##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)



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



For the quarterly period ended September 29, 2002or




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

For the transition period from ___ to ___

Commission file number: 0-15086



---



SUN MICROSYSTEMS, INC.
(Exact name of registrant as specified in its charter)

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

4150 Network Circle, Santa Clara, CA 95054
(Address of principal executive offices with zip code)

(650) 960-1300
(Registrants telephone number, including area code)

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



---



Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

|        |  |       
|------- |  | ------
|YES (X) |  | NO ( )

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

|                                  |  |                                 | 
|--------------------------------- |  | ------------------------------- | 
|Class                             |  | Outstanding at October 24, 2002 | 
|Common Stock  $0.00067 par value |  | 3,114,651,431                   | 







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TABLE OF CONTENTS



|                                       |                                                                                              |                                                                  |  |  |  |  |  | 
|-------------------------------------- | -------------------------------------------------------------------------------------------- | ---------------------------------------------------------------- |  |  |  |  |  | 
|PART I  FINANCIAL INFORMATION        
|                                       | ITEM 1. FINANCIAL STATEMENTS                                                                
|                                       |                                                                                              | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                 
|                                       |                                                                                              | CONDENSED CONSOLIDATED BALANCE SHEETS                           
|                                       |                                                                                              | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                 
|                                       |                                                                                              | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|INDEPENDENT ACCOUNTANTS REVIEW REPORT
|                                       | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
|                                       | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                          
|                                       | ITEM 4. CONTROLS AND PROCEDURES                                                             
|PART II  OTHER INFORMATION           
|                                       | ITEM 1. LEGAL PROCEEDINGS                                                                   
|                                       | ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                           
|                                       | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                    
|SIGNATURES                            
|CERTIFICATION                         
|INDEX TO EXHIBITS                     
|EXHIBIT 15.1                          
|EXHIBIT 99.1                          
|EXHIBIT 99.2                          



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##### Table of Contents



INDEX

|                                                                             |         |  |                                                                                       |  |    | 
|---------------------------------------------------------------------------- | ------- |  | ------------------------------------------------------------------------------------- |  | -- | 
|PART I  FINANCIAL INFORMATION                                               |         |  |                                                                                      
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Item 1. |  | Financial Statements:                                                                 |  |    | 
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             |         |  | Condensed Consolidated Statements of Operations                                       |  | 3  | 
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             |         |  | Condensed Consolidated Balance Sheets                                                 |  | 4  | 
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             |         |  | Condensed Consolidated Statements of Cash Flows                                       |  | 5  | 
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             |         |  | Notes to Condensed Consolidated Financial Statements                                  |  | 6  | 
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             |         |  | Independent Accountants Review Report                                                |  | 16 | 
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 17 | 
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Item 3. |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 38 | 
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Item 4. |  | Controls and Procedures                                                               |  | 39 | 
|                                                                            
|PART II  OTHER INFORMATION                                                  |         |  |                                                                                      
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Item 1. |  | Legal Proceedings                                                                     |  | 40 | 
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Item 2. |  | Changes in Securities and Use of Proceeds                                             |  | 41 | 
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Item 6. |  | Exhibits and Reports on Form 8-K                                                      |  | 41 | 
|                                                                            
|SIGNATURES                                                                   | 43      | 
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|SECURITIES EXCHANGE ACT RULE 13a-14 AND 15d-14 CERTIFICATIONS OF CEO AND CFO | 44      | 

2



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##### Table of Contents






PART I  FINANCIAL INFORMATION




ITEM 1. FINANCIAL STATEMENTS




SUN MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in millions, except per share amounts)

|                                                                              |  |   |                                               |                          |   |                    |       |                    |   |       |       |  
|----------------------------------------------------------------------------- |  | - | --------------------------------------------- | ------------------------ | - | ------------------ | ----- | ------------------ | - | ----- | ----- | -
|                                                                              |  |   |                                               |                          |   | Three Months Ended
|                                                                              |  |   |                                               |                          |   |                   
|                                                                              |  |   |                                               |                          |   | September 29, 2002 |       | September 30, 2001
|                                                                              |  |   |                                               |                          |   |                    |       |                   
|Net revenues:                                                                 |  |   |                                               |                          |   |                    |       |                   
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|                                                                              |  |   | Products                                      |                          | $ | 1,880              |       |                    | $ | 2,057 |      
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|                                                                              |  |   | Services                                      |                          |   | 867                |       |                    |   | 804   |      
|                                                                              |  |   |                                               |                          |   |                    |       |                   
|                                                                              |  |   |                                               | Total net revenues       |   |                    | 2,747 |                    |   |       | 2,861 |  
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|Cost of sales:                                                                |  |   |                                               |                          |   |                    |       |                   
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|                                                                              |  |   | Cost of sales-products                        |                          |   | 1,093              |       |                    |   | 1,287 |      
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|                                                                              |  |   | Cost of sales-services                        |                          |   | 522                |       |                    |   | 518   |      
|                                                                              |  |   |                                               |                          |   |                    |       |                   
|                                                                              |  |   |                                               | Total cost of sales      |   |                    | 1,615 |                    |   |       | 1,805 |  
|                                                                              |  |   |                                               |                          |   |                    |       |                   
|                                                                              |  |   |                                               | Gross margin             |   |                    | 1,132 |                    |   |       | 1,056 |  
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|Operating expenses:                                                           |  |   |                                               |                          |   |                    |       |                   
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|                                                                              |  |   | Research and development                      |                          |   | 437                |       |                    |   | 473   |      
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|                                                                              |  |   | Selling, general and administrative           |                          |   | 882                |       |                    |   | 961   |      
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|                                                                              |  |   | Restructuring charges                         |                          |   | 24                 |       |                    |   | 14    |      
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|                                                                              |  |   | Purchased in-process research and development |                          |   |                   |       |                    |   | 3     |      
|                                                                              |  |   |                                               |                          |   |                    |       |                   
|                                                                              |  |   |                                               | Total operating expenses |   |                    | 1,343 |                    |   |       | 1,451 |  
|                                                                              |  |   |                                               |                          |   |                    |       |                   
|                                                                              |  |   |                                               | Operating loss           |   |                    | (211  | )                  |   |       | (395  | )
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|Loss on equity investments, net                                               |  |   | (31                                           | )                        |   |                    | (19   | )                 
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|Interest income, net                                                          |  |   | 39                                            |                          |   |                    | 107   |                   
|                                                                              |  |   |                                               |                          |   |                    |       |                   
|                                                                              |  |   | Loss before income taxes                      |                          |   | (203               | )     |                    |   | (307  | )    
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|Benefit for income taxes                                                      |  |   | (92                                           | )                        |   |                    | (127  | )                 
|                                                                              |  |   |                                               |                          |   |                    |       |                   
|                                                                              |  |   | Net loss                                      |                          | $ | (111               | )     |                    | $ | (180  | )    
|                                                                              |  |   |                                               |                          |   |                    |       |                   
|Net
loss per common sharebasic and diluted                                   |  | $ | (0.04                                         | )                        |   | $                  | (0.06 | )                 
|                                                                              |  |   |                                               |                          |   |                    |       |                   
|Shares
used in the calculation of net loss per common sharebasic and diluted |  |   | 3,168                                         |                          |   |                    | 3,240 |                   
|                                                                              |  |   |                                               |                          |   |                    |       |                   

See accompanying notes.

