Company Purchase Plan shall be determined by treating the Closing Date as the deemed exercise date in accordance with the terms of the Company Purchase Plan and by making such other pro-rata adjustments as may be necessary to reflect the shortened offering period but otherwise treating such shortened offering period as a fully effective and completed offering period for all purposes under the Company Purchase Plan. Prior to the Effective Time, the Company shall take all actions (including timely distributing notices to participants required by the terms of the Company Purchase Plan and, if appropriate, amending the terms of the Company Purchase Plan) that are

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necessary to give effect to the transactions contemplated by this Section 5.9(c). The form and substance of any materials to be distributed to participants in connection with the termination of the Company Purchase Plan shall be subject to reasonable and timely approval by Parent.

(d) Termination of 401(k) Plans. Effective as of no later than the day immediately preceding the Closing Date, each of the

Company, its Subsidiaries and any ERISA Affiliate shall terminate any and all Company Employee Plans intended to include a Code Section 401(k) arrangement (each a “401(k) Plan”) unless Parent provides written notice to the Company that any such 401(k) plan shall not be terminated. Unless Parent provides such written notice to the Company, no later than five Business Days prior to the Closing Date, the Company shall provide Parent with evidence that such Company Employee Plan(s) have been terminated (effective as of no later than the day immediately preceding the Closing Date) pursuant to resolutions of the Board of Directors of the Company, its Subsidiaries or such ERISA Affiliate, as the case may be. The form and substance of such resolutions shall be provided by Parent subject to the reasonable and timely approval of the Company. The Company also shall take such other actions in furtherance of terminating such Company Employee Plan(s) as Parent may reasonably require.

(e) Specified Employees. Each of Parent, Merger Sub and the Company covenants and agrees that, as of the Effective

Time, with respect to each of the individuals listed on Schedule 5.9(e) (together, the “Specified Employees”), the consummation of the transactions contemplated by this Agreement shall constitute “good reason” (as that term is defined in Section 1.21 of each of the Specified Employee’s currently effective Change of Control Employment Agreement listed on Section 2.16(b)(i) of the Company Disclosure Letter), and each such Specified Employee shall be entitled, should he so desire, to terminate his respective employment with the Company for “good reason” at any time after the Effective Time. If any Specified Employee shall terminate his employment with the Company pursuant to this Section 5.9(e), Parent shall, or shall cause the Surviving Corporation to, provide to such Specified Employee, at such times and in such amounts as provided in such Specified Employee’s Change of Control Employment Agreement, all compensation and benefits to which such Specified Employee is entitled upon a termination of employment for “good reason” under his respective Change of Control Employment Agreement as it may be amended from time to time as mutually agreed by the parties thereto; provided, however, that such Specified Employee provides Parent with a release and waiver of claims and agreement to the foregoing in the form agreed to by Parent and the Company; provided, further, that nothing in this Section 5.9(e) is intended to confer any duplication of benefits on any Specified Employee.

5.10 Form S-8. Parent agrees to file a registration statement on Form S-8 for the shares of Parent Common Stock issuable with

respect to assumed Company Options within 60 days after the Effective Time or as soon as reasonably practicable after the expiration of such 60-day period that registration of shares on Form S-8 first becomes available to Parent. Parent shall also use all reasonable efforts to take any action required to be taken by it under any applicable securities laws in connection with the conversion of Company Options (other than Cashed-Out Options) into options to acquire shares of common stock, par value $0.00067 per share, of Parent (“Parent Common Stock”), and the Company shall furnish any information concerning the Company and the holders of Company Common Stock and Company Options as may be reasonably requested in connection with any such action.

5.11 Indemnification.

(a) Indemnity. From and after the Effective Time, Parent will cause the Surviving Corporation to fulfill and honor in all respects all obligations of the Company to any individual who at or prior to the Effective Time was a director or officer of the Company pursuant to the indemnification provisions of the certificate of incorporation and bylaws of the Company and any indemnification agreements with such persons in effect as of the date hereof and listed in Section 5.11(a) of the Company Disclosure Letter (including, to the extent indemnifiable thereunder, (i) for acts or omissions occurring in connection with the approval of this Agreement and the consummation of the transactions contemplated hereby and (ii) with respect to any director or officer of the Company who, at the request of the Company, served as a director or officer of any of the Company’s Subsidiaries, for acts and omissions occurring in connection with such officer’s or

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director’s role as an officer or director of such Subsidiary of the Company) (the “Indemnified Parties”), subject to applicable law. The certificate of incorporation and bylaws of the Surviving Corporation (or any successor to the Surviving Corporation) will contain provisions with respect to exculpation, indemnification and the advancement of expenses that are at least as favorable to the Indemnified Parties as those contained in the certificate of incorporation and bylaws of the Company as in effect on the date hereof, which provisions will not, except as required by law, be amended, repealed or otherwise modified for a period of six years from the Effective Time in any manner that would adversely affect the rights thereunder of Indemnified Parties unless the Surviving Corporation (or any successor to the Surviving Corporation) provides other assurance to the Indemnified Parties sufficient to ensure the continued exculpation, indemnification and advancement of expenses of the Indemnified Parties as provided in such organizational documents prior to any such amendment, repeal or modification.

(b) Insurance. For a period of six years after the Effective Time, Parent will cause the Surviving Corporation to maintain

directors’ and officers’ liability insurance with one or more reputable unaffiliated third-party insurers with at least the same industry rating covering those persons who are covered by the Company’s directors’ and officers’ liability insurance policy as of the date hereof for events occurring prior to the Effective Time on terms and conditions that are, in the aggregate (other than with respect to the broader coverage provided under the top layer of insurance, which shall be substantially the same as the Company’s policy) no less favorable to the insured than those applicable to the current directors and officers of the Company under policies maintained by the Company; provided, however, that in no event will the Surviving Corporation be required to expend in any one year in excess of 250% of the annual premium currently paid by the Company for such coverage (and to the extent annual premium would exceed 250% of the annual premium currently paid by the Company for such coverage, the Surviving Corporation shall use all reasonable efforts to cause to be maintained the maximum amount of coverage as is available for such 250% of such annual premium); and provided further, however, that notwithstanding the foregoing, Parent may satisfy its obligations under this Section 5.11(b) by purchasing a “tail” policy under the Company’s existing directors’ and officers’ insurance policy which (i) has an effective term of six years from the Effective Time, (ii) covers those persons who are currently covered by the Company’s directors’ and officers’ insurance policy in effect as of the date hereof for actions and omissions occurring on or prior to the Effective Time, and (iii) contains terms and conditions that are, in the aggregate (other than with respect to the broader coverage provided under the top layer of insurance, which shall be substantially the same as the Company’s policy), no less favorable to the insured than those of the Company’s directors’ and officers’ insurance policy in effect as of the date hereof.

(c) Third—Party Beneficiaries. This Section 5.11 is intended to be for the benefit of, and shall be enforceable by the

Indemnified Parties and their heirs and personal representatives and shall be binding on Parent and the Surviving Corporation and their respective successors and assigns. In the event Parent or the Surviving Corporation or its successor or assign (i) consolidates with or merges into any other Person and shall not be the continuing or surviving corporation or entity in such consolidation or merger or (ii) transfers all or substantially all of its properties and assets to any Person, then, and in each case, proper provision shall be made so that the successor and assign of Parent or the Surviving Corporation, as the case may be, honor the obligations set forth with respect to Parent or the Surviving Corporation, as the case may be, in this Section 5.11.

5.12 Section 16 Matters. Prior to the Effective Time, the Company shall take all such reasonable steps as may be required (to

the extent permitted under applicable law) to cause any dispositions of Company Common Stock (including derivative securities with respect to Company Common Stock) resulting from the transactions contemplated by Article I of this Agreement by each individual who is subject to the reporting requirements of Section 16(a) of the Exchange Act with respect to the Company to be exempt under Rule 16b-3 promulgated under the Exchange Act.

5.13 Insurance Approval. The Company shall deliver to Parent at least 15 days prior to the Closing a letter in a form acceptable to Parent validly executed by an officer of the Company, which authorizes Parent’s

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insurance broker, effective as of the Closing Date, to act as the Company’s insurance broker of record with respect to all insurance policies held by the Company.

5.14 FIRPTA Compliance. On the Closing Date, the Company shall deliver to Parent a properly executed FIRPTA Certificate in a form reasonably acceptable to Parent for purposes of satisfying Parent’s obligations under Treasury Regulation Section 1.1445-2(c)(3).

5.15 Immigration-Related Liabilities. Following the Effective Time, Parent shall assume all immigration-related liabilities of the Company with respect to persons who are employees of the Company as of the Effective Time.

ARTICLE VI

CONDITIONS TO THE MERGER

6.1 Conditions to the Obligations of Each Party to Effect the Merger. The respective obligations of each party to this Agreement to effect the Merger shall be subject to the satisfaction at or prior to the Closing Date of the following conditions:

(a) Company Stockholder Approval. This Agreement shall have been approved and adopted, and the Merger shall have been duly approved, by the requisite vote under applicable law, by the stockholders of the Company.

(b) No Order. No Governmental Entity of competent jurisdiction shall have enacted, issued, promulgated, enforced or

entered any statute, rule, regulation, executive order, decree, injunction or other order (whether temporary, preliminary or permanent) which (i) is in effect and (ii) has the effect of making the Merger illegal or otherwise prohibiting or preventing consummation of the Merger.

(c) HSR Act. All waiting periods (and any extension thereof) under the HSR Act relating to the transactions contemplated

hereby will have expired or terminated early. All other material foreign antitrust approvals set forth in Exhibit C hereto shall have been obtained.

6.2 Additional Conditions to the Obligations of Parent. The obligations of Parent and Merger Sub to consummate and effect

the Merger shall be subject to the satisfaction at or prior to the Closing Date of each of the following conditions, any of which may be waived, in writing, exclusively by Parent and Merger Sub.

(a) Representations and Warranties. The representations and warranties of the Company contained in this Agreement (i) shall have been true and correct as of the date hereof (except that those representations and warranties which address matters only as of a particular date shall have been true and correct only on such date) and (ii) shall be true and correct as of the Closing Date with the same force and effect as if made on the Closing Date (except that those representations and warranties which address matters only as of a particular date shall have been true and correct only on such date), except in each case of clauses (i) and (ii), for such inaccuracies or breaches which, individually or in the aggregate, would not reasonably be expect to have a Material Adverse Effect on the Company (it being understood that, for purposes of determining the accuracy of such representations and warranties, any update of or modification to the Company Disclosure Letter made or purported to have been made after the execution of this Agreement shall be disregarded); provided that, in each case of clauses (i) and (ii), the representations and warranties of the Company contained in Section 2.2(a), Section 2.2(b), the first sentence of Section 2.2(d), Section 2.3(a) and Section 2.23 shall be true and correct in all material respects.

(b) Agreements and Covenants. The Company shall have performed or complied in all material respects with all

agreements and covenants required by this Agreement to be performed or complied with by it at or prior to the Closing Date.

(c) Material Adverse Effect. No Effect that, either individually or when taken together with all other Effects that have occurred since the date hereof, has or would reasonably be expected to have a Material Adverse Effect on the Company shall have occurred since the date hereof and be continuing.

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(d) No Governmental Restriction. There shall not be any pending or threatened suit, action or proceeding asserted by any Governmental Authority (i) challenging or seeking to restrain or prohibit the consummation of the Merger or any of the other transactions contemplated by this Agreement, the effect of which restraint or prohibition if obtained would cause the condition set forth in Section 6.1(b) to not be satisfied or (ii) seeking to require Parent or the Company or any Subsidiary or affiliate to effect an Action of Divestiture.

(e) Officer’s Certificate. Parent and Merger Sub shall have received a certificate dated as of the Closing Date to the effect

that conditions set forth in Sections 6.2(a), (b), (c) and (d) have been satisfied signed on behalf of the Company by an authorized executive officer of the Company.

6.3 Additional Conditions to the Obligations of the Company. The obligation of the Company to consummate and effect the

Merger shall be subject to the satisfaction at or prior to the Closing Date of each of the following conditions, any of which may be waived, in writing, exclusively by the Company:

(a) Representations and Warranties. The representations and warranties of Parent and Merger Sub contained in this Agreement (i) shall have been true and correct as of the date hereof (except that those representations and warranties which address matters only as of a particular date shall have been true and correct only on such date) and (ii) shall be true and correct as of the Closing Date with the same force and effect as if made on the Closing Date (except that those representations and warranties which address matters only as of a particular date shall have been true and correct only on such date), except in each case of clauses (i) and (ii) for such inaccuracies or breaches which, individually or in the aggregate, would not reasonably be expect to materially impede the ability of Parent or Merger Sub to consummate the transactions contemplated by this Agreement in accordance with the terms hereof and applicable Legal Requirements; provided that, in each case of clauses (i) and (ii), the representations and warranties of Parent and Merger Sub contained in Section 3.2(a) shall be true and correct in all material respects. The Company shall have received a certificate with respect to the foregoing signed on behalf of Parent, with respect to the representations and warranties of Parent, by an authorized executive officer of Parent and a certificate with respect to the foregoing signed on behalf of Merger Sub, with respect to the representations and warranties of Merger Sub, by an authorized executive officer of Merger Sub.

(b) Agreements and Covenants. Parent and Merger Sub shall have performed or complied in all material respects with all

agreements and covenants required by this Agreement to be performed or complied with by it on or prior to the Closing Date, and the Company shall have received a certificate with respect to the foregoing signed on behalf of Parent, with respect to the covenants of Parent, by an authorized executive officer of Parent and a certificate with respect to the foregoing signed on behalf of Merger Sub, with respect to the covenants of Merger Sub, by an authorized executive officer of Merger Sub.