3



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##### Table of Contents






SUN MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions)

|                                                 |                                                             |                           |        |                    |       |               |        |       |       | 
|------------------------------------------------ | ----------------------------------------------------------- | ------------------------- | ------ | ------------------ | ----- | ------------- | ------ | ----- | ----- | 
|                                                 |                                                             |                           |        | September 29, 2002 |       | June 30, 2002
|                                                 |                                                             |                           |        |                    |       |              
|                                                 |                                                             |                           |        | (unaudited)        |       |               |        |      
|ASSETS                                           |                                                             |                           |        |                    |       |               |        |      
|                                                
|                                                
|                                                
|                                                
|Current assets:                                  |                                                             |                           |        |                    |       |               |        |      
|                                                
|                                                
|                                                
|                                                
|                                                 | Cash and cash equivalents                                   |                           | $      | 1,636              |       |               | $      | 2,024 |      
|                                                
|                                                
|                                                
|                                                
|                                                 | Short-term marketable debt securities                       |                           |        | 996                |       |               |        | 861   |      
|                                                
|                                                
|                                                
|                                                
|                                                 | Accounts receivable, net                                    |                           |        | 2,133              |       |               |        | 2,745 |      
|                                                
|                                                
|                                                
|                                                
|                                                 | Inventories                                                 |                           |        | 509                |       |               |        | 591   |      
|                                                
|                                                
|                                                
|                                                
|                                                 | Deferred and prepaid tax assets                             |                           |        | 706                |       |               |        | 709   |      
|                                                
|                                                
|                                                
|                                                
|                                                 | Prepaid expenses and other current assets                   |                           |        | 923                |       |               |        | 847   |      
|                                                 |                                                             |                           |        |                    |       |               |        |      
|                                                 |                                                             | Total current assets      |        |                    | 6,903 |               |        |       | 7,777 | 
|                                                
|                                                
|                                                
|                                                
|Property, plant and equipment, net               |                                                             |                           | 2,408  |                    |       |               | 2,453  |      
|                                                
|                                                
|                                                
|                                                
|Long-term marketable debt securities             |                                                             |                           | 2,612  |                    |       |               | 2,979  |      
|                                                
|                                                
|                                                
|                                                
|Goodwill                                         |                                                             |                           | 2,182  |                    |       |               | 2,182  |      
|                                                
|                                                
|                                                
|                                                
|Other acquisition-related intangible assets, net |                                                             |                           | 148    |                    |       |               | 104    |      
|                                                
|                                                
|                                                
|                                                
|Other non-current assets, net                    |                                                             |                           | 1,123  |                    |       |               | 1,027  |      
|                                                 |                                                             |                           |        |                    |       |               |        |      
|                                                 |                                                             | $                         | 15,376 |                    |       | $             | 16,522 |      
|                                                 |                                                             |                           |        |                    |       |               |        |      
|LIABILITIES AND STOCKHOLDERS EQUITY             |                                                             |                           |        |                    |       |               |        |      
|                                                
|                                                
|                                                
|                                                
|Current liabilities:                             |                                                             |                           |        |                    |       |               |        |      
|                                                
|                                                
|                                                
|                                                
|                                                 | Current portion of long-term debt and short-term
borrowings |                           | $      |                   |       |               | $      | 205   |      
|                                                
|                                                
|                                                
|                                                
|                                                 | Accounts payable                                            |                           |        | 798                |       |               |        | 1,044 |      
|                                                
|                                                
|                                                
|                                                
|                                                 | Accrued payroll-related liabilities                         |                           |        | 449                |       |               |        | 538   |      
|                                                
|                                                
|                                                
|                                                
|                                                 | Accrued liabilities                                         |                           |        | 1,147              |       |               |        | 1,201 |      
|                                                
|                                                
|                                                
|                                                
|                                                 | Deferred revenues and other                                 |                           |        | 1,643              |       |               |        | 1,785 |      
|                                                
|                                                
|                                                
|                                                
|                                                 | Warranty reserve                                            |                           |        | 277                |       |               |        | 284   |      
|                                                 |                                                             |                           |        |                    |       |               |        |      
|                                                 |                                                             | Total current liabilities |        |                    | 4,314 |               |        |       | 5,057 | 
|                                                
|                                                
|                                                
|                                                
|Long-term debt                                   |                                                             |                           | 1,500  |                    |       |               | 1,449  |      
|                                                
|                                                
|                                                
|                                                
|Other non-current obligations                    |                                                             |                           | 253    |                    |       |               | 215    |      
|                                                
|                                                
|                                                
|                                                
|Total stockholders equity                       |                                                             |                           | 9,309  |                    |       |               | 9,801  |      
|                                                 |                                                             |                           |        |                    |       |               |        |      
|                                                 |                                                             | $                         | 15,376 |                    |       | $             | 16,522 |      
|                                                 |                                                             |                           |        |                    |       |               |        |      

See accompanying notes.

4



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##### Table of Contents






SUN MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in millions)

|                                      |                                                        |                                                                                                            |                                                                                              |                          |      |                    |      |                    |      |        |      |  
|------------------------------------- | ------------------------------------------------------ | ---------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------- | ------------------------ | ---- | ------------------ | ---- | ------------------ | ---- | ------ | ---- | -
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      | Three Months Ended
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      |                   
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      | September 29, 2002 |      | September 30, 2001
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      |                    |      |                   
|Cash flows from operating activities: |                                                        |                                                                                                            |                                                                                              |                          |      |                    |      |                   
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        | Net loss                                                                                                   |                                                                                              | $                        | (111 | )                  |      | $                  | (180 | )     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Adjustments to reconcile net loss to net cash provided by
operating activities:              |                          |      |                    |      |                    |      |        |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Depreciation and amortization                                                                |                          |      | 241                |      |                    |      | 245    |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Amortization of acquisition-related other intangible assets and
unearned equity compensation |                          |      | 31                 |      |                    |      | 28     |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Tax benefits from employee stock plans                                                       |                          |      | 2                  |      |                    |      | 25     |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Deferred taxes                                                                               |                          |      | (92                | )    |                    |      | (90    | )   
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Loss on equity investments, net                                                              |                          |      | 31                 |      |                    |      | 19     |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | IPRD                                                                                         |                          |      |                   |      |                    |      | 3      |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Changes in operating assets and liabilities:                                                 |                          |      |                    |      |                    |      |        |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            |                                                                                              | Accounts receivable, net |      |                    | 612  |                    |      |        | 772  |  
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            |                                                                                              | Inventories              |      |                    | 82   |                    |      |        | 204  |  
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            |                                                                                              | Prepaid and other assets |      |                    | (82  | )                  |      |        | (22  | )
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            |                                                                                              | Accounts payable         |      |                    | (246 | )                  |      |        | (238 | )
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            |                                                                                              | Other liabilities        |      |                    | (286 | )                  |      |        | (433 | )
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      |                    |      |                   
|                                      | Net cash provided by operating activities              |                                                                                                            |                                                                                              | 182                      |      |                    |      | 333                |     
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      |                    |      |                   
|                                      | Cash flows from investing activities:                  |                                                                                                            |                                                                                              |                          |      |                    |      |                    |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Purchases of marketable debt securities                                                      |                          |      | (1,245             | )    |                    |      | (4,266 | )   
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Proceeds from sales of marketable debt securities                                            |                          |      | 1,387              |      |                    |      | 3,905  |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Proceeds from maturities of marketable debt securities                                       |                          |      | 111                |      |                    |      | 117    |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Purchases of equity investments                                                              |                          |      | (1                 | )    |                    |      | (15    | )   
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Proceeds from sales of equity investments                                                    |                          |      |                   |      |                    |      | 5      |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Acquisition of property, plant and equipment, net                                            |                          |      | (83                | )    |                    |      | (213   | )   
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Acquisition of spare parts and other assets                                                  |                          |      | (44                | )    |                    |      | (27    | )   
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Payments for acquisitions, net of cash acquired                                              |                          |      | 1                  |      |                    |      | (40    | )   
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      |                    |      |                   
|                                      | Net cash provided by (used in) investing activities    |                                                                                                            |                                                                                              | 126                      |      |                    |      | (534               | )   
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      |                    |      |                   
|                                      | Cash flows from financing activities:                  |                                                                                                            |                                                                                              |                          |      |                    |      |                    |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Acquisition of treasury stock                                                                |                          |      | (499               | )    |                    |      | (266   | )   
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Proceeds from issuance of common stock, net                                                  |                          |      | 4                  |      |                    |      | 19     |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        |                                                                                                            | Principal payments on borrowings and other obligations                                       |                          |      | (201               | )    |                    |      | (3     | )   
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      |                    |      |                   
|                                      | Net cash used in financing activities                  |                                                                                                            |                                                                                              | (696                     | )    |                    |      | (250               | )   
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      |                    |      |                   
|                                      | Net decrease in cash and cash equivalents              |                                                                                                            |                                                                                              | (388                     | )    |                    |      | (451               | )   
|                                     
|                                     
|                                     
|                                     
|                                      | Cash and cash equivalents, beginning of period         |                                                                                                            |                                                                                              | 2,024                    |      |                    |      | 1,472              |     
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      |                    |      |                   
|                                      | Cash and cash equivalents, end of period               |                                                                                                            | $                                                                                            | 1,636                    |      |                    | $    | 1,021              |     
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      |                    |      |                   
|                                      | Supplemental disclosures of cash flow information:     |                                                                                                            |                                                                                              |                          |      |                    |      |                    |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        | Interest paid (net of interest received from swap agreements of
$36 million and $15 million, respectively) |                                                                                              | $                        | 20   |                    |      | $                  | 41   |       
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      |                    |      |                   
|                                      |                                                        | Income taxes (net of refunds of $7 million and $1 million,
respectively)                                   |                                                                                              | $                        | 26   |                    |      | $                  | 50   |       
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      |                    |      |                   
|                                      | Supplemental schedule of noncash investing activities: |                                                                                                            |                                                                                              |                          |      |                    |      |                    |     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                        | Stock and options issued in connection with acquisitions                                                   |                                                                                              | $                        | 27   |                    |      | $                  | 29   |       
|                                      |                                                        |                                                                                                            |                                                                                              |                          |      |                    |      |                   

See accompanying notes.

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SUN MICROSYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. DESCRIPTION OF BUSINESS

Our business is singularly focused on products and services for network
computing. Network computing has been our focus for the 20 years of our
existence, and is based on the premise that the power of a single computer can
be increased dramatically as it is interconnected with other computer systems
for the purposes of communication and sharing of computing power. Our product
line consists of computer systems and workstations, storage, software and
associated services. Our customers use our products and services to build
mission-critical computing systems on which they operate critical elements of
their businesses. Our products and services are used in a wide range of
technical/scientific and engineering applications in industries such as
telecommunications, financial services, government, manufacturing, education,
retail, life sciences, media and entertainment and healthcare.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Fiscal year

Suns first three quarters in fiscal year 2003 end on September 29, December
29, and March 30. In fiscal year 2002 the quarters ended on September 30,
December 30, and March 31. The fourth quarter in all fiscal years ends on June
30.

Basis of Presentation

The accompanying condensed consolidated financial statements (Interim Financial
Statements) include the accounts of Sun and its subsidiaries. Intercompany
accounts and transactions have been eliminated. Certain amounts from prior
years have been reclassified to conform to the current year presentation.

These Interim Financial Statements have been prepared in accordance with
accounting principles generally accepted in the United States of America (US
GAAP) for interim financial information, the rules and regulations of the
Securities and Exchange Commission for interim financial statements and
accounting policies, consistent, in all material respects, with those applied
in preparing our audited consolidated financial statements included in our
Annual Report on Form 10-K for the fiscal year ended June 30, 2002. These
Interim Financial Statements are unaudited but reflect all adjustments
(consisting of normal recurring adjustments) management considers necessary for
a fair presentation of our financial position, operating results and cash flows
for the interim periods presented. The results for the interim periods are not
necessarily indicative of the results for the entire year. The condensed
consolidated balance sheet as of June 30, 2002 has been derived from the
audited consolidated balance sheet as of that date. The information included in
this report should be read in conjunction with our Annual Report on Form 10-K
for fiscal year ended June 30, 2002, filed with the Securities and Exchange
Commission on September 30, 2002.

Computation of net loss per common share

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

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US GAAP requires all anti-dilutive securities, including stock options, to be
excluded from the diluted earnings per share computation. For the first
quarters of fiscal 2003 and 2002, due to our net loss, all of our outstanding
609 million options and 531 million options, respectively, were excluded from
the diluted loss per share calculation because their inclusion would have been
anti-dilutive. If we had earned a profit during the first quarter of fiscal
2003 and/or 2002, we would have added 33 million and 113 million equivalent
shares, respectively, to our basic weighted-average shares outstanding to
compute the diluted weighted average shares outstanding.

Recent pronouncements

In October, 2001, the Financial Accounting Standard Board (FASB) issued
Statement of Financial Accounting Standard No. 144 (SFAS 144), Accounting for
the Impairment or Disposal of Long-Lived Assets. SFAS 144 supersedes SFAS 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be disposed of. The primary objectives of SFAS 144 are to develop one
accounting model based on the framework established in SFAS 121 for long-lived
assets to be disposed of by sale, and to address significant implementation
issues identified after the issuance of SFAS 121. We adopted SFAS 144 for our
fiscal year beginning July 1, 2002; however, adoption did not have a
significant impact on our financial statements.

In June 2002, the FASB issued SFAS 146, Accounting for Costs Associated with
Exit or Disposal Activities, which addresses accounting for restructuring and
similar costs. SFAS 146 supersedes previous accounting guidance, principally
Emerging Issues Task Force (EITF) Issue No. 94-3 Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring). Application of SFAS 146 is
required for restructuring activities initiated after December 31, 2002. SFAS
146 requires recognition of the liability for costs associated with an exit or
disposal activity when the liability is incurred. Under EITF Issue No. 94-3, a
liability for an exit cost is recognized at the date a company commits to an
exit plan. SFAS 146 also establishes that the liability should initially be
measured and recorded at fair value. Accordingly, SFAS 146 may affect the
timing of recognizing future restructuring costs, as well as the amounts
recognized. We do not intend to early adopt this new standard. See Note 11 for
a discussion on the difference in recognition of our proposed restructuring
plan for accounting purposes had we early adopted this statement.

3. ACQUISITION OF A DEVELOPMENT STAGE ENTERPRISE

During July 2002, we acquired Afara Websystems, Inc. (Afara), a development
stage enterprise. Afaras primary focus was to develop next-generation, SPARC®
based microprocessor technology with an emphasis on delivering breakthrough
levels of processor performance. We acquired Afara to accelerate the
development of future generations of UltraSPARC® chips. Afara was acquired by
means of a merger pursuant to which all of the outstanding shares of capital
stock of Afara were exchanged for Suns common stock. In addition, all
outstanding options and warrants to purchase Afara capital stock were exchanged
and converted into options and warrants to purchase shares of Suns common
stock. In accordance with Emerging Issues Task Force (EITF) Issue No. 98-3,
Determining Whether a Nonmonetary Transaction Involves Receipt of Productive
Assets or of a Business, this transaction was accounted for as a purchase of a
group of net assets rather than a business combination.

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The total purchase price was approximately $28 million and consisted of
approximately 5 million shares of Suns common stock issued in the merger or
issuable upon exercise of options and warrants issued in the merger valued in
the aggregate at approximately $27 million together with transaction costs of
approximately $1 million. The total purchase price was allocated as follows (in
millions):

|                                                     |  |   |     |  
|---------------------------------------------------- |  | - | --- | -
|Assembled workforce                                  |  | $ | 68  |  
|                                                    
|                                                    
|                                                    
|                                                    
|Unearned stock-based compensation                    |  |   | 4   |  
|                                                    
|                                                    
|                                                    
|                                                    
|Tangible assets acquired and net liabilities assumed |  |   | (17 | )
|                                                    
|                                                    
|                                                    
|                                                    
|Deferred tax liabilities                             |  |   | (27 | )
|                                                     |  |   |     |  
|Total                                                |  | $ | 28  |  
|                                                     |  |   |     |  

The assembled workforce will be amortized on a straight line basis over a three
year period and will be reflected as research and development expenses.

On September 17, 2002, we entered into an agreement to acquire Pirus Networks,
Inc. (Pirus), a corporation based in Acton, Massachusetts, in a stock-for-stock
merger at a purchase price of approximately $160 million. Pirus develops
intelligent storage networking systems that enable the delivery of advanced
storage services within multi-protocol environments from a single, centrally
managed platform. This acquisition will be accounted for as a
business combination and is
expected to be completed during our second quarter ending
December 29, 2002. The closing of the acquisition is subject to customary
closing conditions including Pirus shareholders approval.

4. INVENTORY

Inventories consisted of the following (in millions):

|                |  |                    |     |               |  |   |     | 
|--------------- |  | ------------------ | --- | ------------- |  | - | --- | 
|                |  | September 29, 2002 |     | June 30, 2002
|                |  |                    |     |              
|Raw Materials   |  | $                  | 136 |               |  | $ | 168 | 
|               
|               
|               
|               
|Work in Process |  |                    | 123 |               |  |   | 125 | 
|               
|               
|               
|               
|Finished Goods  |  |                    | 250 |               |  |   | 298 | 
|                |  |                    |     |               |  |   |     | 
|                |  | $                  | 509 |               |  | $ | 591 | 
|                |  |                    |     |               |  |   |     | 

5. GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS

At September 29, 2002, we had goodwill with a carrying value of $2,182 million.
Based on our new segment reporting units disclosure (see Note 9), $2,116
million of goodwill was allocated to the Product Group segment and $66 million
was allocated to the Sun Services segment. No additional goodwill was
recognized during the quarter ended September 29, 2002.