ARTICLE VII

TERMINATION, AMENDMENT AND WAIVER

7.1 Termination. This Agreement may be terminated at any time prior to the Effective Time, by action taken by the terminating

party or parties, and except as provided below, whether before or after the requisite approvals of the stockholders of the Company:

(a) by mutual written consent duly authorized by the Boards of Directors of each of Parent and the Company;

(b) by either the Company or Parent if the Merger shall not have been consummated by December 31, 2005 which date shall be extended to February 28, 2006 if the Merger shall not have been consummated as a result of a failure to satisfy the conditions set forth in Section 6.1(c) (the “End Date”); provided, however, that the right to terminate this Agreement under this Section 7.1(b) shall not be available to any party whose action or failure to act has been a principal cause of or resulted in the failure of the Merger to occur on or before such date and such action or failure to act constitutes a breach of this Agreement;

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(c) by either the Company or Parent if a Governmental Entity shall have issued an order, decree or ruling or taken any other action (including the failure to have taken an action), in any case having the effect of permanently restraining, enjoining or otherwise prohibiting the Merger, which order, decree, ruling or other action is final and nonappealable;

(d) by either the Company or Parent if the required approval of the stockholders of the Company contemplated by this

Agreement shall not have been obtained by reason of the failure to obtain the required vote at a meeting of the Company stockholders duly convened therefore or at any adjournment thereof; provided, however, that the Company shall give Parent three Business Days prior written notice before terminating this Agreement under this Section 7.1(d);

(e) by Parent (at any time prior to the adoption and approval of this Agreement and the Merger by the required vote of the

stockholders of the Company) if a Triggering Event with respect to the Company shall have occurred;

(f) by the Company, upon a breach of any representation, warranty, covenant or agreement on the part of Parent set forth in this Agreement, or if any representation or warranty of Parent shall have become untrue, in either case such that the conditions set forth in Section 6.3(a) or Section 6.3(b) would not be satisfied as of the time of such breach or as of the time such representation or warranty shall have become untrue; provided, however, that if such inaccuracy in Parent’s representations and warranties or breach by Parent is curable by Parent prior to the End Date through the exercise of reasonable efforts, then the Company may not terminate this Agreement under this Section 7.1(f) prior to 20 days following the receipt of written notice from the Company to Parent of such breach provided Parent continues to exercise all reasonable efforts to cure such breach through such 20 day period (it being understood that the Company may not terminate this Agreement pursuant to this paragraph (f) if it shall have materially breached this Agreement or if such breach by Parent is cured within such 20 day period);

(g) by Parent, upon a breach of any representation, warranty, covenant or agreement on the part of the Company set forth

in this Agreement, or if any representation or warranty of the Company shall have become untrue, in either case such that the conditions set forth in Section 6.2(a) or Section 6.2(b) would not be satisfied as of the time of such breach or as of the time such representation or warranty shall have become untrue; provided, however, that if such inaccuracy in the Company’s representations and warranties or breach by the Company is curable by the Company prior to the End Date through the exercise of reasonable efforts, then Parent may not terminate this Agreement under this Section 7.1(g) prior to 20 days following the receipt of written notice from Parent to the Company of such breach provided the Company continues to exercise all reasonable efforts to cure such breach through such 20 day period (it being understood that Parent may not terminate this Agreement pursuant to this paragraph (g) if it shall have materially breached this Agreement or if such breach by the Company is cured within such 20 day period);

(h) by the Company, if, the Company shall have entered into a definitive binding agreement with respect to a Superior

Offer pursuant to and in compliance with Section 5.3(d), the Company shall have paid Parent the Termination Fee described in Section 7.3(b); and

(i) by Parent, if (A) any Effect that, individually or when taken together with all other Effects that have occurred since the

date hereof, has or would reasonably be expected to have a Material Adverse Effect on the Company shall have occurred since the date hereof and (B) if such Material Adverse Effect is curable within such time period and the Company uses commercially reasonable efforts to cure such Material Adverse Effect within such time period, such Material Adverse Effect is not cured within 20 days of Parent providing written notice of such Material Adverse Effect to the Company.

For the purposes of this Agreement, a “Triggering Event,” with respect to the Company, shall be deemed to have occurred if:

(i) its Board of Directors or any committee thereof shall for any reason have withdrawn or shall have amended or modified in a manner adverse to Parent its recommendation in favor of, the adoption and approval of the Agreement or the approval of the Merger; (ii) it shall have failed to include in the Proxy Statement the recommendation of its Board of Directors in favor of the adoption and approval of the Agreement and the approval of the Merger; (iii) its Board of Directors fails to reaffirm (publicly, if so requested) its

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recommendation in favor of the adoption and approval of this Agreement and the approval of the Merger within five Business Days after Parent requests in writing that such recommendation be reaffirmed (or such longer time as is reasonably necessary for the Company and the Board of Directors to comply with the procedures set forth in Section 5.3(d) but in any event no later than two Business Days before the Stockholders’ Meeting); (iv) its Board of Directors or any committee thereof shall have approved or recommended any Acquisition Proposal; (v) the Company shall have entered into any letter of intent or similar document or any agreement; contract or commitment accepting any Acquisition Proposal; (vi) a tender or exchange offer relating to its securities shall have been commenced by a Person unaffiliated with Parent, and the Company shall not have sent to its security holders pursuant to Rule 14e-2 promulgated under the Exchange Act, within ten business days after such tender or exchange offer is first published, sent or given, a statement disclosing that the Board of Directors of the Company recommends rejection of such tender or exchange offer; or (vii) the Board of Directors of the Company shall have resolved to do any of the foregoing.

7.2 Notice of Termination; Effect of Termination. Any termination of this Agreement under Section 7.1 above will be effective immediately upon the delivery of a valid written notice of the terminating party to the other party hereto. In the event of the termination of this Agreement as provided in Section 7.1, this Agreement shall be of no further force or effect and there shall be no liability or obligation on the part of Parent or the Company or their respective Subsidiaries, officers or directors, except (i) as set forth in Section 5.4(a), this Section 7.2, Section 7.3 and Article VIII, each of which shall survive the termination of this Agreement and (ii) with respect to any liabilities or damages incurred or suffered by a party as a result of fraud or the intentional and material breach by the other party of any of its representations, warranties, covenants or other agreements set forth in this Agreement. No termination of this Agreement shall affect the obligations of the parties contained in the Confidentiality Agreement, all of which obligations shall survive termination of this Agreement in accordance with their terms.

7.3 Fees and Expenses.

(a) General. Except as set forth in this Section 7.3, all fees and expenses incurred in connection with this Agreement and the transactions contemplated hereby shall be paid by the party incurring such expenses whether or not the Merger is consummated; provided, however, that Parent and the Company shall share equally the filing fee for the Notification and Report Forms filed with the FTC and DOJ under the HSR Act, and all premerger notification and reports forms under similar applicable laws of other jurisdictions, in each case pursuant to Section 5.6(a).

(b) Company Payment.

(i) Payment. In the event that this Agreement is terminated by Parent or the Company, as applicable, pursuant to

Section 7.1(b), Section 7.1(d), Section 7.1(e) or Section 7.1(h), the Company shall promptly, but in no event later than two Business Days after the date of such termination, pay Parent a fee equal to $12,600,000 in immediately available funds (the “Termination Fee”); provided, however, that:

(1) in the case of termination under Section 7.1(h), such payment shall be made prior to such termination, and

(2) in the case of termination under Section 7.1(b), (a) such payment shall be made only if (i) Parent is not in

breach of the Agreement and (ii) following the date hereof and prior to the date of the termination of this Agreement, there has been disclosure publicly or to any member of the Board of Directors or any officer of the Company of an Acquisition Proposal with respect to the Company and, within 12 months following the termination of this Agreement, an Acquisition of the Company is consummated, or the Company enters into a definitive agreement, with the party that made such Proposal or, if such Acquisition or definitive agreement reasonably relates to or otherwise was made in response to or during the pendency of such Acquisition Proposal, and

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(b) such payment shall be made promptly, but in no event later than two Business Days after the consummation of such Acquisition of the Company or the entry into such definitive agreement by the Company, and

(3) in the case of termination under Section 7.1(d), (a) such payment shall be made only if following the date

hereof and prior to the meeting of the Company’s Stockholders to vote on the Merger, there has been disclosure publicly of an Acquisition Proposal with respect to the Company and within 12 months following the termination of this Agreement an Acquisition of the Company is consummated or the Company enters into a definitive agreement with respect to an Acquisition of the Company and (b) such payment shall be made promptly, but in no event later than two Business Days after the consummation of such Acquisition of the Company or the entry into such definitive agreement by the Company.

(ii) Interest and Costs; Other Remedies. The Company acknowledges that the agreements contained in this Section

7.3(b) are an integral part of the transactions contemplated by this Agreement, and that, without these agreements, Parent would not enter into this Agreement; accordingly, if the Company fails to pay in a timely manner the amounts due pursuant to this Section 7.3(b), and, in order to obtain such payment, Parent makes a claim that results in a judgment against the Company for the amounts set forth in this Section 7.3(b), the Company shall pay to Parent the reasonable costs and expenses of Parent (including reasonable attorneys’ fees and expenses) in connection with such suit, together with interest on the amounts set forth in this Section 7.3(b) at the prime rate of Citibank, N.A. in effect on the date such payment was required to be made. Payment of the fees described in this Section 7.3(b) shall not be in lieu of damages incurred in the event of breach of this Agreement to the extent provided in clause (ii) of the second sentence of Section 7.2.

(iii) Certain Definitions. For the purposes of this Section 7.3(b) only, “Acquisition,” with respect to a party hereto,

shall mean any of the following transactions (other than the transactions contemplated by this Agreement): (i) a merger, consolidation, business combination, recapitalization, liquidation, dissolution or similar transaction involving the party pursuant to which the equity interests held in such party and retained following such transaction or issued to or otherwise received in such transaction by the stockholders of the party immediately preceding such transaction constitute less than 50% of the aggregate equity interests in the surviving or resulting entity of such transaction or any direct or indirect parent thereof, (ii) a sale or other disposition by the party of assets representing in excess of 50% of the aggregate fair market value of the party’s business immediately prior to such sale, or (iii) the acquisition by any Person or group (including by way of a tender offer or an exchange offer or issuance by the party or such Person or group), directly or indirectly, of beneficial ownership or a right to acquire beneficial ownership of shares representing in excess of 50% of the voting power of the then outstanding shares of capital stock of the party.

7.4 Amendment. Subject to applicable law, this Agreement may be amended by the parties hereto, by action taken or authorized

by their respective Boards of Directors, at any time before or after approval of the Merger by the stockholders of the Company; provided, however, that after approval of the Merger by the stockholders of the Company, no amendment shall be made which by law requires further approval by the stockholders of the Company without such further stockholder approval. This Agreement may not be amended except by execution of an instrument in writing signed on behalf of each of Parent, Merger Sub and the Company.

7.5 Extension; Waiver. At any time prior to the Effective Time either party hereto, by action taken or authorized by their respective Board of Directors, may, to the extent legally allowed: (i) extend the time for the performance of any of the obligations or other acts of the other parties hereto, (ii) waive any inaccuracies in the representations and warranties made to such party contained herein or in any document delivered pursuant hereto, and (iii) waive compliance with any of the agreements or conditions for the benefit of such party contained herein. Any agreement on the part of a party hereto to any such extension or waiver shall be valid only if set forth in an instrument in writing signed on behalf of such party. Delay in exercising any right under this Agreement, including pursuant to Section 7.1(b), shall not constitute a waiver of such right.

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ARTICLE VIII

GENERAL PROVISIONS

8.1 Non-Survival of Representations and Warranties. The representations and warranties of the Company, Parent and Merger Sub contained in this Agreement, or any instrument delivered pursuant to this Agreement, shall terminate at the Effective Time, and only the covenants that by their terms survive the Effective Time and this Article VIII shall survive the Effective Time.

8.2 Notices. All notices and other communications hereunder shall be in writing and shall be deemed duly given (i) on the date of delivery if delivered personally and/or by messenger service, (ii) on the date of confirmation of receipt (or, the first Business Day following such receipt if the date is not a Business Day) of transmission by facsimile, or (iii) on the date of confirmation of receipt (or, the first Business Day following such receipt if the date is not a Business Day) if delivered by a nationally recognized courier service. All notices hereunder shall be delivered as set forth below, or pursuant to such other instructions as may be designated in writing by the party to receive such notice:

(a) if to Parent or Merger Sub, to:

Sun Microsystems, Inc. 4120 Network Circle Santa Clara, CA 95054 Attention: Brian Sutphin Telephone No.: 1-800-555-9786 Telecopy No.: 1-408-276-4601

with copies to:

Sun Microsystems, Inc. 4120 Network Circle Santa Clara, CA 95054 Attention: Brian Martin Telephone No.: 1-800-555-9786 Telecopy No.: 1-408-276-4601

and

Skadden, Arps, Slate, Meagher & Flom LLP 525 University Ave., Suite 1100 Palo Alto, CA 94301 Attention: Kenton J. King Telephone No.: 1-650-470-4500 Telecopy No.: 1-650-470-4570

if to the Company, to:

SeeBeyond Technology Corporation 181 W. Huntington Drive, Suite 110 Monrovia, CA 91016 Attention: Mark Brooks, Esq. Telephone No.: 1-626-408-3130 Telecopy No.: 1-626-408-3380

with copies to:

Latham & Watkins LLP 633 West Fifth St., Suite 4000 Los Angeles, CA 90071 Attention: Edward Sonnenschein, Jr., Esq./David M. Hernand, Esq. Telephone No.: 1-213-485-1234 Telecopy No.: 1-213-891-8763

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8.3 Interpretation; Knowledge.