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

|                     |  |                          |     |                     |  |     |      |        |  |              |     |             |  |   |     |  |  |   |      |   |  |   |     | 
|-------------------- |  | ------------------------ | --- | ------------------- |  | --- | ---- | ------ |  | ------------ | --- | ----------- |  | - | --- |  |  | - | ---- | - |  | - | --- | 
|                     |  | As of September 29, 2002 |     | As of June 30, 2002
|                     |  |                          |     |                    
|                     |  | Gross                    |     |                     |  |     |      |        |  |              |     | Gross       |  |   |     |  |  |   |      |  
|                     |  | Carrying                 |     | Accumulated         |  |     |      |        |  | Carrying     |     | Accumulated |  |   |     | 
|                     |  | Amount                   |     | Amortization        |  | Net |      | Amount |  | Amortization |     | Net        
|                     |  |                          |     |                     |  |     |      |        |  |              |     |            
|Developed Technology |  | $                        | 308 |                     |  | $   | (238 | )      |  | $            | 70  |             |  | $ | 308 |  |  | $ | (224 | ) |  | $ | 84  | 
|                    
|                    
|                    
|                    
|Customer Base        |  |                          | 51  |                     |  |     | (38  | )      |  |              | 13  |             |  |   | 51  |  |  |   | (34  | ) |  |   | 17  | 
|                    
|                    
|                    
|                    
|Other                |  |                          | 75  |                     |  |     | (10  | )      |  |              | 65  |             |  |   | 7   |  |  |   | (4   | ) |  |   | 3   | 
|                     |  |                          |     |                     |  |     |      |        |  |              |     |             |  |   |     |  |  |   |      |   |  |   |     | 
|                     |  | $                        | 434 |                     |  | $   | (286 | )      |  | $            | 148 |             |  | $ | 366 |  |  | $ | (262 | ) |  | $ | 104 | 
|                     |  |                          |     |                     |  |     |      |        |  |              |     |             |  |   |     |  |  |   |      |   |  |   |     | 

Amortization expense of other acquisition-related intangible assets was $24
million for the three months ended September 29, 2002, and $18 million for the
three months ended September 30, 2001.

Estimated amortization expense for acquisition-related intangible assets for
the fiscal years ending June 30, are as follows (in millions):

|                                                                                          |  |   |     | 
|----------------------------------------------------------------------------------------- |  | - | --- | 
|2003 (including $24 million of amortization
expense for the first quarter of fiscal 2003) |  | $ | 92  | 
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|2004                                                                                      |  |   | 55  | 
|                                                                                         
|                                                                                         
|                                                                                         
|                                                                                         
|2005                                                                                      |  |   | 25  | 
|                                                                                          |  |   |     | 
|                                                                                          |  | $ | 172 | 
|                                                                                          |  |   |     | 

The above amounts reflect only amortization of intangible assets on our
September 29, 2002 balance sheet and exclude any intangible assets (and the
related amortization) that will be acquired in the future.

6. RESTRUCTURING CHARGES

We committed to a restructuring plan in fiscal 2002 (Fiscal 2002 Restructuring
Plan) and a facility exit plan in fiscal 2001 (Fiscal 2001 Facility Exit Plan).
We recorded initial restructuring charges in fiscal years 2002 and 2001 based
on assumptions and related estimates that were deemed appropriate for the
economic environment that existed at the time these estimates were made.
However, due to the continued deterioration of the commercial real estate
market, primarily in the U.S., we revised certain estimates and made
the appropriate adjustments to the initial restructuring charges recorded in
fiscal 2002 and 2001. During the first quarter of fiscal 2003, we recorded a
net charge of $13 million related to our Fiscal 2002 Restructuring Plan, and a
charge of $11 million for the Fiscal 2001 Facility Exit Plan, primarily due to
a lower estimate of sublease income. At September 29, 2002, we had an aggregate
accrued liability of $243 million with respect to these two plans.

Our accrued liability at September 29, 2002,
was net of approximately $207 million of estimated sublease
income to be generated from sublease contracts not yet negotiated. Our ability to
generate this amount of sublease income, as well as our ability to terminate
lease obligations at the amounts we have estimated, is highly dependent upon
economic conditions, particularly lease market conditions in certain
geographies, at the time we negotiate the lease termination and sublease
arrangements with third parties. While the amount we have accrued represents
our best estimate of the total remaining loss we expect to incur in
connection with these plans, estimates are subject to change and may require
routine adjustment as conditions and facts change through the implementation
period. If macroeconomic conditions, particularly as they pertain to the
commercial real estate market, continue to be negative, we may be required to
increase our estimated cost to exit certain facilities.

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The following table sets forth an analysis of the restructuring accrual
activity (in millions):

|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |      |     | 
|------------------------------------------- | --------------------------------- | ------------------------------------------ | -- | ------------------- | --- | ----------- | --- | --------- | --- | ----- | -- | --- | -- | - | --- | ---- | --- | 
|                                            |                                   |                                            |    | FY'02 Restructuring |     |             |     |           |     |       |    |    
|                                            |                                   |                                            |    | Plan                |     |             |     |           |     |       |    |    
|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |    
|                                            |                                   |                                            |    | Severance           |     |             |     |           |     | FY'01 |    |     |    |  
|                                            |                                   |                                            |    | and                 |     | Facilities- |     | Facility  |     |       |    |    
|                                            |                                   |                                            |    | Benefits            |     | Related     |     | Exit Plan |     | Total
|                                            |                                   |                                            |    |                     |     |             |     |           |     |      
|Restructuring provision in fiscal 2001:     |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |     
|                                           
|                                           
|                                           
|                                           
|                                            | Accrued lease costs               |                                            |    |                     |     |             |     |           |     |       | $  | 46  |    |   | $   | 46   |    
|                                           
|                                           
|                                           
|                                           
|                                            | Property and equipment impairment |                                            |    |                     |     |             |     |           |     |       |    | 29  |    |   |     | 29   |    
|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |     
|                                            |                                   | Total restructuring charges in fiscal 2001 |    |                     |     |             |     |           |     |       |    |     | 75 |   |     |      | 75  | 
|                                           
|                                           
|                                           
|                                           
|                                            | Non-cash charges                  |                                            |    |                     |     |             |     |           |     |       |    | (29 | )  |   |     | (29  | )  
|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |     
|Balance of accrual as of June 30, 2001      |                                   |                                            |    |                     |     |             |     |           |     |       | 46 |     |    |   | 46  |     
|                                           
|                                           
|                                           
|                                           
|Restructuring provision in fiscal 2002:     |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |     
|                                           
|                                           
|                                           
|                                           
|                                            | Severance and benefits            |                                            | $  | 146                 |     |             |     |          |     |       |    |    |    |   |     | 146  |    
|                                           
|                                           
|                                           
|                                           
|                                            | Accrued lease costs               |                                            |    |                    |     |             | $   | 282       |     |       |    |    |    |   |     | 282  |    
|                                           
|                                           
|                                           
|                                           
|                                            | Property and equipment impairment |                                            |    |                    |     |             |     | 83        |     |       |    |    |    |   |     | 83   |    
|                                           
|                                           
|                                           
|                                           
|                                            | Provision adjustments             |                                            |    |                    |     |             |     | (20       | )   |       |    | 26  |    |   |     | 6    |    
|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |      |    
|                                            |                                   | Total restructuring charges in fiscal 2002 |    |                     | 146 |             |     |           | 345 |       |    |     | 26 |   |     |      | 517 | 
|                                           
|                                           
|                                           
|                                           
|                                            | Cash paid                         |                                            |    | (127                | )   |             |     | (93       | )   |       |    | (19 | )  |   |     | (239 | )  
|                                           
|                                           
|                                           
|                                           
|                                            | Non-cash charges                  |                                            |    |                    |     |             |     | (83       | )   |       |    |    |    |   |     | (83  | )  
|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |      |    
|Balance of accrual as of June 30, 2002      |                                   |                                            | 19 |                     |     |             | 169 |           |     |       | 53 |     |    |   | 241 |     
|                                           
|                                           
|                                           
|                                           
|                                            | Provision adjustments             |                                            |    | (1                  | )   |             |     | 14        |     |       |    | 11  |    |   |     | 24   |    
|                                           
|                                           
|                                           
|                                           
|                                            | Cash paid                         |                                            |    | (9                  | )   |             |     | (7        | )   |       |    | (6  | )  |   |     | (22  | )  
|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |      |    
|Balance of accrual as of September 29, 2002 |                                   | $                                          | 9  |                     |     | $           | 176 |           |     | $     | 58 |     |    | $ | 243 |     
|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |      |    

The remaining cash expenditures relating to workforce reductions are expected
to be paid by the third quarter of fiscal 2003. The current estimates accrued
for abandoned leases (net of anticipated sublease proceeds) will be paid over
their respective lease terms through fiscal 2018. As of September 29, 2002, $80
million of the $243 million accrual was classified as current and the remaining
$163 million was classified as non-current.