(a) When a reference is made in this Agreement to Exhibits, such reference shall be to an Exhibit to this Agreement unless otherwise indicated. When a reference is made in this Agreement to Sections, such reference shall be to a section of this Agreement unless otherwise indicated. For purposes of this Agreement, the words “include,” “includes” and “including,” when used herein, shall be deemed in each case to be followed by the words “without limitation.” The table of contents and headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. When reference is made herein to “the business of” an entity, such reference shall be deemed to include the business of such entity and its Subsidiaries, taken as a whole.

(b) For purposes of this Agreement, the term “Knowledge” means, with respect to a party hereto, with respect to any

matter in question, that any of the individuals listed on Schedule 8.3(b) has actual knowledge of such matter.

(c) For purposes of this Agreement, the term “Made Available” shall mean that the Company has posted such materials to a virtual data room and has given Parent or its agents or representatives all necessary access to such virtual data room or otherwise delivered such materials.

(d) For purposes of this Agreement, the term “Material Adverse Effect,” when used in connection with an entity, means

any change, event, violation, inaccuracy, circumstance or effect (any such item, an “Effect”) that (i) is materially adverse to the business, assets (including intangible assets), liabilities, capitalization, financial condition or results of operations of such entity taken as a whole with its Subsidiaries, other than any Effect (A) primarily resulting from changes affecting the United States or world economy generally which changes do not disproportionately affect such entity taken as a whole with its Subsidiaries, (B) primarily resulting from changes affecting the industry in which such entity and its Subsidiaries operate generally which changes do not disproportionately affect such entity taken as a whole with its Subsidiaries, (C) primarily resulting from a change in such entity’s stock price or the trading volume in such stock; provided, however, that this clause (C) shall not exclude any underlying Effect which may have caused such change in stock price or trading volume, (D) primarily resulting from acts of terrorism or war which changes do not disproportionately affect such entity taken as a whole with its Subsidiaries, (E) primarily resulting from the loss of customers (including prospective customers with whom or which the Company or its Subsidiaries are engaged in sales discussions as of the date of this Agreement) or Employees as a result of the announcement of this Agreement and the transactions contemplated hereby, or (F) primarily resulting from a failure to meet securities analysts’ published revenue or earnings predictions for the Company for any period ending (or for which revenues or earnings are released) on or after the date of this Agreement; provided that this clause (F) shall not exclude the revenues or earnings of the Company themselves or any Effect which may have affected the Company’s revenues or earnings; or (ii) would materially impede the authority of such entity, or, in any case, Parent, to consummate the transactions contemplated by this Agreement in accordance with the terms hereof and applicable Legal Requirements.

(e) For purposes of this Agreement, the term “Person” shall mean any individual, corporation (including any non-profit

corporation), general partnership, limited partnership, limited liability partnership, joint venture, estate, trust, company (including any limited liability company or joint stock company), firm or other enterprise, association, organization, entity or Governmental Entity.

8.4 Counterparts. This Agreement may be executed in two or more counterparts, all of which shall be considered one and the

same agreement and shall become effective when one or more counterparts have been signed by each of the parties and delivered to the other party, it being understood that all parties need not sign the same counterpart.

8.5 Entire Agreement; Third-Party Beneficiaries. This Agreement and the documents and instruments and other agreements among the parties hereto as contemplated by or referred to herein, including the Company Disclosure Letter and the Voting Agreements and other Exhibits hereto (i) constitute the entire agreement among the parties with respect to the subject matter hereof and supersede all prior agreements and understandings, both

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written and oral, among the parties with respect to the subject matter hereof, it being understood that the Confidentiality Agreement shall continue in full force and effect until the Closing and shall survive any termination of this Agreement and (ii) are not intended to confer upon any other Person any rights or remedies hereunder, except as specifically provided, following the Effective Time, in Section 5.11.

8.6 Severability. In the event that any provision of this Agreement or the application thereof, becomes or is declared by a court of competent jurisdiction to be illegal, void or unenforceable, the remainder of this Agreement will continue in full force and effect and the application of such provision to other Persons or circumstances will be interpreted so as reasonably to effect the intent of the parties hereto. The parties further agree to replace such void or unenforceable provision of this Agreement with a valid and enforceable provision that will achieve, to the greatest extent possible, the economic, business and other purposes of such void or unenforceable provision.

8.7 Other Remedies. Except as otherwise provided herein, any and all remedies herein expressly conferred upon a party will be deemed cumulative with and not exclusive of any other remedy conferred hereby, or by law or equity upon such party, and the exercise by a party of any one remedy will not preclude the exercise of any other remedy. The parties hereto agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached.

8.8 Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware, regardless of the laws that might otherwise govern under applicable principles of conflicts of law thereof. Each of the parties hereto irrevocably consents to the exclusive jurisdiction and venue of the Delaware Court of Chancery and any state appellate court therefrom within the State of Delaware (or, if the Delaware Court of Chancery declines to accept jurisdiction over a particular matter, any state or federal court within the State of Delaware) in connection with any matter based upon or arising out of this Agreement or the matters contemplated herein, agrees that process may be served upon them in any manner authorized by the laws of the State of Delaware for such persons and waives and covenants not to assert or plead any objection which they might otherwise have to such jurisdiction, venue and such process.

8.9 Rules of Construction. The parties hereto agree that they have been represented by counsel during the negotiation and execution of this Agreement and, therefore, waive the application of any law, regulation, holding or rule of construction providing that ambiguities in an agreement or other document will be construed against the party drafting such agreement or document.

8.10 Assignment. No party may assign either this Agreement or any of its rights, interests, or obligations hereunder without the prior written approval of the other parties, except that Parent may assign its rights and delegate its obligations hereunder to its affiliates as long as Parent remains ultimately liable for all of Parent’s obligations hereunder. Any purported assignment in violation of this Section 8.10 shall be void. Subject to the preceding sentence, this Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and permitted assigns.

8.11 Waiver of Jury Trial. EACH OF PARENT, MERGER SUB AND THE COMPANY HEREBY IRREVOCABLY WAIVES ALL RIGHT TO TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM (WHETHER BASED ON CONTRACT, TORT OR OTHERWISE) ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE ACTIONS OF PARENT, MERGER SUB OR THE COMPANY IN THE NEGOTIATION, ADMINISTRATION, PERFORMANCE AND ENFORCEMENT HEREOF.

*******

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IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their duly authorized respective officers as of the date first written above.

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SUN MICROSYSTEMS, INC.

By:

/s/ JOHN P. LOIACONO

Name: John P. LoiaconoTitle: Executive Vice President, Software

BIG BEAR ACQUISITION CORPORATION

By:

/s/ BRIAN MARTIN

Name: Brian MartinTitle: President and Secretary

SEEBEYOND TECHNOLOGY CORPORATION

By:

/s/ JAMES T. DEMETRIADES

Name: James T. DemetriadesTitle: Chief Executive Officer

Exhibit 10.3

SUN MICROSYSTEMS, INC.

RESTRICTED STOCK PURCHASE AGREEMENT

This Restricted Purchase Agreement (the “Agreement”) is made as of the xxth day of xx xx by and between SUN MICROSYSTEMS, INC., a Delaware corporation (the “Company”), and xx xx (the “Purchaser”).

The parties agree as follows:

1. SALE OF COMMON STOCK.

Subject to the terms and conditions of this Agreement and the Company’s 1990 Long-Term Equity Incentive Plan (the “Plan”),

the Company hereby sells to the Purchaser and the Purchaser hereby purchases from the Company, on the closing date (as defined herein) xx shares of the Company’s Common Stock (the “Shares”) at a price of $0.01 per share for an aggregate purchase price of $xx The term “Shares” refers to the Shares purchased herein and all securities received in replacement thereof, pursuant to or in consequence of other similar change in the Company’s capitalization.

2. CLOSING; SECURITY INTEREST.

2.1 Closing. The purchase and sale of the shares shall occur at a closing (the “Closing”) to be held at the principal office of the Company as of the date hereof (the “Closing Date”).

3. LIMITATIONS ON TRANSFER.

2.2 Payment and Delivery of Certificate. At the Closing, the Company shall deliver to the Purchaser a certificate or certificates representing the Shares to be purchased by the Purchaser (which shall be issued in the name of the Purchaser or jointly in the name of the Purchaser and the Purchaser’s spouse) against payment of the purchase price therefor. The purchase price for the Shares shall be paid on the Closing Date by delivery of a check payable to the Company.

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

Initially, all of the Shares purchased by the Purchaser shall be subject to the Company’s Repurchase Option as set forth above.

The Shares held by the Purchaser shall be released from the Company’s Repurchase Option under this Section 3.1 as follows:

3.1 Repurchase Option. In the event of the voluntary or involuntary termination or cessation of employment or association of the Purchaser with the Company or any subsidiary in which the Company has a majority ownership interest for any reason whatsoever, with or without cause (including death or disability), the Company shall, upon the date of such termination, have an irrevocable, exclusive option to repurchase (the “Repurchase Option”) all or any portions of the Shares held by the Purchaser which are subject to the Repurchase Option as of such date at the original purchase price per share specified in Section1. Termination of the Purchaser’s employment with the Company shall not be deemed to have occurred during any period that the Purchaser is on a duly authorized leave of absence from the Company of less than twelve (12) months, or such longer period as the Committee of the Board of Directors administering the Plan approved in writing. If Purchaser does not return to work with the Company on or prior to the last day of an authorized leave of absence, Purchaser’s employment with the Company shall be deemed to terminate on the last day of the authorized leave of absence and the Company’s repurchase option specified herein shall become exercisable on such date. For the purposes of this Agreement, an authorized leave of absence shall mean a leave of absence approved by an officer of the Company and by the Human Resources Department.

(a) 50% of the shares (i.e., xx Shares) shall be released on xx and

(b) The remaining 50% of the Shares (i.e., xx Shares) shall be released on provided in each such case the Purchaser is still employed with the Company on such dates. The continuation of the Purchaser’s employment with the Company is a material inducement to the Company in selling the Shares to Purchaser and failure to provide services to the Company, for any reason whatsoever shall trigger the Company’s Repurchase Option.

Notwithstanding the foregoing, vesting of the Shares shall be suspended during any authorized unpaid leave of absence (including a leave of absence for military, educational, disability or personal purposes) of more than thirty (30) days or an authorized paid leave of absence of more than ninety (90) days. The suspension of vesting shall commence on the thirty-first (31st) day of an authorized unpaid leave of absence of more than thirty (30) days or, in the case of an authorized paid leave of absence of more than ninety (90) days, on the ninety-first (91st) day of such leave and suspension of vesting shall terminate on the earlier of (1) the last business day preceding the date on which such individual’s leave of absence terminates or (2) a date twelve (12) months after the commencement of the leave of absence, unless the Compensation Committee of the Board of Directors extends such period. The release dates specified above shall be extended by a number of days equal to the number of days during which vesting was suspended.

Within forty-five (45) days following the Purchaser’s termination, the Company shall notify the Purchaser as to whether it wishes to purchase the Shares pursuant to the exercise of the Repurchase Option. If the Company elects to purchase said Shares hereunder, it shall set a date for the closing of the transaction at a place specified by the Company not later than thirty (30) days from the date of such notice. At such closing, the Company shall tender payment for the Shares and the certificate or certificates representing the Shares so purchased shall be cancelled. The Purchaser hereby authorizes and directs the Secretary or Transfer Agent of the Company to transfer the Shares as to which the Repurchase Option has been exercised from the Purchaser to the Company. Except as provided under Section 3.5, the Purchaser shall not transfer by sale, assignment, hypothecation, donation or otherwise any of the Shares or any interest therein prior to the release of such Shares from the Repurchase Option. The Purchaser further authorizes the Company to refuse or to cause its Transfer Agent to refuse to transfer or record any Shares to be transferred in violation of this Agreement.

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

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

3.4 Replacement Certificate. In the event the restrictions imposed by this Agreement shall be terminated as provided in this

Section 3, a new certificate or certificates representing the Shares shall be issued, on request, without the legend referred to in Section 5 herein.

4. ESCROW.

3.5 Excluded Transfers. The restrictions on transfer of this Section 3 shall not apply to an inter-vivos transfer to the

Purchaser’s ancestors or descendants or spouse or to a trustee for their benefit, provided that such transferee shall agree in writing to take such Shares subject to all the terms of this Agreement, including restrictions on further transfer.

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

4.2 Certificate Held in Escrow. The certificate or certificates representing the Shares and the duly executed blank stock

assignment delivered at the Closing by the Purchaser of the Pledge Holder or Escrow Agent (as the case may be) shall be

held by the Escrow Agent pursuant to the joint escrow instructions attached hereto as Exhibit B and made a part hereof, which joint escrow instructions shall be signed by the Purchaser, the Company and the Escrow Agent at the Closing.

5. LEGENDS.

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

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

6. SECTION 83(b); SATISFACTION OF WITHHOLDING OBLIGATION.

The Purchaser shall notify the Company in writing if the Purchaser files an election pursuant to Section 83(b) of the Internal

Revenue Code of 1986 (an “83(b) Election”) with the Internal Revenue Services within thirty (30) days from the date of the sale of the Shares hereunder. The Company intends to claim a tax deduction for any amount which is taxable to the Purchaser regardless of whether such an election is filed.

IF SUCH AN ELECTION IS NOT FILED, THE PURCHASER ACKNOWLEDGES THAT THE COMPANY HAS THE RIGHT TO SATISFY ANY PORTION OF ANY WITHHOLDING TAX OBLIGATIONS TO WHICH THE COMPANY MAY BE SUBJECT IN CONNECTION WITH THE SHARES BY SELLING SUFFICIENT SHARES ON BEHALF OF THE PURCHASER WHICH ARE NO LONGER SUBJECT TO THE REPURCHASE OPTION AND/OR BY WITHHOLDING CERTAIN AMOUNTS FROM PURCHASER’S FUTURE SALARY PAYMENTS. IN THE EVENT THAT THE COMPANY DESIREs TO SATISFY THE WITHHOLDING TAX OBLIGATIONS THROUGH THE SALE OF SHARES WHICH ARE NO LONGER SUBJECT TO THE REPURCHASE OPTION, THE COMPANY SHALL NOTIFY THE ESCROW AGENT TO SELL, AT THE THEN CURRENT MARKET PRICE, A SUFFICIENT PORTION OF SUCH PURCHASER’S SHARES WHICH ARE NO LONGER SUBJECT TO THE REPURCHASE OPTION, TO SATISFY THE AMOUNT OF COMPANY’S WITHHOLDING TAX OBLIGATION, AND TRANSFER TO COMPANY SUCH PROCEEDS DERIVED FROM SUCH SALE AS WILL BE NECESSARY TO SATISFY SUCH PORTION OF COMPANY’S WITHHOLDING TAX OBLIGATION AS THE COMPANY MAY ELECT.

PURCHASER ACKNOWLEDGES THAT THE COMPANY HAS DISCLOSED TO HIM OR TO HER THAT IF HE OR SHE FILES AN 83(b) ELECTION, THE SPREAD BETWEEN THE PURCHASE PRICE OF THE SHARES AND THE FAIR MARKET VALUE OF THE SHARES ON THE DATE OF PURCHASE WILL BE IMMEDIATELY TAXABLE TO HIM OR HER AS ORDINARY INCOME AND THE COMPANY WILL BE REQUIRED TO WITHHOLD CERTAIN AMOUNTS FROM HIS OR HER PAYCHECK. THE SHARES WILL NOT BE SALEABLE TO PAY SUCH TAXES DUE TO THE COMPANY’S REPURCHASE OPTION. IF PURCHASER DOES NOT FILE SUCH AN 83(b) ELECTION, THE SPREAD BETWEEN THE PURCHASE PRICE AND THE FAIR MARKET VALUE OF THE SHARES WHICH VEST WILL BE TAXABLE AS ORDINARY INCOME TO PURCHASER ON THE DATE UPON WHICH SUCH SHARES VEST AND THE COMPANY WILL BE REQUIRED TO WITHHOLD CERTAIN AMOUNTS FROM PURCHASER’S PAYCHECK. FURTHER, THE COMPANY RESERVES THE RIGHT TO SATISFY, EITHER IN WHOLE OR IN PART, ANY WITHHOLDING OBLIGATION, TO WHICH THE COMPANY MAY BE SUBJECT WITH RESPECT TO PURCHASER’S SHARES, BY REQUIRING THE ESCROW AGENT TO SELL, AT THE THEN CURRENT MARKET PRICE, A SUFFICIENT PORTION OF PURCHASER’S SHARES WHICH ARE NO LONGER SUBJECT TO THE REPURCHASE OPTION, TO SATISFY ALL OR A PORTION OF THE COMPANY’S WITH HOLDING TAX OBLIGATION, AND TRANSFER TO COMPANY THE PROCEEDS DERIVED OF SUCH SALE.

7. MISCELLANEOUS.

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

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

7.3 Assignment. The rights and benefits of this Agreement shall inure to the benefit of and be enforceable by the Company’s

successors and assigns. The rights and obligations of the Purchaser under this Agreement may only be assigned with the prior written consent of the Company.

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

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

7.6 Specific Performance. The Purchaser agrees that the Company and/or other shareholders shall be entitled to a decree of

specific performance of the terms hereof or an injunction restraining violations of this Agreement, said right to be in addition to any of the remedies of the Company.

7.7 Delaware Law. This Agreement shall be construed under the laws of the State of Delaware, and covers the entire

understanding of the parties hereto, superseding all prior written or oral agreements and no amendment or addition hereto shall be deemed effective unless agreed to in writing by the parties hereto.

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

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

7.9 No Continuing Obligations. THIS AGREEMENT IS NOT AN EMPLOYMENT CONTRACT AND NOTHING IN THIS

AGREEMENT SHALL BE DEEMED TO CREATE IN ANY WAY WHATSOEVER ANY OBLIGATION ON THE PART OF THE COMPANY TO CONTINUE THE PURCHASER’S EMPLOYMENT WITH THE COMPANY.

THE “COMPANY” SUN MICROSYSTEMS, INC.

A Delaware Corporation

By:

Michael A. Dillon Title: Senior Vice President, General Counsel & Secretary

THE “PURCHASER”

Address:

Date:

Date of Commencement Vesting:

CONSENT

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

Spouse of Purchaser

Date:

EXHIBIT A

ASSIGNMENT SEPARATE FROM CERTIFICATE

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

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

Signature:

EXHIBIT B ATTN: SECRETARY Sun Microsystems, Inc. 4120 Network Circle Santa Clara, CA 95054

RE: Joint Escrow Instructions Dear Secretary:

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

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

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

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

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

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

6. If at the time of termination of this escrow you shall have in your possession any documents, securities, or other

property belonging to the Purchaser, you shall deliver all of the same to the Purchaser and shall be discharged of all further obligations.

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

8. You shall not be personally liable for any act you may do or omit to do hereunder as Escrow Agent or attorney-in-

fact for the Purchaser while acting in good faith and in the exercise of your own good judgment and any act done or omitted by you pursuant to the advice of your own attorneys shall be conclusive evidence of such good faith.

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

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

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

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

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

14. If prior to the termination of this Escrow you shall die or shall cease to be Secretary of the Company your successor as

Secretary of the Company may, from time to time, at the request of the Company’s Board of Directors discharge any of the duties and perform any of the acts to be performed by you as Escrow Agent.

Dated: , SUN MICROSYSTEMS, INC. A Delaware corporation

By:

Michael A. DillonTitle: Senior Vice President, General Counsel & Secretary

Address: 4120 Network Circle Santa Clara, CA 95054

ESCROW AGENT

Michael A. DillonSecretary of Sun Microsystems, Inc.

Address: 4120 Network Circle Santa Clara, CA 95054

PURCHASER

Date:

Address:

THE FOLLOWING PAGE IS TO BE COMPLETED

ONLY IF YOU ARE SUBJECT TO

U.S. TAXES

ELECTION UNDER SECTION 83(b) OF THE INTERNAL REVENUS CODE OF 1986 The undersigned taxpayer hereby elects, pursuant to the above-referenced Federal Code, to include in his gross income for the current taxable year, the amount of any compensation taxable to him in connection with his receipt of the property described below: 1. The name, address, taxpayer identification number and taxable year of the undersigned are as follows:

TAXPAYER NAME: _______________________________________

TAXPAYER ADDRESS: _______________________________________

_______________________________________

TAXPAYER ID NUMBER: _______________________________________

TAXABLE YEAR: __________

2. The property with respect to which the election is made is described as follows:

shares of the Common Stock of Sun Microsystems, Inc.

3. The date on which the property was transferred is:

4. The property is subject to the following restrictions:

Restriction on transfer is provided in a stock restriction agreement between the undersigned and the Company.

The undersigned has submitted a copy of this statement to the person for whom the services were performed in connection with the undersigned’s receipt of the above-described property. The transferee of such property is the person performing the services in connection with the transfer of said property. The undersigned understands that the foregoing election may not be revoked except with the consent of the Commissioner.

5. The fair market value at the time of transfer, determined without regard to any restriction other than a restriction which by its terms will never lapse, of such property is:

6. The amount (if any) paid for such property is:

Date:

Taxpayer

Exhibit 10.5

SUN COPY

SUN MICROSYSTEMS, INC. DIRECTORS’ NONSTATUTORY STOCK OPTION AGREEMENT

GRANT #

SUN MICROSYSTEMS, INC., a Delaware corporation (the “Company”) has granted to (the “Optionee”), an option to purchase a total of shares of the Company’s Common Stock, at the price determined as provided herein, and in all respects subject to the terms, definitions and provisions of the 1988 Directors’ Stock Option Plan (the “Plan”) adopted by the Company which is incorporated herein by reference. The terms defined in the Plan shall have the same defined meanings herein.

1) NATURE OF THE OPTION

This option is a nonstatutory option and is not intended to qualify for any special tax benefits to the Optionee.

2) OPTION PRICE

The option price is $ for each share of Common Stock, which is 100% of the fair market value of the Common Stock on the date of grant of this Option.

3) EXERCISE OF OPTION

This Option shall be exercisable during its term in accordance with the provisions of Section 9 of the Plan as follows: (a) RIGHT TO EXERCISE

(i) This Option shall become exercisable in cumulative installments of twenty-five percent (25%) of the Shares subject to the Option on each of the first, second, third and fourth anniversaries of the date of grant specified on page 3 of this Agreement (each a “Vesting Date”); provided, however, if the Company’s Annual Meeting of Stockholders for any year after the Annual Meeting date on which the Option is granted is held prior to a Vesting Date, the Vesting Date for that year shall be the date of the Annual Meeting of Stockholders. Notwithstanding the foregoing, in no event shall any portion of the Option vest before the date six (6) months after the date of grant of the Option.

(ii) This Option may not be exercised for a fraction of a share.

(iii) In the event of Optionee’s death, disability or other termination of service as a Director, the exercisability of the Option is governed by Section 6, 7 and 8 of this Agreement.

(b) METHOD OF EXERCISE

This Option shall be exercisable by written notice which shall state the election to exercise the Option, the number of Shares in respect of which the Option is being exercised, and such other representations and agreements as to the holder’s investment intent with respect to such Shares of Common Stock as may be required by the Company pursuant to the provisions of the Plan. Such written notice shall be signed by the Optionee and shall be delivered in person or by certified mail to the Secretary of the Company. The written notice shall be accompanied by payment of the exercise price. Revised June 2004 – Michael Dillon

Page 2 Directors’ Nonstatutory Stock Option Agreement

4) METHOD OF PAYMENT

Payment of the exercise price shall be by any of the following, or a combination thereof, at the election of the Optionee.

(a) cash; (b) check; or (c) surrender of other Shares of Common Stock of the Company having a fair market value equal to the exercise price of the Shares with respect to which the Option is being exercised.

5) RESTRICTIONS ON EXERCISE

This option may not be exercised if the issuance of such Shares upon such exercise or the method of payment of consideration for such shares would constitute a violation of any applicable federal or state securities or other law or regulations, or if such issuance would not comply with the requirements of any stock exchange upon which the Shares may then be listed. As a condition to the exercise of this Option, the Company may require Optionee to make any representation and warranty to the Company as may be required by any applicable law or regulation.

6) TERMINATION OF STATUS AS A DIRECTOR

If Optionee ceases to serve as a Director, Optionee may, but only within ninety (90) days after the date Optionee ceases to be a Director of the Company, exercise this Option to the extent that Optionee was entitled to exercise this Option at the date of such termination, or if Optionee does not exercise this Option within the time specified herein, the Option shall terminate.

7) DISABILITY OF OPTIONEE

Notwithstanding the provisions of Section 6 above, if Optionee is unable to continue his or her service as a Director as a result of his or her total and permanent disability (as defined in Section 22(c)(3) of the Internal Revenue Code), Optionee may, but only within six (6) months from the date of termination, exercise this Option to the extent Optionee was entitled to exercise it at the date of such termination. To the extent that Optionee was not entitled to exercise this Option at the date of termination, or if Optionee does not exercise this Option within the time specified herein, the Option shall terminate.

8) DEATH OF OPTIONEE

In the event of the death of Optionee:

(a) during the term of this Option and while a Director of the Company and having been in Continuous Status as a Director since the date of grant of this Option, the Option may be exercised, at any time within six (6) months following the date of death, by Optionee’s estate of by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent of the right to exercise that would have accrued had Optionee continued living and remain in Continuous Status as Director for six (6) months after the date of death; or

(b) within one (1) month after the termination of Optionee’s Continuous Status as a Director, this Option may be exercised, at any time within six (6) months following the date of death, by Optionee’s estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent of the right to exercise that had accrued at the date of termination.

9) NON-TRANSFERABILITY OF OPTION

This Option may not be sold, pledged, assigned, hypothecated, transferred or disposed of in any manner other than by will of by the laws of descent and distribution or pursuant to a qualified domestic relations order as defined by the Code or Title I of the Employee Retirement Income Security Act, or the rules thereunder. The designation of a beneficiary by the Optionee does not constitute a transfer. This Option may be exercised, during the lifetime of the Optionee, only by the Optionee or a transferee permitted by this Section 9. The terms of the Option shall be binding upon the executors, administrators, heirs, successors and assigns of the Optionee.

Page 3 Directors’ Nonstatutory Stock Option Agreement

10) TERM OF OPTION

This option may not be exercised more than five (5) years from the date of grant of this Option, and may be exercised during such term only in accordance with the Plan and the terms of this Option.