The above restructuring charges are based on estimates that are subject to
change. Changes to the estimates have been reflected as Provision adjustments
on the above table in the period the changes in estimates were made.

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7. COMPREHENSIVE LOSS

The components of comprehensive loss, net of related taxes, were as follows (in
millions):

|                                                          |  |                    |      |                    |  |   |      |  
|--------------------------------------------------------- |  | ------------------ | ---- | ------------------ |  | - | ---- | -
|                                                          |  | Three Months Ended
|                                                          |  |                   
|                                                          |  | September 29, 2002 |      | September 30, 2001
|                                                          |  |                    |      |                   
|Net loss                                                  |  | $                  | (111 | )                  |  | $ | (180 | )
|                                                         
|                                                         
|                                                         
|                                                         
|Change in unrealized value on investments, net            |  |                    | 21   |                    |  |   | 23   |  
|                                                         
|                                                         
|                                                         
|                                                         
|Change in unrealized fair value of derivative
instruments |  |                    | 9    |                    |  |   | (28  | )
|                                                         
|                                                         
|                                                         
|                                                         
|Translation adjustments, net                              |  |                    | 49   |                    |  |   | 53   |  
|                                                          |  |                    |      |                    |  |   |      |  
|                                                          |  | $                  | (32  | )                  |  | $ | (132 | )
|                                                          |  |                    |      |                    |  |   |      |  

The components of accumulated other comprehensive income (loss), net of related
taxes, were as follows (in millions):

|                                            |  |                    |     |               |  |   |     |  
|------------------------------------------- |  | ------------------ | --- | ------------- |  | - | --- | -
|                                            |  | September 29, 2002 |     | June 30, 2002
|                                            |  |                    |     |              
|Unrealized gains on investments, net        |  | $                  | 46  |               |  | $ | 25  |  
|                                           
|                                           
|                                           
|                                           
|Unrealized losses on derivative instruments |  |                    | (22 | )             |  |   | (31 | )
|                                           
|                                           
|                                           
|                                           
|Cumulative translation adjustments          |  |                    | 24  |               |  |   | (25 | )
|                                            |  |                    |     |               |  |   |     |  
|                                            |  | $                  | 48  |               |  | $ | (31 | )
|                                            |  |                    |     |               |  |   |     |  

8. STOCK OPTIONS AND INCENTIVE PLANS

Information with respect to stock option and stock purchase rights activity for
the quarter ended September 29, 2002, is as follows (in millions, except per
share amounts):

|                              |  |           |     |        |  |                     |     |          |  |   |       | 
|----------------------------- |  | --------- | --- | ------ |  | ------------------- | --- | -------- |  | - | ----- | 
|                              |  |           |     |        |  | Outstanding Options
|                              |  |           |     |        |  |                    
|                              |  | Shares    |     |        |  |                     |     | Weighted
|                              |  | Available |     | Number |  | Average            
|                              |  | for       |     | of     |  | Exercise           
|                              |  | Grant     |     | Shares |  | Price              
|                              |  |           |     |        |  |                    
|Balance at June 30, 2002      |  |           | 244 |        |  |                     | 556 |          |  | $ | 15.86 | 
|                             
|                             
|                             
|                             
|Additional shares reserved    |  |           | 15  |        |  |                     |    |          |  |   |      | 
|                             
|                             
|                             
|                             
|Grants and assumptions        |  |           | (67 | )      |  |                     | 67  |          |  |   | 3.68  | 
|                             
|                             
|                             
|                             
|Exercises                     |  |           |    |        |  |                     | (3  | )        |  |   | 1.48  | 
|                             
|                             
|                             
|                             
|Cancellations                 |  |           | 11  |        |  |                     | (11 | )        |  |   | 17.79 | 
|                             
|                             
|                             
|                             
|Plan expiration               |  |           | (18 | )      |  |                     |    |          |  |   |      | 
|                              |  |           |     |        |  |                     |     |          |  |   |       | 
|Balance at September 29, 2002 |  |           | 185 |        |  |                     | 609 |          |  | $ | 14.56 | 
|                              |  |           |     |        |  |                     |     |          |  |   |       | 

11



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The following table summarizes significant ranges of outstanding and
exercisable options at September 29, 2002 (shares and aggregate intrinsic value
in millions):

|                         |  |                     |     |                     |  |           |     |          |  |           |       |           |  |       |    |       |  |          |      |           |  |           |     |  |  |   |       |  |  |   |    |  |  |  |     |  
|------------------------ |  | ------------------- | --- | ------------------- |  | --------- | --- | -------- |  | --------- | ----- | --------- |  | ----- | -- | ----- |  | -------- | ---- | --------- |  | --------- | --- |  |  | - | ----- |  |  | - | -- |  |  |  | --- | -
|                         |  | Outstanding Options |     | Options Exercisable
|                         |  |                     |     |                    
|                         |  |                     |     |                     |  | Weighted  |     |          |  |           |       |           |  |       |    |       |  |          |      |           |  |           |     |  |  |   |       |  |  |   |    |  |  | 
|                         |  |                     |     |                     |  | Average   |     | Weighted |  |           |       |           |  |       |    |       |  |          |      |           |  | Weighted  |     |  |  |   |       |  |  |  
|                         |  |                     |     |                     |  | Remaining |     | Average  |  | Aggregate |       |           |  |       |    |       |  |          |      | Average   |  | Aggregate |     |  |  |  
|                         |  |                     |     |                     |  | Life      |     | Exercise |  | Intrinsic |       | Potential |  |       |    |       |  | Exercise |      | Intrinsic |  | Potential
|Range of Exercise Prices |  | Shares              |     | in Years            |  | Price     |     | Value    |  | Dilution  |       | Shares    |  | Price |    | Value |  | Dilution
|                         |  |                     |     |                     |  |           |     |          |  |           |       |           |  |       |    |       |  |         
|$0.01 - $2.67            |  |                     | 36  |                     |  |           | 1.8 |          |  | $         | 1.14  |           |  | $     | 55 |       |  |          | 1.2  | %         |  |           | 35  |  |  | $ | 1.14  |  |  | $ | 54 |  |  |  | 1.1 | %
|                        
|                        
|                        
|                        
|$2.68 - $5.01            |  |                     | 144 |                     |  |           | 5.1 |          |  |           | 3.59  |           |  |       |   |       |  |          | 4.6  | %         |  |           | 75  |  |  |   | 3.46  |  |  |   |   |  |  |  | 2.4 | %
|                        
|                        
|                        
|                        
|$5.02 - $10.00           |  |                     | 172 |                     |  |           | 5.8 |          |  |           | 7.32  |           |  |       |   |       |  |          | 5.5  | %         |  |           | 63  |  |  |   | 6.00  |  |  |   |   |  |  |  | 2.0 | %
|                        
|                        
|                        
|                        
|$10.01 - $15.00          |  |                     | 54  |                     |  |           | 5.7 |          |  |           | 12.63 |           |  |       |   |       |  |          | 1.7  | %         |  |           | 21  |  |  |   | 12.70 |  |  |   |   |  |  |  | 0.7 | %
|                        
|                        
|                        
|                        
|$15.01 - $20.00          |  |                     | 95  |                     |  |           | 6.3 |          |  |           | 17.96 |           |  |       |   |       |  |          | 3.1  | %         |  |           | 28  |  |  |   | 17.63 |  |  |   |   |  |  |  | 0.9 | %
|                        
|                        
|                        
|                        
|$20.01 - $40.00          |  |                     | 57  |                     |  |           | 5.6 |          |  |           | 37.55 |           |  |       |   |       |  |          | 1.8  | %         |  |           | 23  |  |  |   | 37.19 |  |  |   |   |  |  |  | 0.7 | %
|                        
|                        
|                        
|                        
|$40.00 - $108.30         |  |                     | 51  |                     |  |           | 5.8 |          |  |           | 49.90 |           |  |       |   |       |  |          | 1.6  | %         |  |           | 18  |  |  |   | 49.66 |  |  |   |   |  |  |  | 0.6 | %
|                         |  |                     |     |                     |  |           |     |          |  |           |       |           |  |       |    |       |  |          |      |           |  |           |     |  |  |   |       |  |  |   |    |  |  |  |     |  
|                         |  |                     | 609 |                     |  |           | 5.4 |          |  | $         | 14.56 |           |  | $     | 55 |       |  |          | 19.5 | %         |  |           | 263 |  |  | $ | 12.09 |  |  | $ | 54 |  |  |  | 8.4 | %
|                         |  |                     |     |                     |  |           |     |          |  |           |       |           |  |       |    |       |  |          |      |           |  |           |     |  |  |   |       |  |  |   |    |  |  |  |     |  

The aggregate intrinsic value in the table above represents the total pretax
intrinsic value (i.e., the difference between Suns closing stock price of
$2.67 at September 27, 2002, and the exercise price, times the number of
shares) that would have been received by the option holder had all option
holders exercised their options on September 29, 2002. This amount changes
based on the fair market value of Suns stock.