11) TAXATION UPON EXERCISE OF OPTION

Optionee understands that, upon exercise of this Option, Optionee will recognize income for tax purposes in an amount equal to the excess of the then fair market value of the Shares purchased over the exercise price paid for such Shares. The Company may require the Optionee to make a cash payment to cover any applicable withholding tax liability as a condition of exercise of this Option. Upon a resale of such Shares by the Optionee, any difference between the sale price and the fair market value of the Shares on the date of exercise of the Option will be treated as capital gain or loss.

Optionee acknowledges receipt of a copy of the Plan, which is annexed hereto, and represents that Optionee is familiar with the terms and provisions thereof, and hereby accepts this Option subject to all of the terms and provisions thereof. Optionee hereby agrees to accept as binding, conclusive and final all decisions or interpretations of the Board upon any questions arising under the Plan.

SUN TREASURY DEPARTMENT COPY PLEASE SIGN AND RETURN THIS AGREEMENT TO: Sun Microsystems, Inc. 4120 Network Circle, M/S SCA12-205 Santa Clara, CA 95054

DATE OF GRANT:

BY:

Michael DillonSr. Vice President, General Counsel & Secretary

OPTIONEE SIGNATURE DATE SIGNED

OPTIONEE SOCIAL SECURITY NUMBER

Exhibit 10.7

NON-STATUTORY STOCK OPTION AGREEMENT SUN MICROSYSTEMS, INC. (the “Company”), a Delaware corporation, hereby grants to (the “Optionee”), an option to purchase a total of shares of Common Stock (the “Shares”), at the price determined as provided herein, and in all respects subject to the terms, definitions and provisions of the 1996 Equity Compensation Acquisition Plan (the “Plan”) adopted by the Company which is incorporated herein by reference. The terms defined in the Plan shall have the same defined meanings herein. 1) NATURE OF THE OPTION

This option is intended by the Company and the Optionee to be a nonstatutory stock option, and does not qualify for any special tax benefits to the Optionee. This option is not an Incentive Stock Option and is not subject to Section 7(g) of the Plan.

2) OPTION PRICE

The option Price is for each share of Common Stock. 3) EXERCISE OF OPTION

This option shall be exercisable during its term in accordance with the provisions of Section 7 of the Plan as follows:

(i) RIGHT TO EXERCISE

(a) Subject to subsections 3(i)(b), (c) and (d), below, this option shall be exercisable cumulatively, to the extent of 20% of the Shares subject to the option on or after and to the extent of an additional 20% of the Shares on each yearly anniversary of such date thereafter.

(b) Notwithstanding subsection 3(i)(a), above, and subject to subsections 3(i)(c), 7 and 8, below, in the event of Optionee’s death or disability, this option shall be exercisable cumulatively, to the extent of 1.6667% of the Shares subject to the option on or after one month following the vesting commencement date and to the extent of an additional 1.6667% of the Shares on each monthly anniversary of such date thereafter.

(c) This option may not be exercised for a fraction of a share.

(d) In the event of Optionee’s termination of employment, the exercisability of the option is governed by Section 6 below.

(ii) METHOD OF EXERCISE

This option shall be exercisable by written notice which shall state the election to exercise the option, the number of Shares in respect of which the option is being exercised, and such other representations and agreements as to the holder’s investment intent with respect to such shares of Common Stock as may be required by the Company pursuant to the provisions of the Plan. Such written notice shall be signed by the Optionee, shall be delivered in person or by certified mail to the Treasury Department of the Company, and shall be accompanied by payment of the purchase price.

4) METHOD OF PAYMENT

Payment of the purchase price shall be by any of the following, or a combination thereof, at the election of the Optionee: cash, check, surrender of other shares of Common Stock of the Company of a value equal to the purchase price of the shares as to which the option is exercised, or the Optionee may elect to transact a “same-day-sale” thereby executing a “cash-less” option exercise provided such a sale does not violate any applicable Federal or State laws or regulations”.

5) RESTRICTIONS ON EXERCISE

This option may not be exercised if the issuance of such shares upon such exercise would constitute a violation of any applicable Federal or State Securities or other law or regulation, including any rule under Regulation G as promulgated by the Federal Reserve Board. As a condition to the exercise of this option, the Company may require the Optionee to make any representation and warranty to the Company as may be required by any applicable law or regulation.

6) TERMINATION OF STATUS AS AN EMPLOYEE

(i) Subject to Sections 6(ii) and 10 below, if Optionee ceases to serve as an Employee, he may, but only within 90 days after the date he ceases to be an Employee of the Company, exercise his option to the extent that he was entitled to exercise it at the date of such termination. To the extent that he was not entitled to exercise the option at the date of such termination, and to the extent that he does not exercise the exerciseable portion of the option within the time specified herein, the option shall terminate.

(ii) Retirement

(a) For purposes of this Agreement the term “retirement” shall mean the Optionee’s voluntary resignation from the Company: (1) at or after attaining age 55 and (2) with a number of full years of service with the Company that when added

to Optionee’s age (in full years), the sum equals or exceeds 65, (b) Notwithstanding subsection 6(i) above, in the case of an Optionee who is not in a job classification of director-level or above and who ceases to serve as an Employee by reason of retirement (as defined above), then for purposes of this Agreement, the option shall remain outstanding and shall be exercisable as though the Optionee had remained in Continuous Status as an Employee for twelve (12) months after the date of retirement. Subject to earlier termination under Section 10 below, such Optionee may, but only within ninety (90) days after the end of such twelve (12)-month period, exercise his/her option to the extent that Optionee was entitled to exercise it at the end of such twelve (12)-month period. To the extent that Optionee was not entitled to exercise the option at the end of such twelve (12)-month period and to the extent Optionee does not exercise the exercisable portion of the option within the time specified herein, the option shall terminate.

(c) Nothwithstanding Section 6(i) above, in the case of an Optionee (1) who is in a job classification of director-level or above, (2) who ceases to serve as an Employee by reason of retirement (as defined above) and (3) who during the period beginning on the date of retirement and ending fifteen (15) months thereafter, does not directly or indirectly solicit, encourage or take any other action which is intended to induce or encourage, or has the effect of inducing or encouraging any employee of the Company to terminate his or her employment with the Company, then, subject to earlier termination under Section 10 below, for purposes of this Agreement, the option shall remain outstanding and exerciseable for fifteen (15) months after the date of retirement, to the extent that Optionee was entitled to exercise it at the date of retirement. To the extent the Optionee was not entitled to exercise the option on the date of retirement and to the extent the Optionee does not exercise the exerciseable portion of the option within the time specified herein, the option shall terminate. Notwithstanding the foregoing, in the event Optionee breaches the terms set forth in Section 6(ii)(c)(3), the option shall immediately terminate and no longer be exerciseable.

7) DISABILITY OF OPTIONEE

Notwithstanding the provisions of Section 6 above and subject to earlier termination as set forth in Section 10 below, if Optionee is unable to continue his employment relationship with the Company as a result of his total and permanent disability (as defined in Section 22(e)(3) of the Code), he may, but only within six (6) months after the date he ceases to be an Employee of the Company and only to the extent of the right to exercise that would have accrued in accordance with Section 3(i)(b) hereof had Optionee remained in Continuos Status as an employee for 12 months after the date of such termination. To the extent that he was not entitled to exercise the option at the date of such termination, and into the extent that he does not exercise the exerciseable portion of the option within the time specified herein, the option shall terminate.

8) DEATH OF OPTIONEE

Notwithstanding the provisions of Section 6 above and subject to Section 10 below, in the event of the death of Optionee:

(i) during the option period while an Employee of the Company and having been in Continuous Status as an Employee since the date of grant of the option, the option may be exercised, at any time within six (6) months following the date of death, by the Optionee’s estate or by a person who acquired the right to exercise the option by bequest or inheritance, but only to the extent of the right to exercise that would have accrued in accordance with Section 3(i)(b) hereof had the Optionee continued living and remained in Continuous Status as an Employee for 12 months after the date of death; or

(ii) within one (1) month after the termination of the Optionee’s Continuous Status as an Employee, the option may be exercised, at any time within six (6) months following the date of death, by the Optionee’s estate or by a person who acquired the right to exercise the option by bequest or inheritance, but only to the extent of the right to exercise that had accrued in accordance with Section 3(i)(b) hereof at the date of termination. To the extent that he was not entitled to exercise the option at the date of death (in accordance with the above), and to the extent that he does not exercise the exerciseable portion of the option within the times specified herein, the option will terminate.

Revised June 2004 – Michael Dillon

9) NON-TRANSFERABILITY OF OPTION

This option may not be transferred in any manner otherwise than by will or by the laws of descent or distribution and may be exercised during the lifetime of the Optionee only by him. The terms of this option shall be binding upon the executors, administrators, heirs, successors and assigns of the Optionee.

10) TERM OF OPTION

This Option may not be exercised more than eight years from the date of grant of this option, and may be exercised during such term only in accordance with the Plan and the terms of this option.

11) ADDITIONAL TERMS FOR OPTIONS GRANTED TO EMPLOYEES OUTSIDE THE UNITED STATES

(i) DATA PRIVACY

Optionee hereby explicitly and unambiguously consents to the collection, use and transfer, in electronic or other form, of personal data as described in this document by and among, as applicable, employer (“Employer”), and Company, including its subsidiaries and affiliates, for the exclusive purpose of implementing, administering and managing Optionee’s participation in the Plan. Optionee understands that the Company and Optionee’s Employer hold certain personal information, including, but not limited to, Optionee’s name, home address and telephone number, date of birth, social insurance number or other identification number, salary, nationality, job title, any shares of stock or directorships held in the Company, details of all options or any other entitlement to shares of stock awarded, canceled, exercised, vested, unvested or outstanding in Optionee’s favor, for the purpose of implementing, administering and managing the Plan (“Data”). Optionee understands that Data may be transferred to any third parties assisting in the implementation, administration and management of the Plan, that these recipients may be located in Optionee’s country, or elsewhere, and that the recipient’s country may have different data privacy laws and protections than Optionee’s country. Optionee authorizes the recipients to receive, possess, use, retain and transfer the Data, in electronic or other form, for the purposes of implementing, administering and managing Optionee’s participation in the Plan, including any requisite transfer of such Data as may be required to a broker or other third party with whom Optionee may elect to deposit any shares of stock acquired upon exercise of the option. Optionee understands that Data will be held only as long as is necessary to implement, administer and manage Optionee’s participation in the Plan. Optionee understands that he or she may, at any time, view Data, request additional information about the storage and processing of Data, require any necessary amendments to Data or withdraw the consents herein by contacting in writing Optionee’s local human resources representative. Optionee understands that withdrawal of consent may affect his or her ability to exercise or realize benefits from the option.

(ii) NATURE OF GRANT

In accepting the grant, Optionee acknowledges that: (i) the Plan is discretionary in nature and may be suspended or terminated by the Company at any time; (ii) the grant of the options is voluntary and occasional and does not create any contractual or other right to receive future grants of options, or benefits in lieu of options even if options have been granted repeatedly in the past; (iii) all decisions with respect to any such future grants will be at the sole discretion of the Company; (iv) Optionee’s participation in the Plan shall not create a right to further employment with Optionee’s Employer and shall not interfere with the ability of Optionee’s Employer to terminate Optionee’s employment relationship at any time with or without cause; (v) Optionee’s participation in the Plan is voluntary; (vi) the value of the option is an extraordinary item of compensation which is outside the scope of Optionee’s employment contract, if any; (vii) the options are not part of normal or expected compensation or salary for any purposes, including, but not limited to, calculating any severance, resignation, redundancy, end of service payments, bonuses, long-service awards, pension or retirement benefits or similar payments; (viii) in the event of involuntary termination of Optionee’s employment, Optionee’s right to receive the options and vest in the options under the Plan, if any, will terminate effective as of the date that Optionee is no longer actively employed regardless of any reasonable notice period mandated under local law; furthermore, in the event of involuntary termination of employment, Optionee’s right to exercise the options after termination of employment, if any, will be measured by the date of termination of Optionee’s active employment and will not be extended by any reasonable notice period mandated under local law; (ix) the options have been granted to Optionee in his or her status as an employee of Optionee’s Employer, and, in the event that Optionee’s Employer is not the Company the option grant can in no event be understood or interpreted to mean that the Company is the Optionee’s employer or that Optionee has an employment relationship with the Company; (x) the future value of the underlying shares is unknown and cannot be predicted with certainty; (xi) if the underlying shares do not increase in value, the options will have no value; and (xii) no claim or entitlement to compensation or damages arises from termination of the options or diminution in value of the options or Shares purchased through exercise of the options and Optionee irrevocably releases the Company and Employer from any such claim that may arise.

(iii) RESPONSIBILITY FOR TAXES

Optionee hereby acknowledges and agrees that the ultimate liability for any and all tax, social insurance and payroll tax withholding (“Tax-Related Items”) is and remains Optionee’s responsibility and liability and that the Company and/or

Optionee’s Employer (a) make no representations or undertakings regarding the treatment of any Tax-Related Items in connection with any aspect of the option grant, including the grant, vesting or exercise of the option and the subsequent sale of Shares acquired pursuant to such exercise; and (b) do not commit to structure the terms of the grant or any aspect of the option to reduce or eliminate Optionee’s liability for Tax-Related Items. Prior to exercise of the option, Optionee shall pay or make adequate arrangements satisfactory to the Company and/or Optionee’s Employer to satisfy all withholding obligations of the Company and/or Optionee’s Employer. In this regard, Optionee authorizes the Company and/or the Optionee’s Employer to withhold all applicable Tax-Related Items legally payable by Optionee from Optionee’s wages or other cash compensation paid to Optionee by the Company and/or Optionee’s Employer or from proceeds of sale. Alternatively, or in addition, if permissible under local law, the Company may sell or arrange for the sale of Shares that Optionee is due to acquire to meet the minimum withholding obligation for Tax Related Items. Any estimated withholding which is not required in satisfaction of any Tax Related Items will be repaid to Optionee by the Company or Optionee’s Employer. Finally, Optionee shall pay to the Company or Optionee’s Employer any amount of any Tax Related Items that the Company or Optionee’s Employer may be required to withhold as a result of Optionee’s participation in the Plan or Optionee’s purchase of Shares that cannot be satisfied by the means previously described.