Potential dilution is computed by dividing the options in the related range of
exercise prices by the shares of common stock issued, adjusted for treasury
stock, as of September 29, 2002 (3,116 million shares).

The 609 million options outstanding will vest as follows (in millions):

|                  |  |                 |     |      |  |      |    |      |  |      |    |      |  |      |    |       |  |  |    |  |  |  |    |  |  |  |    |  |  |  |     | 
|----------------- |  | --------------- | --- | ---- |  | ---- | -- | ---- |  | ---- | -- | ---- |  | ---- | -- | ----- |  |  | -- |  |  |  | -- |  |  |  | -- |  |  |  | --- | 
|                  |  | Q1'03 and prior |     | 2003 |  | 2004 |    | 2005 |  | 2006 |    | 2007 |  | 2008 |    | Total
|                  |  |                 |     |      |  |      |    |      |  |      |    |      |  |      |    |      
|Number of Options |  |                 | 263 |      |  |      | 74 |      |  |      | 90 |      |  |      | 77 |       |  |  | 55 |  |  |  | 36 |  |  |  | 14 |  |  |  | 609 | 
|                  |  |                 |     |      |  |      |    |      |  |      |    |      |  |      |    |       |  |  |    |  |  |  |    |  |  |  |    |  |  |  |     | 

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Equity Compensation Plan Information

A summary of our stockholder approved and non-approved equity compensation
plans as of September 29, 2002 is as follows (in millions, except per share
amounts):

|                                                                            |  |                      |     |                      |  |                           |       |  |  |  |     | 
|--------------------------------------------------------------------------- |  | -------------------- | --- | -------------------- |  | ------------------------- | ----- |  |  |  | --- | 
|                                                                            |  | Number of Securities |     | Weighted Average     |  |                           |       | 
|                                                                            |  | to be Issued upon    |     | Exercise Price of    |  | Number of Securities     
|                                                                            |  | Exercise of          |     | Outstanding Options, |  | Remaining Available for  
|                                                                            |  | Outstanding Options, |     | Warrants and Rights  |  | Future Issuance Under    
|Plan Category                                                               |  | Warrants and Rights  |     | (in dollars)         |  | Equity Compensation Plans
|                                                                            |  |                      |     |                      |  |                          
|Equity compensation plans approved by
security holders (excluding ESPP)     |  |                      | 594 |                      |  | $                         | 14.60 |  |  |  | 152 | 
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|Equity compensation plans not approved by
security holders (excluding ESPP) |  |                      | 15  |                      |  | $                         | 13.28 |  |  |  | 33  | 
|                                                                            |  |                      |     |                      |  |                           |       |  |  |  |     | 
|Total
(excluding ESPP)                                                      |  |                      | 609 |                      |  | $                         | 14.56 |  |  |  | 185 | 
|                                                                            |  |                      |     |                      |  |                           |       |  |  |  |     | 
|Equity compensation plans approved by
security holders (ESPP only)          |  |                      | N/A |                      |  |                           | N/A   |  |  |  | 94  | 
|Equity compensation plans not approved by
security holders (ESPP only)      |  |                      | N/A |                      |  |                           | N/A   |  |  |  | 1   | 
|                                                                            |  |                      |     |                      |  |                           |       |  |  |  |     | 
|Total
(ESPP only)                                                           |  |                      | N/A |                      |  |                           | N/A   |  |  |  | 95  | 
|                                                                            |  |                      |     |                      |  |                           |       |  |  |  |     | 
|All Plans                                                                   |  |                      | 609 |                      |  | $                         | 14.56 |  |  |  | 280 | 
|                                                                            |  |                      |     |                      |  |                           |       |  |  |  |     | 

9. INDUSTRY SEGMENTS

We design, manufacture, market, and service network computing systems and
software solutions that feature networked desktops and servers. Effective July
1, 2002, we changed our organization structure from a divisional to a
functional structure. Under the new structure, our chairman of the board of
directors, president and chief executive officer has been identified as the
chief operating decision maker (CODM) as defined by SFAS 131, Disclosures
About Segments of an Enterprise and Related Information (SFAS 131). The CODM
is managing the Company based on the broad functional categories of sales,
manufacturing, product development and engineering and marketing and strategy.
Financial reporting to the CODM mirrors this functional approach to managing
the Company. The CODM reviews consolidated financial information on revenues
and gross margins for products and services.

As a result of the change in organizational structure from a divisional to a
functional structure, and the related change in financial reporting to the
CODM, we operate in two segments: Product Group and Sun Services. Our Product
Group segment comprises a broad range of servers from data center/high
performance computing servers to entry level servers, a comprehensive suite of
storage products including storage software, processor and network products
based on our UltraSPARC technology and a suite of software products
encompassing the Sun ONE platform. In the Sun Services segment, we provide a
full range of services and support to existing and new customers, including
professional services, systems integration and education.

We have a Worldwide Operations (WWOPS) organization and a Global Sales
Organization (GSO) that manufacture and sell all our products. The CODM holds
the GSO accountable for overall products revenue and margins on a consolidated
level. In addition, as part of the new organization structure, we also created
a Marketing Strategy Organization (MSO) that is responsible for developing and
executing Suns overall business strategy. With the formation of the MSO, the
CODM looks to this functional organization for advertising, pricing and other
marketing strategies for the products being delivered to market.

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For the year ended June 30, 2002, Sun disclosed the following reportable
segments under SFAS 131: (1) Computer Systems and Network Storage, (2)
Enterprise Services, (3) iPlanet and (4) Other. This was based on how the then
CODM (the Companys then president/chief operating officer) managed the
Company, which included a review of revenues, cost of goods sold and operating
expenses by division and reflected the accountability of the various divisions
for revenues and operating expenses. Under the new organization structure, the
Computer Systems and Network Storage and iPlanet have been
eliminated. The entities that made up these divisions have been recast as
product engineering groups focused on Enterprise Systems Products, Volume
Systems Products, and Processor and Network Products, Network Storage Products
and Software Products. The CODM holds these groups responsible for all product
development and product engineering related matters. In addition, the CODM
continues to evaluate the Sun Services segment (formerly Enterprise Services
segment) based on its stand alone contribution margin.

The financial information required to be disclosed for these two segments under
SFAS 131 is provided in our consolidated statements of operations and
is as follows:

|                   |  |         |       |          |  |       |     |  |  |   |       | 
|------------------ |  | ------- | ----- | -------- |  | ----- | --- |  |  | - | ----- | 
|                   |  | Product |       | Sun      |  |      
|                   |  | Group   |       | Services |  | Total
|                   |  |         |       |          |  |      
|September 29, 2002 |  |         |       |          |  |       |     |  |  |   |       | 
|Revenues           |  | $       | 1,880 |          |  | $     | 867 |  |  | $ | 2,747 | 
|Gross Margin       |  |         | 787   |          |  |       | 345 |  |  |   | 1,132 | 
|September 30, 2001 |  |         |       |          |  |       |     |  |  |   |       | 
|Revenues           |  |         | 2,057 |          |  |       | 804 |  |  |   | 2,861 | 
|Gross Margin       |  |         | 770   |          |  |       | 286 |  |  |   | 1,056 | 

10. LEGAL PROCEEDINGS

On February 11, 2002, Eastman Kodak Company (Kodak) filed a civil lawsuit
against us, Eastman Kodak Company v. Sun Microsystems, Inc., Civil Action No.
02-CV-6074, in the United States District Court for the Western District of New
York. Kodak filed a First Amended Complaint on March 22, 2002. In the First
Amended Complaint Kodak asserts that our products, including those relating to
Java technology, infringe one or more claims of U.S. Patent No. 5,206,951, U.S.
Patent No. 5,421,012, and U.S. Patent No. 5,226,161 (collectively, the Kodak
Patents) and seeks injunctive relief against future infringement, unspecified
damages for past infringement, as well as costs and attorneys fees. On May 24,
2002, we filed an Answer to First Amended Complaint and Counterclaims, denying
infringement of any valid and enforceable claim of any of the Kodak Patents. In
the Answer and Counterclaims, we are also seeking declaratory judgment of
noninfringement, invalidity and/or unenforceability of the Kodak Patents, we
further allege that Kodaks claims are barred in whole or in part by the
doctrines of estoppel, laches and patent exhaustion, and that we have license
and/or sublicense rights to the Kodak Patents. We also sought declaratory
judgment of noninfringement, invalidity and/or unenforceability of four other
patents that Kodak cited in letters to us but which were not included in
Kodaks First Amended Complaint (the Additional Kodak Patents). On August 23,
2002, the Court dismissed our counterclaims regarding the Additional Kodak
Patents on the grounds that we had no reasonable apprehension that we would be
sued for infringement of those patents, and that accordingly, the Court lacked
jurisdiction to hear counterclaims with respect to those patents. Based on
discussions over many months with Kodak, we believe that this suit is without
merit, and, accordingly, we will defend ourselves and pursue our counterclaims
vigorously. We cannot forecast at this time with reasonable certainty the
potential costs associated with an adverse outcome of this matter.

On March 8, 2002, we filed suit against Microsoft Corporation (Microsoft) in
the United States District Court for the Northern District of California
pursuant to United States and State of California antitrust laws alleging
illegal efforts to acquire, maintain and expand a number of monopolies; illegal
tying arrangements; exclusive dealings; copyright infringement; unreasonable
restraint of trade; and unfair competition. Sun is seeking remedies that
include: (1) preliminary injunctions that require Microsoft to distribute our
binary implementation of the Java Run-time Environment as part of Windows XP
and Internet Explorer and to stop the unlicensed distribution of Microsofts
Virtual Machine for Java in violation of a January 23, 2001 settlement
agreement; (2) a permanent injunction to restore competition to the markets in
which Microsoft is unlawfully attempting to acquire, maintain and expand a
number of monopolies; and (3) compensation for losses we suffered as a result
of Microsofts unlawful actions. On August 9, 2002, the Judicial Panel on
Multidistrict Litigation issued an order transferring Suns lawsuit to the
District of Maryland for inclusion in the central pretrial proceedings in the
Microsoft Corp. Windows Operating System Antitrust Litigation, MDL-1332. We
filed an amended complaint on August 26, 2002, alleging additional illegal
tying arrangements and acts of illegal monopoly maintenance. An evidentiary
hearing on our pending motion for preliminary injunctions will be conducted by
the District of Maryland beginning December 3, 2002. On October 4, 2002,
Microsoft filed motions to dismiss some of the claims in our complaint. We
filed our response to those motions to dismiss on November 5, 2002. At the
conclusion of the pretrial proceedings in MDL-1332, the lawsuit will return for
trial to the Northern District of California.

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In early February 2002, Sun and two of its subsidiaries received several
charging letters from the United States Department of Commerce, Bureau of
Industry and Security, Office of Export Enforcement (BIS) claiming that we had
violated export control regulations. The letters relate to sales in 1998 in
Egypt and in 1997 to a reseller in Hong Kong for subsequent resale in the
Peoples Republic of China. The letters specify, and the export statute
authorizes the imposition of monetary penalties, denial of export privileges
and exclusion from practice before the BIS if a violation is found. Sun
representatives and outside counsel have been in settlement discussions with
authorities at the BIS regarding penalties and remedies. In order to facilitate
these discussions, the BIS granted us an extension until November 1, 2002 to
respond to the charging letters. A subsequent extension was granted until
January 31, 2003. In addition, the BIS informed us verbally that additional
charges would be added to the current claims against us. Based on settlement
discussions with the BIS, we believe that it is reasonably likely that we will
reach a negotiated resolution of these charging letters that will not have a
material adverse effect on our operations. However, absent a negotiated
resolution, an administrative hearing would be set at some date after January
31, 2003. In such case, we would assert a vigorous defense. We believe that any
monetary penalties imposed would not have a material adverse effect on our
financial condition or operating results. In addition, while we do not believe
the evidence would support the extreme sanction of a denial of export
privileges or exclusion from practice before the BIS, any such penalties would
have a material adverse effect on our business.

11. SUBSEQUENT EVENTS

On October 9, 2002, we entered into an agreement to acquire Terraspring, Inc.,
a corporation based in Fremont, California for a cash purchase price not to
exceed $35 million. Terraspring develops and sells network and compute
virtualization provisioning software for various information technology
automation activities for Solaris, Linux and Windows/NT. This acquisition will
be accounted for as a business combination and is expected to be completed
during our second quarter ending December 29, 2002. The closing of the
acquisition is subject to customary closing conditions including approval by
Terraspring shareholders.

On October 17, 2002, we announced a plan to reduce our workforce by
approximately 11% (based on the level of headcount at July 1, 2002) across all
employee levels, business functions, operating units, and geographic regions
and consolidate and eliminate excess facility space (Fiscal 2003 Restructuring
Plan). We currently expect to record a charge of approximately $300 million in
the second quarter of fiscal 2003 related to this plan. However, this amount
may be revised as we identify: (1) the affected employees and (2) the
facilities we will exit. As discussed in Note 2, we do not plan to adopt SFAS
146 until its effective date (January 1, 2003). Accordingly, the Fiscal 2003
Restructuring Plan is expected to be accounted for similar to our Fiscal
2001 and 2002 Restructuring Plans. The most significant difference between
applying EITF issue No. 94-3 and SFAS 146 to our Fiscal 2003 Restructuring Plan
relates to the timing of recognizing losses on leases to be exited. If we had
early adopted SFAS 146, we currently estimate that between $100 million and
$125 million of the Fiscal 2003 Restructuring Plan would not be recognized as a
restructuring expense in the second quarter of fiscal 2003 but would be
recognized later in fiscal 2003 as we exit facilities.

In October 2002, based on a combination of factors, particularly: (1) our
current and projected operating results, (2) our decision to reduce our
workforce and eliminate excess facility space, and (3) our current market
capitalization, we concluded that there were sufficient indicators to require
us to perform an analysis to assess whether any portion of our recorded
goodwill balance of $2,182 million is impaired. We have completed the first
phase of the impairment analysis and have concluded that our recognized
goodwill is impaired. We have engaged independent valuation experts to assist
us in determining the amount of goodwill impairment we will recognize in the
second quarter of fiscal 2003; accordingly, until those valuations are
completed, we are unable to quantify the goodwill impairment charge to be
recognized. In addition, pursuant to the considerations outlined in the preceding discussion on
goodwill, we concluded that there were sufficient indicators to require us to
perform an analysis to assess whether a portion of our other intangible asset
balance of approximately $245 million is impaired. We will conclude our
impairment assessment by the end of our second quarter ending December 29,
2002. As of September 29, 2002, other intangible assets consisted of $148
million related to intangible assets acquired through business combinations and
$97 million related to a revenue generating technology license.

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INDEPENDENT ACCOUNTANTS REVIEW REPORT

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

We have reviewed the accompanying condensed consolidated balance sheet of Sun
Microsystems, Inc. as of September 29, 2002, and the related
condensed consolidated statements of operations for the three-month period
ended September 29, 2002 and September 30, 2001, and the condensed consolidated
statements of cash flows for the three-month period ended September 29, 2002
and September 30, 2001. These financial statements are the responsibility of
the Companys management.

We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in accordance with auditing standards generally accepted in the United States,
which will be performed for the full year with the objective of expressing an
opinion regarding the financial statements taken as a whole. Accordingly, we do
not express such an opinion.

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

We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of Sun
Microsystems, Inc. as of June 30, 2002, and the related consolidated statements
of operations, stockholders equity, and cash flows for the year then ended
(not presented herein) and in our report dated September 16, 2002, we expressed
an unqualified opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of June 30, 2002, is fairly stated, in all material respects,
in relation to the consolidated balance sheet from which it has been derived.

| |                       
| | ----------------------
| | /s/  Ernst & Young LLP

San Jose, California
October 17, 2002

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

This quarterly report, including the
following sections, contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995,
particularly statements regarding our expected loss from sublease
income, our expectations regarding the timing of payments to be made
related to workforce and facility reductions, our intent to reduce
our workforce by approximately 11%, our expectations to record a
charge of $200 million in the second quarter of fiscal 2003
related to the fiscal 2003 restructuring, our expected tax benefit
rate, our plan to conclude our impairment assessment by the end of
our fiscal 2003 second quarter, our intent to focus on inventory
management, our expectations to make significant investing and
financing cash outlays during fiscal 2003, statements regarding our
liquidity and capital resources, our belief that there is no need to
repatriate funds to the U.S., our belief that we have sufficient
capital to meet our requirements for at least the next twelve months,
our belief that the level of our financial reserves is a competitive
factor, our belief that the Kodak litigation is without merit and our
belief regarding our ability to reach a negotiated settlement with
the BIS, and as set forth in the section entitled Purchased
in-process research and development expenses: statements
regarding our belief about the realization of expected economic
return from acquired in-processed technology and resulting or related
products, our expected expense reductions or synergies, our ability
to continue making substantial progress in the development and
commercialization of acquired technologies, the expected total cost
to complete the technologies and the significant assumptions
underlying the valuation related to the IPRD.