The Optionee acknowledges receipt of a copy of the Plan Summary, a copy of which is annexed hereto, and represents that Optionee is familiar with the terms and provisions thereof, and hereby accepts this option subject to all of the terms and provisions thereof. The Optionee hereby agrees to accept as binding, conclusive and final all decisions or interpretations of the Board or of the Committee upon any questions arising under the Plan.

Revised June 2004 – Michael Dillon

DATE OF GRANT: <GRANT_DATE>

APPROVED BY: SUN MICROSYSTEMS, INC.,

Michael Dillon Sr. Vice President, General Counsel & Secretary

OPTIONEE SIGNATURE

DATE SIGNED (DD/MM/YY)

Exhibit 10.10

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 is adopted effective July 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;

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

Effective Date July 1, 2005 Page 1 of 15

• Employed at the Vice President level or above; and

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. Conditions For Receiving Plan Benefits You will receive Plan benefits if you are an Eligible Employee and meet all of the following conditions:

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

Headcount Policy.

• 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

“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 the purposes of this Plan means your voluntary resignation from Sun at or 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.

• 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.

Effective Date July 1, 2005 Page 2 of 15

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 an 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.

Temporary Job Assignments

• 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.

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 Effective Date July 1, 2005 Page 3 of 15

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 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

Effective Date July 1, 2005 Page 4 of 15

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 will be ineligible to receive Plan benefits if:

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

• 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

Notification Benefits

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

You need not sign a Release and Waiver Agreement in order to be eligible for Notification Benefits. 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 thirty-nine (39) weeks. The period of Employment Transition services available to you begins running on the date of your Termination Letter.

• Vesting of Stock Options. If you are eligible for benefits under the Plan due to your Retirement, vesting of your stock options will continue for 15 months after the date of your Retirement.

Effective Date July 1, 2005 Page 5 of 15

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 after your employment termination date (as determined by Sun in its sole discretion) 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

The Severance Payment and Severance COBRA 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 and Severance COBRA 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. A partial year of service will be treated as a full year of service. A “Severance COBRA Payment” for purposes of this Plan is based on the monthly 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. The Severance COBRA Payment is calculated based on the COBRA premiums in effect on your employment termination date. If you are not eligible for COBRA continuation coverage at the time you terminate employment, for example,

• Severance COBRA Payment (defined below). This is a lump sum payment based on four (4) weeks of COBRA

premiums for each Year of Service up to a maximum determined by your Position plus sixteen (16) or thirty-two (32) weeks of COBRA premiums determined by your Position.

Effective Date July 1, 2005 Page 6 of 15

because you waived Sun medical, dental and vision coverage, you will not receive a Severance COBRA Payment under this Plan. “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 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 an employee’s 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.

*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 agreement 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.

Effective Date July 1, 2005 Page 7 of 15

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. Incentive Pay Programs The Plan does not change the terms of any incentive pay program for which you may have been eligible at the time of your termination with Sun. Accordingly, if you are eligible for incentive pay 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 incentive pay for the quarter or fiscal year in which you terminate employment, except to the extent the incentive pay program provides otherwise. Unless the incentive pay program provides otherwise, incentive plan 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 Effective Date July 1, 2005 Page 8 of 15

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.

SUN MICROSYSTEMS, INC. U.S. VICE PRESIDENT SEVERANCE PLAN

SUMMARY OF PLAN BENEFITS

To receive the Severance Payment and Severance COBRA Payment, 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

SEVERANCE COBRA PAYMENT

Vice President

16 weeks of Pay

39 weeks 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

39 weeks 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

Effective Date July 1, 2005 Page 9 of 15

IMPORTANT NOTES TO SUMMARY OF PLAN BENEFITS

Plan Operation, Administration and General Provisions

NOTIFICATION PAYMENT

EMPLOYMENT TRANSITION SERVICES

SEVERANCE PAYMENT

SEVERANCE COBRA PAYMENT

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. Lump sum Severance COBRA Payment 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. Severance COBRA Payment is based on COBRA premiums in effect on employment termination date. 4. The 16 weeks/32 weeks additional COBRA payment is not included for purpose of calculating the maximum COBRA payment based on Years of Service.

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 payment you receive under any plan, or agreement, if any (including any payments pursuant to a Sun foreign subsidiary’s or an acquired company’s plan or agreement). 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. Effective Date July 1, 2005 Page 10 of 15

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. 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. 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 Effective Date July 1, 2005 Page 11 of 15

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. 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 Effective Date July 1, 2005 Page 12 of 15

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. 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 Effective Date July 1, 2005 Page 13 of 15

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. 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. Effective Date July 1, 2005 Page 14 of 15

Execution To record the adoption of the Plan effective July 1, 2005 as set forth herein, Sun Microsystems, Inc. has caused its authorized representative to sign this document the day of June, 2005.

Sun Microsystems, Inc.

By:

Printed Name: William N. MacGowanTitle: Senior Vice President, Human Resources

Effective Date July 1, 2005 Page 15 of 15

EXHIBIT 10.15

Chief Executive Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus Plan

Plan Objective Sun’s Chief Executive Officer Bonus Terms for FY06 under its Section 162(m) Executive Officer Performance-Based Bonus Plan (the “Plan”) are designed to compensate the Chief Executive Officer (“CEO”) for contributions to Sun during the fiscal year. The Plan provides for quarterly cash compensation based on performance against the Plan measures. Plan Year/Performance Periods The Plan year is Sun’s fiscal year 2006. The Performance Periods (as such term is defined in the Plan) are each of Sun’s four fiscal quarters during that fiscal year. Eligibility These terms apply to the person serving as Sun’s CEO as of July 1, 2005. In order to receive a bonus payment with respect to any fiscal quarter, the participant must be serving as Sun’s CEO as of the last day of that fiscal quarter, except as provided below. A participant who retires, becomes disabled, or dies during any fiscal quarter may receive a prorated bonus for the period of time during the fiscal quarter that the participant provided services to Sun. A participant who leaves Sun prior to the end of a fiscal quarter for any other reason, including but not limited to a reduction in force, voluntary resignation, or termination by Sun, will be ineligible for a bonus payment with respect to that fiscal quarter and any subsequent fiscal quarter during fiscal year 2006. Bonus Target The participant’s bonus target under the Plan is 2,500% of the participant’s Eligible Wages for fiscal year 2006, as determined below (the “Bonus Target”). The Bonus Target is divided between the four fiscal quarters of fiscal year 2006 as follows (each, a “Quarterly Bonus Target”):

For example, for FY06 Q1, the Quarterly Bonus Target would be 2,500% multiplied by 10%, or 250% of Eligible Wages for that quarter. Payouts under the Plan are capped at the lesser of 300% of the Bonus Target or $7.5 million for fiscal year 2006. Eligible Wages

Fiscal Quarter

Percentage

Quarterly Bonus Target

FY06 Q1 10% 250%FY06 Q2 25% 625%FY06 Q3 25% 625%FY06 Q4 40% 1,000%

Eligible Wages with respect to any fiscal quarter in fiscal year 2006 (“Eligible Wages”) shall be determined based upon the participant’s annual base salary on the last day of such fiscal quarter (September 25, 2005 for FY06 Q1, December 25, 2005 for FY 06 Q2, March 26, 2006 for FY06 Q3, and June 30, 2006 for FY06 Q4). For example, for FY06 Q2, assuming the participant’s annual base salary on December 25, 2005 was $127,000, the participant’s Eligible Wages would be $127,000.

Page 1 of 4

Chief Executive Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus Plan

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

Company Performance Measures The Plan is based on performance against the following measures: 1. FY06 Q1- quarterly Operating Income;

2. FY06 Q2 - quarterly Operating Income;

3. FY06 Q3 – quarterly Operating Income; and

For FY06 Q4, quarterly Operating Income, annual Free Cash Flow, and annual Revenue are relatively weighted as follows: 50%, 25% and 25%. Operating Income: “Operating Income” is defined as GAAP Operating Income adjusted to exclude the impact of the following:

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

• Restructuring charges

• In-process R & D charges

• Intangible impairment charges

• Stock compensation expense

Free Cash Flow: “Free Cash Flow” is defined as GAAP Cash Flow from Operations, adjusted to exclude cash flow associated with:

• FY06 bonus accrual

• Restructuring activity

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

• Real estate transactions

Attached hereto is a schedule (the “Schedule”), which provides percentages based upon Sun’s actual performance against the Company’s goal(s) with respect to the Company Performance Measures for each quarter. The Bonus Plan Funding Percentage is determined for each fiscal quarter as follows: 1. With respect to the first three fiscal quarters: By referring to the Schedule, which provides a percentage based on Sun’s actual performance against its goal with respect to quarterly Operating Income.

Page 2 of 4

Chief Executive Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus Plan

2. With respect to the fourth fiscal quarter: By referral to the Schedule, which provides percentages based on Sun’s actual performance against its goals with respect to quarterly Operating Income, annual Free Cash Flow and annual Revenue and then relatively weighting these percentages as described above under the heading “Company Performance Measures.” With respect to each fiscal quarter, this percentage is referred to as the “Bonus Plan Funding Percentage”. Bonus Calculation The participant’s quarterly bonus payment for each fiscal quarter of fiscal year 2006 will be calculated as follows:

Quarterly Bonus Target x Bonus Plan Funding Percentage x Eligible Wages = Actual Quarterly Bonus Payment*

1. Example: In FY06 Q2, if Sun achieves 100% of its Operating Income goal, the participant’s actual quarterly bonus

payment will be calculated as follows:

Quarterly Bonus Target 625%Bonus Plan Funding Percentage X 100%Eligible Wages X $127,000

Actual Quarterly Bonus Payment for FY06 Q2* $793,750

2. Example: In FY06 Q4, if Sun achieves 100% of its quarterly Operating Income goal, 70% of its annual Free Cash Flow

goal, and 90% of its Revenue goal, the actual participant’s quarterly bonus payment will be calculated as follows:

Step One – Determine Bonus Plan Funding Percentage:

Step Two – Determine actual quarterly bonus payment:

Page 3 of 4

Company Actual Performance for FY06 Q4

Percentage fromSchedule

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%

Quarterly Bonus Target 1,000%Bonus Plan Funding Percentage X 90%

Chief Executive Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus Plan

Bonus Payment

Eligible Wages X $ 127,000

Actual Quarterly Bonus Payment for FY06 Q4* $1,143,000

* Before applicable taxes and other withholdings, if any.

In the U.S., bonus awards are taxable income, and should be paid within 75 days after the close of each fiscal quarter. Bonuses are paid in accordance with local payroll schedules in countries outside the U.S and subject to local and regional tax provisions. Communication of Results With respect to any particular fiscal quarter during fiscal year 2006, results will be communicated as soon as possible after Sun’s quarterly financial results are publicly announced. General This Plan is in all respects subject to the terms, definitions and provisions of Sun’s Section 162(m) Executive Officer Performance-Based Bonus Plan, which is incorporated herein by reference.

Page 4 of 4

EXHIBIT 10.16

Chief Operating Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus Plan

Plan Objective Sun’s Chief Operating Officer Bonus Terms for FY06 under its Section 162(m) Executive Officer Performance-Based Bonus Plan (the “Plan”) are designed to compensate the Chief Operating Officer (“COO”) for contributions to Sun during the fiscal year. The Plan provides for quarterly cash compensation based on performance against the Plan measures. Plan Year/Performance Periods The Plan year is Sun’s fiscal year 2006. The Performance Periods (as such term is defined in the Plan) are each of Sun’s four fiscal quarters during that fiscal year. Eligibility These terms apply to the person serving as Sun’s COO as of July 1, 2005. In order to receive a bonus payment with respect to any fiscal quarter, the participant must be serving as Sun’s COO as of the last day of that fiscal quarter, except as provided below. A participant who retires, becomes disabled, or dies during any fiscal quarter may receive a prorated bonus for the period of time during the fiscal quarter that the participant provided services to Sun. A participant who leaves Sun prior to the end of a fiscal quarter for any other reason, including but not limited to a reduction in force, voluntary resignation, or termination by Sun, will be ineligible for a bonus payment with respect to that fiscal quarter and any subsequent fiscal quarter during fiscal year 2006. Bonus Target The participant’s bonus target under the Plan is 200% of the participant’s Eligible Wages for fiscal year 2006, as determined below (the “Bonus Target”). The Bonus Target is divided between the four fiscal quarters of fiscal year 2006 as follows (each, a “Quarterly Bonus Target”):

For example, for FY06 Q1, the Quarterly Bonus Target would be 200% multiplied by 10%, or 20% of Eligible Wages for that quarter. Payouts under the Plan are capped at the lesser of 300% of the Bonus Target or $7.5 million for fiscal year 2006. Eligible Wages

Fiscal Quarter

Percentage

Quarterly Bonus Target

FY06 Q1 10% 20%FY06 Q2 25% 50%FY06 Q3 25% 50%FY06 Q4 40% 80%

Eligible Wages with respect to any fiscal quarter in fiscal year 2006 (“Eligible Wages”) shall be determined based upon the participant’s annual base salary on the last day of such fiscal quarter (September 25, 2005 for FY06 Q1, December 25, 2005 for FY 06 Q2, March 26, 2006 for FY06 Q3, and June 30, 2006 for FY06 Q4). For example, for FY06 Q2, assuming the participant’s annual base salary on December 25, 2005 was $900,000, the participant’s Eligible Wages would be $900,000.

Page 1 of 4

Chief Operating Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus Plan

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

Company Performance Measures The Plan is based on performance against the following measures: 1. FY06 Q1- quarterly Operating Income;

2. FY06 Q2 - quarterly Operating Income;

3. FY06 Q3 – quarterly Operating Income; and

For FY06 Q4, quarterly Operating Income, annual Free Cash Flow, and annual Revenue are relatively weighted as follows: 50%, 25% and 25%. Operating Income: “Operating Income” is defined as GAAP Operating Income adjusted to exclude the impact of the following:

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

• Restructuring charges

• In-process R & D charges

• Intangible impairment charges

• Stock compensation expense

Free Cash Flow: “Free Cash Flow” is defined as GAAP Cash Flow from Operations, adjusted to exclude cash flow associated with:

• FY06 bonus accrual

• Restructuring activity

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

• Real estate transactions

Attached hereto is a schedule (the “Schedule”), which provides percentages based upon Sun’s actual performance against the Company’s goal(s) with respect to the Company Performance Measures for each quarter. The Bonus Plan Funding Percentage is determined for each fiscal quarter as follows: 1. With respect to the first three fiscal quarters: By referring to the Schedule, which provides a percentage based on Sun’s actual performance against its goal with respect to quarterly Operating Income.

Page 2 of 4

Chief Operating Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus Plan

2. With respect to the fourth fiscal quarter: By referral to the Schedule, which provides percentages based on Sun’s actual performance against its goals with respect to quarterly Operating Income, annual Free Cash Flow and annual Revenue and then relatively weighting these percentages as described above under the heading “Company Performance Measures.” With respect to each fiscal quarter, this percentage is referred to as the “Bonus Plan Funding Percentage”. Bonus Calculation The participant’s quarterly bonus payment for each fiscal quarter of fiscal year 2006 will be calculated as follows:

Quarterly Bonus Target x Bonus Plan Funding Percentage x Eligible Wages = Actual Quarterly Bonus Payment*

1. Example: In FY06 Q2, if Sun achieves 100% of its Operating Income goal, the participant’s actual quarterly bonus

payment will be calculated as follows:

Quarterly Bonus Target 50%Bonus Plan Funding Percentage X 100%Eligible Wages X $900,000

Actual Quarterly Bonus Payment for FY06 Q2* $450,000

2. Example: In FY06 Q4, if Sun achieves 100% of its quarterly Operating Income goal, 70% of its annual Free Cash Flow

goal, and 90% of its Revenue goal, the actual participant’s quarterly bonus payment will be calculated as follows:

Step One – Determine Bonus Plan Funding Percentage:

Step Two – Determine actual quarterly bonus payment:

Page 3 of 4

Company Actual Performance for FY06 Q4

Percentage fromSchedule

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%

Quarterly Bonus Target 80%Bonus Plan Funding Percentage X 90%

Chief Operating Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus Plan

Bonus Payment

Eligible Wages X $900,000

Actual Quarterly Bonus Payment for FY06 Q4* $648,000

* Before applicable taxes and other withholdings, if any.

In the U.S., bonus awards are taxable income, and should be paid within 75 days after the close of each fiscal quarter. Bonuses are paid in accordance with local payroll schedules in countries outside the U.S and subject to local and regional tax provisions. Communication of Results With respect to any particular fiscal quarter during fiscal year 2006, results will be communicated as soon as possible after Sun’s quarterly financial results are publicly announced. General This Plan is in all respects subject to the terms, definitions and provisions of Sun’s Section 162(m) Executive Officer Performance-Based Bonus Plan, which is incorporated herein by reference.

Page 4 of 4

Exhibit 10.17

SMX Staff Executive Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus

Plan Plan Objective Sun’s SMX Staff Executive Officer Bonus Terms for FY06 under its Section 162(m) Executive Officer Performance-Based Bonus Plan (the “Plan”) are designed to compensate Executive Officers who are SMX Staff members, other than the Chief Executive Officer (“SMX Staff”) for contributions to Sun during the fiscal year. The Plan provides for quarterly cash compensation based on performance against the Plan measures. Plan Year/Performance Periods The Plan year is Sun’s fiscal year 2006. The Performance Periods (as such term is defined in the Plan) are each of Sun’s four fiscal quarters during that fiscal year. Eligibility These terms apply to persons serving as members of Sun’s SMX Staff as of July 1, 2005. In order to receive a bonus payment with respect to any fiscal quarter, the participant must be serving as a member of Sun’s SMX Staff as of the last day of that fiscal quarter, except as provided below. A participant who retires, becomes disabled, or dies during any fiscal quarter may receive a prorated bonus for the period of time during the fiscal quarter that the participant provided services to Sun. A participant who leaves Sun prior to the end of a fiscal quarter for any other reason, including but not limited to a reduction in force, voluntary resignation, or termination by Sun, will be ineligible for a bonus payment with respect to that fiscal quarter and any subsequent fiscal quarter during fiscal year 2006. Bonus Target The bonus target under the Plan for members of SMX Staff is 90% of the participant’s Eligible Wages for fiscal year 2006, as determined below (the “Bonus Target”). The Bonus Target is divided between the four fiscal quarters of fiscal year 2006 as follows (each, a “Quarterly Bonus Target”):

For example, for FY06 Q1, the Quarterly Bonus Target would be 90% multiplied by 10%, or 9% of Eligible Wages for that quarter. Payouts under the Plan are capped at the lesser of 300% of the Bonus Target or $7.5 million for fiscal year 2006. Eligible Wages

Fiscal Quarter

Percentage

Quarterly Bonus Target

FY06 Q1 10% 9%FY06 Q2 25% 22.5%FY06 Q3 25% 22.5%FY06 Q4 40% 36%

Eligible Wages with respect to any fiscal quarter in fiscal year 2006 (“Eligible Wages”) shall be determined based upon the participant’s annual base salary on the last day of such fiscal quarter (September 25, 2005 for FY06 Q1, December 25, 2005 for FY 06 Q2, March 26, 2006 for FY06 Q3, and June 30, 2006 for FY06 Q4). For example, for FY06 Q2, assuming the participant’s annual base salary on December 25, 2005 was $400,000, the participant’s Eligible Wages would be $400,000.

Page 1 of 4

SMX Staff Executive Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus

Plan

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

Company Performance Measures The Plan is based on performance against the following measures: 1. FY06 Q1- quarterly Operating Income; 2. FY06 Q2 - quarterly Operating Income; 3. FY06 Q3 – quarterly Operating Income; and 4. FY06 Q4- quarterly Operating Income, annual Free Cash Flow, and annual Revenue. For FY06 Q4, quarterly Operating Income, annual Free Cash Flow, and annual Revenue are relatively weighted as follows: 50%, 25% and 25%. Operating Income: “Operating Income” is defined as GAAP Operating Income adjusted to exclude the impact of the following:

• Restructuring charges

• In-process R & D charges

• Intangible impairment charges

• Stock compensation expense

Free Cash Flow: “Free Cash Flow” is defined as GAAP Cash Flow from Operations, adjusted to exclude cash flow associated with:

• FY06 bonus accrual

• Restructuring activity

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

• Real estate transactions

Attached hereto is a schedule (the “Schedule”), which provides percentages based upon Sun’s actual performance against the Company’s goal(s) with respect to the Company Performance Measures for each quarter. The Bonus Plan Funding Percentage is determined for each fiscal quarter as follows: 1. With respect to the first three fiscal quarters: By referring to the Schedule, which provides a percentage based on Sun’s actual performance against its goal with respect to quarterly Operating Income.

Page 2 of 4

SMX Staff Executive Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus

Plan 2. With respect to the fourth fiscal quarter: By referral to the Schedule, which provides percentages based on Sun’s actual performance against its goals with respect to quarterly Operating Income, annual Free Cash Flow and annual Revenue and then relatively weighting these percentages as described above under the heading “Company Performance Measures.” With respect to each fiscal quarter, this percentage is referred to as the “Bonus Plan Funding Percentage”. Bonus Calculation The participant’s quarterly bonus payment for each fiscal quarter of fiscal year 2006 will be calculated as follows:

Quarterly Bonus Target

x Bonus Plan Funding Percentage

x Eligible Wages

= Actual Quarterly Bonus Payment*

Step One – Determine Bonus Plan Funding Percentage:

Step Two – Determine actual quarterly bonus payment:

Page 3 of 4

1. Example: In FY06 Q2, if Sun achieves 100% of its Operating Income goal, the participant’s actual quarterly bonus

payment will be calculated as follows:

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

2. Example: In FY06 Q4, if Sun achieves 100% of its quarterly Operating Income goal, 70% of its annual Free Cash Flow

goal, and 90% of its Revenue goal, the actual participant’s quarterly bonus payment will be calculated as follows:

Company Actual Performance for FY06 Q4

Percentage fromSchedule

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%

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

* Before applicable taxes and other withholdings, if any.

SMX Staff Executive Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus

Plan Bonus Payment In the U.S., bonus awards are taxable income, and should be paid within 75 days after the close of each fiscal quarter. Bonuses are paid in accordance with local payroll schedules in countries outside the U.S and subject to local and regional tax provisions. Communication of Results With respect to any particular fiscal quarter during fiscal year 2006, results will be communicated as soon as possible after Sun’s quarterly financial results are publicly announced. General This Plan is in all respects subject to the terms, definitions and provisions of Sun’s Section 162(m) Executive Officer Performance-Based Bonus Plan, which is incorporated herein by reference.

Page 4 of 4

Exhibit 10.18

EMG Staff Executive Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus

Plan Plan Objective Sun’s EMG Staff Executive Officer Bonus Terms for FY06 under its Section 162(m) Executive Officer Performance-Based Bonus Plan (the “Plan”) are designed to compensate Executive Officers who are EMG Staff members (“EMG Staff”) for contributions to Sun during the fiscal year. The Plan provides for quarterly cash compensation based on performance against the Plan measures. Plan Year/Performance Periods The Plan year is Sun’s fiscal year 2006. The Performance Periods (as such term is defined in the Plan) are each of Sun’s four fiscal quarters during that fiscal year. Eligibility These terms apply to persons serving as members of Sun’s EMG Staff as of July 1, 2005. In order to receive a bonus payment with respect to any fiscal quarter, the participant must be serving as a member of Sun’s EMG Staff as of the last day of that fiscal quarter, except as provided below. A participant who retires, becomes disabled, or dies during any fiscal quarter may receive a prorated bonus for the period of time during the fiscal quarter that the participant provided services to Sun. A participant who leaves Sun prior to the end of a fiscal quarter for any other reason, including but not limited to a reduction in force, voluntary resignation, or termination by Sun, will be ineligible for a bonus payment with respect to that fiscal quarter and any subsequent fiscal quarter during fiscal year 2006. Bonus Target The bonus targets under the Plan for members of EMG Staff range from 55% to 85% of the participant’s Eligible Wages for fiscal year 2006, as determined below (the “Bonus Target”). The Bonus Target is divided between the four fiscal quarters of fiscal year 2006 as provided in the table below (each, a “Quarterly Bonus Target”). For example, if a participant’s Bonus Target is 60%, the participant’s Bonus Target would be divided into Quarterly Bonus Targets as follows:

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

Fiscal Quarter

Percentage

Quarterly Bonus Target

FY06 Q1 10% 6%FY06 Q2 25% 15%FY06 Q3 25% 15%FY06 Q4 40% 24%

Eligible Wages with respect to any fiscal quarter in fiscal year 2006 (“Eligible Wages”) shall be determined based upon the participant’s annual base salary on the last day of such fiscal quarter (September 25, 2005 for FY06 Q1, December 25, 2005 for FY 06 Q2, March 26, 2006 for FY06 Q3, and June 30, 2006 for FY06 Q4). For example, for FY06 Q2, assuming the participant’s annual base salary on December 25, 2005 was $300,000, the participant’s Eligible Wages would be $300,000.

Page 1 of 4

EMG Staff Executive Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus

Plan

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

Company Performance Measures The Plan is based on performance against the following measures: 1. FY06 Q1 - quarterly Operating Income; 2. FY06 Q2 - quarterly Operating Income; 3. FY06 Q3 – quarterly Operating Income; and 4. FY06 Q4- quarterly Operating Income, annual Free Cash Flow, and annual Revenue. For FY06 Q4, quarterly Operating Income, annual Free Cash Flow, and annual Revenue are relatively weighted as follows: 50%, 25% and 25%. Operating Income: “Operating Income” is defined as GAAP Operating Income adjusted to exclude the impact of the following:

• Restructuring charges

• In-process R & D charges

• Intangible impairment charges

• Stock compensation expense

Free Cash Flow: “Free Cash Flow” is defined as GAAP Cash Flow from Operations, adjusted to exclude cash flow associated with:

• FY06 bonus accrual

• Restructuring activity

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

• Real estate transactions

Attached hereto is a schedule (the “Schedule”), which provides percentages based upon Sun’s actual performance against the Company’s goal(s) with respect to the Company Performance Measures for each quarter. The Bonus Plan Funding Percentage is determined for each fiscal quarter as follows: 1. With respect to the first three fiscal quarters: By referring to the Schedule, which provides a percentage based on Sun’s actual performance against its goal with respect to quarterly Operating Income.

Page 2 of 4

EMG Staff Executive Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus

Plan 2. With respect to the fourth fiscal quarter: By referral to the Schedule, which provides percentages based on Sun’s actual performance against its goals with respect to quarterly Operating Income, annual Free Cash Flow and annual Revenue and then relatively weighting these percentages as described above under the heading “Company Performance Measures.” With respect to each fiscal quarter, this percentage is referred to as the “Bonus Plan Funding Percentage”. Bonus Calculation The participant’s quarterly bonus payment for each fiscal quarter of fiscal year 2006 will be calculated as follows:

Quarterly Bonus Target

x Bonus Plan Funding Percentage

x Eligible Wages

= Actual Quarterly Bonus Payment*

1. Example: In FY06 Q2, if Sun achieves 100% of its Operating Income goal, the participant’s actual quarterly bonus

payment will be calculated as follows:

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

2. Example: In FY06 Q4, if Sun achieves 100% of its quarterly Operating Income goal, 70% of its annual Free Cash Flow

goal, and 90% of its Revenue goal, the actual participant’s quarterly bonus payment will be calculated as follows:

Step One – Determine Bonus Plan Funding Percentage:

Step Two – Determine actual quarterly bonus payment:

Page 3 of 4

Company Actual Performance for FY06 Q4

Percentage fromSchedule

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%

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

* Before applicable taxes and other withholdings, if any.

EMG Staff Executive Officer Bonus Terms for FY06 Under the Section 162(m) Executive Officer Performance-Based Bonus

Plan Bonus Payment In the U.S., bonus awards are taxable income, and should be paid within 75 days after the close of each fiscal quarter. Bonuses are paid in accordance with local payroll schedules in countries outside the U.S and subject to local and regional tax provisions. Communication of Results With respect to any particular fiscal quarter during fiscal year 2006, results will be communicated as soon as possible after Sun’s quarterly financial results are publicly announced. General This Plan is in all respects subject to the terms, definitions and provisions of Sun’s Section 162(m) Executive Officer Performance-Based Bonus Plan, which is incorporated herein by reference.

Page 4 of 4

Exhibit 21.1

Sun Microsystems, Inc. Subsidiaries

Jurisdiction of Incorporation or Formation

3055855 Nova Scotia Company Canada514713 N.B. Inc. CanadaAfara Websystems, Inc. DelawareBeduin Nova Scotia Company CanadaBelle Gate Investment B.V. NetherlandsBlue Spruce Networks, Inc. DelawareCenterRun, Inc. DelawareChili!Soft, Inc. CaliforniaClustra Systems Inc. DelawareClustra Systems Limited United KingdomCobalt Networks B.V. NetherlandsCobalt Networks GmbH GermanyCobalt Networks Inc. DelawareCobalt Networks (UK) Limited United KingdomCobalt Progressive Systems, Inc. DelawareDakota Scientific Software, Inc. South DakotaDiba, Inc. DelawareEd Learning Systems, Inc. Tennesseee-tech, inc. TennesseeForte Software, Inc. DelawareForte Software Canada, Ltd. CanadaForte Software (UK) Limited United KingdomgrapeVine Technologies, L.L.C. DelawareHighGround Systems, Inc. DelawareHighGround Systems International, Inc. DelawareInfraSearch, Inc. DelawareInnosoft International, Inc. CaliforniaIntegrity Arts, Inc. Californiai-Planet, Inc. CaliforniaISOPIA Company CanadaISOPIA Corp. New YorkISOPIA Limited United KingdomJCP Computer Services Limited United KingdomKealia, LLC CaliforniaLighthouse Design Ltd. MarylandLighthouse Design R&D Corporation CaliforniaLSC, Incorporated MinnesotaMaxStrat Corporation CaliforniaNauticus Networks, Inc. DelawareNauticus Networks Securities Corporation MassachusettsNetDynamics International, Inc. CalifornianetIX System Consulting GmbH GermanyNihon Storage Technology Co. Ltd. JapanNiwot Acquisition Corp. DelawarePirus Networks, Inc. DelawarePixo, Inc. DelawarePixo International Holding Company CaliforniaPixo UK Limited United KingdomSarrus Software, Inc. CaliforniaSeeBeyond (Belguim) N.V. BelgiumSeeBeyond (Deutschland) GmbH GermanySeeBeyond (France) SARL FranceSeeBeyond (Italy) S.R.L. ItalySeeBeyond (Nordic) ApS Nordic

SeeBeyond (Norway) AS NorwaySeeBeyond (Schweiz) AG SwitzerlandSeeBeyond (Sweden) AB SwedenSeeBeyond (UK) Ltd. United KingdomSeeBeyond B.V. NetherlandsSeeBeyond Espana SL SpainSeeBeyond Limited (New Zealand) New ZealandSeeBeyond Pte Ltd. SingaporeSeeBeyond Pty Ltd. AustraliaSeeBeyond Technology Corporation DelawareSeeBeyond Technology Corporation Japan KK JapanSeeBeyond Technology Corporation Korea Ltd. KoreaSevenSpace, Inc. DelawareSolaris Assurance, Inc. Bermuda

Solaris Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CaliforniaSolaris Indemnity, Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . BermudaSTC Systems Pvt Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . AustraliaStorage Technology (Belgium) N.V./S.A. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . BelgiumStorage Technology (Bermuda) Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . BermudaStorage Technology (The Netherlands) B.V. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . NetherlandsStorage Technology Asia/Pacific, K.K. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . JapanStorage Technology Austria GmbH . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . AustriaStorage Technology Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . DelawareStorage Technology European Operations, S.A.S. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FranceStorage Technology France, S.A.S. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FranceStorage Technology GmbH . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . GermanyStorage Technology Holding GmbH . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . GermanyStorage Technology Holding Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United KingdomStorage Technology Italia, S.p.A. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ItalyStorage Technology Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United KingdomStorage Technology of Australia Pty., Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . AustraliaStorage Technology Sweden AB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SwedenStorageTek (Bermuda) Finance Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . BermudaStorageTek (China) Services Company Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ChinaStorageTek (Malaysia) Sdn. Bhd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . MalaysiaStorageTek (Netherlands Antilles) Holding N.V. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Netherlands AntillesStorageTek A/S . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . DenmarkStorageTek AG . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SwitzerlandStorageTek AS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . NorwayStorageTek Brasil Ltda. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . BrazilStorageTek Canada, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CanadaStorageTek Chile S.A. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ChileStorageTek de Mexico, S.A. de C.V. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . MexicoStorageTek Espana, S.A. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SpainStorageTek European Holding, B.V. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . NetherlandsStorageTek Global Trading B.V. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . NetherlandsStorageTek International Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . DelawareStorageTek International Corporation, Taiwan Branch (TW2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . TaiwanStorageTek International Services Corp. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . DelawareStorageTek Ireland Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . IrelandStorageTek Korea, Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . KoreaStorageTek New Zealand Pty., Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . New ZealandStorageTek North Asia Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Hong KongStorageTek OY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FinlandStorageTek Poland Sp. Zo.o. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . PolandStorageTek SBG Europe S.A.S. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FranceStorageTek South Asia Pte. Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SingaporeSun Microsystems AB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SwedenSun Microsystems AO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . RussiaSun Microsystems AS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . NorwaySun Microsystems Australia Pty. Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . AustraliaSun Microsystems (Barbados), Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . BarbadosSun Microsystems Belgium N.V./S.A. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . BelgiumSun Microsystems Benelux B.V. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . NetherlandsSun Microsystems (Bilgisayar Sistemleri) L.S. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . TurkeySun Microsystems Capital, LLC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . DelawareSun Microsystems Capital Investments Plc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . GibraltarSun Microsystems (China) Co., Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . People’s Republic of ChinaSun Microsystems China Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Hong KongSun Microsystems Consulting Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . People’s Republic of ChinaSun Microsystems Czech s.r.o. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Czech RepublicSun Microsystems Danmark A/S . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . DenmarkSun Microsystems de Argentina S.A. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ArgentinaSun Microsystems de Chile, S.A. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ChileSun Microsystems de Colombia, S.A. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ColombiaSun Microsystems de Mexico, S.A. de C.V. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . MexicoSun Microsystems de Venezuela, S.A. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Venezuela

Sun Microsystems of California, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CaliforniaSun Microsystems of California Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Hong KongSun Microsystems of Canada Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CanadaSun Microsystems Oy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FinlandSun Microsystems Poland Sp.z.o.o . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . PolandSun Microsystems (Portugal) Tecnicas de Informatica, Sociedade Unipessoal, Limitada . . . . . . . . . . . . . PortugalSun Microsystems Products, Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . People’s Republic of ChinaSun Microsystems Properties, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CaliforniaSun Microsystems Pte. Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SingaporeSun Microsystems Risk Management, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CaliforniaSun Microsystems (Schweiz) A.G. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SwitzerlandSun Microsystems Scotland B.V. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . NetherlandsSun Microsystems Scotland Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ScotlandSun Microsystems Scotland LP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ScotlandSun Microsystems Slovakia, s.r.o . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Slovak RepublicSun Microsystems (South Africa) (Pty) Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Republic of South AfricaSun Microsystems Superannuation Nominees Pty. Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . AustraliaSun Microsystems SPB LLC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Russian FederationSun Microsystems Taiwan Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . TaiwanSun Microsystems Technology Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . BermudaSun Microsystems Technology Pty. Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . AustraliaSun Microsystems (Thailand) Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ThailandSun Microsystems (U.A.E.) Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cayman IslandsSunSoft, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CaliforniaSunSoft International, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CaliforniaSun TSI Subsidiary, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . DelawareTerraspring, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . DelawareTerraspring (Private) Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . PakistanThe Sun Microsystems Foundation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CaliforniaTrustbase Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United KingdomWaveset Technologies, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . DelawareWaveset Technologies UK Limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United Kingdom

EXHIBIT 23.1

Consent of Independent Registered Public Accounting Firm

We consent to 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, 333-102920, 333-108639, 333-109303, 333-111968, 333-114550, 333-114551, 333-122586 and 333-127063; and Form S-3 Nos. 333-81101 and 333-63716) of Sun Microsystems, Inc. of ourreports dated September 12, 2005, with respect to the consolidated financial statements of Sun Microsystems, Inc., SunMicrosystems, Inc. management’s assessment of the effectiveness of internal control over financial reporting, and theeffectiveness of internal control over financial reporting of Sun Microsystems, Inc., included in this Annual Report(Form 10-K) for the year ended June 30, 2005.

/s/ ERNST & YOUNG LLP

San Jose, CaliforniaSeptember 12, 2005

Exhibit 31.1

CERTIFICATION

I, Scott G. McNealy, certify that:

1. I have reviewed this annual report on Form 10-K 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 amaterial fact necessary to make the statements made, in light of the circumstances under which suchstatements 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 theregistrant 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 disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controlover financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant andhave:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures tobe 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, particularlyduring the period in which this report is being prepared;

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

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in thisreport our conclusions about the effectiveness of the disclosure controls and procedures, as of the end ofthe 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 thatoccurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in thecase of an annual report) that has materially affected, or is reasonably likely to materially affect, theregistrant’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 ofinternal control over financial reporting, to the registrant’s auditors and the audit committee of theregistrant’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 overfinancial 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 asignificant role in the registrant’s internal control over financial reporting.

Date: September 13, 2005

/s/ SCOTT G. MCNEALY

Scott G. McNealy

Chief Executive Officer

Exhibit 31.2

CERTIFICATION

I, Stephen T. McGowan, certify that:

1. I have reviewed this annual report on Form 10-K 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 amaterial fact necessary to make the statements made, in light of the circumstances under which suchstatements 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 theregistrant 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 disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controlover financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant andhave:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures tobe 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, particularlyduring the period in which this report is being prepared;

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

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in thisreport our conclusions about the effectiveness of the disclosure controls and procedures, as of the end ofthe 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 thatoccurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in thecase of an annual report) that has materially affected, or is reasonably likely to materially affect, theregistrant’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 ofinternal control over financial reporting, to the registrant’s auditors and the audit committee of theregistrant’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 overfinancial 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 asignificant role in the registrant’s internal control over financial reporting.

Date: September 13, 2005

/s/ STEPHEN T. MCGOWAN

Stephen T. McGowan

Chief Financial Officer

Exhibit 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICERPURSUANT 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 Annual Report of Sun Microsystems, Inc. on Form 10-K for the period ended June 30,2005 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and thatinformation contained in such Annual Report on Form 10-K fairly presents in all material respects the financialcondition and results of operations of Sun Microsystems, Inc.

Date: September 13, 2005 By: /s/ SCOTT G. MCNEALY

Name: Scott G. McNealyTitle: Chief Executive Officer

Exhibit 32.2

CERTIFICATION OF CHIEF FINANCIAL OFFICERPURSUANT 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 theSarbanes-Oxley Act of 2002, that the Annual Report of Sun Microsystems, Inc. on Form 10-K for the period endedJune 30, 2005 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934and that information contained in such Annual Report on Form 10-K fairly presents in all material respects thefinancial condition and results of operations of Sun Microsystems, Inc.

Date: September 13, 2005 By: /s/ STEPHEN T. MCGOWAN

Name: Stephen T. McGowanTitle: Chief Financial Officer