These forward-looking statements
involve risks and uncertainties, and the cautionary statements set
forth below and those contained in RISK FACTORS, identify
important factors that could cause actual results to differ
materially from those predicted in any such forward-looking
statements. Such factors include, but are not limited to, increased
competition, continued adverse economic conditions in the U.S. and
internationally, including adverse economic conditions in the
specific markets for our products, adverse business conditions, the
inability to successfully manage inventory levels, lack of acceptance
of new products, pricing pressures, lack of success in technological
advancements, failure to reduce costs or improve operating
efficiencies, and our ability to attract, hire and retain key and
qualified employees.

With respect to risks related to
purchased in-process research and development, there can be no
assurance that any new technologies will be developed into products,
that such products will achieve either technological or commercial
success, or that we will receive any economic benefit from such
products as a result of delays in the development of the technology
or release of such products into the market, the complexity of the
technology, our ability to successfully manage product introductions,
lack of customer acceptance, competition and changes in technological
trends, and fluctuations in market or general economic conditions.

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RESULTS OF OPERATIONS

Net Revenues(dollars in millions)

|                     |                                  |   |                    |      |                    |   |        |      |   |  |      |    | 
|-------------------- | -------------------------------- | - | ------------------ | ---- | ------------------ | - | ------ | ---- | - |  | ---- | -- | 
|                     |                                  |   | Three Months Ended |      |                    |   |       
|                     |                                  |   |                   
|                     |                                  |   | September 29, 2002 |      | September 30, 2001 |   | Change
|                     |                                  |   |                    |      |                    |   |       
|Products net revenue |                                  | $ | 1,880              |      |                    | $ | 2,057  |      |   |  | (8.6 | )%
|                    
|                    
|                    
|                    
|                     | Percentage of total net revenues |   |                    | 68.4 | %                  |   |        | 71.9 | % |  |      |    | 
|                    
|                    
|                    
|                    
|Services net revenue |                                  | $ | 867                |      |                    | $ | 804    |      |   |  | 7.8  | % 
|                    
|                    
|                    
|                    
|                     | Percentage of total net revenues |   |                    | 31.6 | %                  |   |        | 28.1 | % |  |      |    | 
|                    
|                    
|                    
|                    
|Total net revenue    |                                  | $ | 2,747              |      |                    | $ | 2,861  |      |   |  | (4.0 | )%

Products Net Revenue

Products net revenue consists of revenue generated from the sale of computer
systems and workstations, storage and software products. Accordingly, our
business is highly dependent on information technology (IT) spending.

In the first quarter of fiscal 2003, our products net revenue decreased, as
compared with the corresponding period of fiscal 2002, primarily as a result of
the continuing adverse macroeconomic conditions that began at the end of the
second quarter of fiscal 2001. These conditions have led to significant
reductions and deferrals in IT spending, particularly by customers in the
telecommunications and financial services industries who are being
significantly affected by the adverse economic conditions. As a result, during
the first quarter of fiscal 2003, we experienced continued lower sales volumes
and increased competitive pricing pressure on most of our product lines.
Specifically, we experienced decreases in net revenues in our desktop and
enterprise server products during the first quarter of fiscal 2003, as compared
with the corresponding period of fiscal 2002. These decreases in net revenues
were partially offset by increases in net revenues in our mid-range server and
our data center server products.

Services Net Revenue

Services net revenue consists of revenue generated from Sun Services (formerly
Enterprise Services) which includes Support Services, Professional Services and
Educational Services.

In the first quarter of fiscal 2003, the 7.8% growth in services net revenue,
as compared with the corresponding period of fiscal 2002, was due to an
increase in revenue from Support Services, partially offset by decreases in
revenue from Professional Services and Educational Services. Support Services
revenue, which represents over 70% of services net revenue for all periods
presented, consists of maintenance contract revenue, which is recognized
ratably over the contractual period. Support Services revenue growth was
primarily a result of an increase in our installed base of systems. Sun
Professional Services revenue is generated from technical consulting and
systems integration services to help customers plan, implement, and manage
distributed network computing environments. Sun Educational Services revenue is
generated by developing and delivering integrated learning solutions for
enterprises, IT organizations, and individual IT professionals. The
Professional Services and the Educational Services revenue decrease during the
first quarter of fiscal 2003 was due to a combination of: (1) a reduction in
customers discretionary spending, and (2) the continuing decline in new
product sales, all resulting primarily from the adverse economic conditions
discussed above.

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##### Table of Contents



A significant portion of our services net revenue is generated by contracts
related to new product sales; as a result, our services net revenue could be
negatively impacted if global macroeconomic conditions continue to negatively
impact our products net revenue.

Net Revenues by Geographic Area
(dollars in millions)

|                                          |                            |   |                    |      |                    |   |        |      |   |  |      |    | 
|----------------------------------------- | -------------------------- | - | ------------------ | ---- | ------------------ | - | ------ | ---- | - |  | ---- | -- | 
|                                          |                            |   | Three Months Ended |      |                    |   |       
|                                          |                            |   |                    |      |                    |   |       
|                                          |                            |   | September 29, 2002 |      | September 30, 2001 |   | Change
|                                          |                            |   |                    |      |                    |   |       
|U.S.                                      |                            | $ | 1,242              |      |                    | $ | 1,347  |      |   |  | (7.8 | )%
|                                         
|                                         
|                                         
|                                         
|Americas-Other (Canada and Latin America) |                            |   | 122                |      |                    |   | 110    |      |   |  | 10.9 | % 
|                                          |                            |   |                    |      |                    |   |        |      |   |  |      |   
|Americas-Total                            |                            |   | 1,364              |      |                    |   | 1,457  |      |   |  | (6.4 | )%
|                                         
|                                         
|                                         
|                                         
|                                          | Percentage of net revenues |   |                    | 49.7 | %                  |   |        | 50.9 | % |  |      |    | 
|                                         
|                                         
|                                         
|                                         
|EMEA (Europe, Middle East and Africa)     |                            |   | 852                |      |                    |   | 862    |      |   |  | (1.2 | )%
|                                         
|                                         
|                                         
|                                         
|                                          | Percentage of net revenues |   |                    | 31.0 | %                  |   |        | 30.1 | % |  |      |    | 
|                                         
|                                         
|                                         
|                                         
|APAC (Asia, Australia and New Zealand)    |                            |   | 531                |      |                    |   | 542    |      |   |  | (2.0 | )%
|                                         
|                                         
|                                         
|                                         
|                                          | Percentage of net revenues |   |                    | 19.3 | %                  |   |        | 18.9 | % |  |      |    | 
|                                         
|                                         
|                                         
|                                         
|Total net revenues                        |                            | $ | 2,747              |      |                    | $ | 2,861  |      |   |  | (4.0 | )%

|                   |                            |   |                    |      |                    |   |        |      |   |  |      |    | 
|------------------ | -------------------------- | - | ------------------ | ---- | ------------------ | - | ------ | ---- | - |  | ---- | -- | 
|                   |                            |   | Three Months Ended |      |                    |   |       
|                   |                            |   |                    |      |                    |   |       
|                   |                            |   | September 29, 2002 |      | September 30, 2001 |   | Change
|                   |                            |   |                    |      |                    |   |       
|U.S.               |                            | $ | 1,242              |      |                    | $ | 1,347  |      |   |  | (7.8 | )%
|                  
|                  
|                  
|                  
|                   | Percentage of net revenues |   |                    | 45.2 | %                  |   |        | 47.1 | % |  |      |    | 
|                  
|                  
|                  
|                  
|International      |                            | $ | 1,505              |      |                    | $ | 1,514  |      |   |  | (0.6 | )%
|                  
|                  
|                  
|                  
|                   | Percentage of net revenues |   |                    | 54.8 | %                  |   |        | 52.9 | % |  |      |    | 
|                  
|                  
|                  
|                  
|Total net revenues |                            | $ | 2,747              |      |                    | $ | 2,861  |      |   |  | (4.0 | )%

In the first quarter of fiscal 2003, our total net revenues decreased by 7.8%
in the U.S. and 0.6% internationally, as compared with the corresponding period
of fiscal 2002. The decrease in the U.S. and internationally is primarily the
result of continued adverse economic conditions.

In the first quarter of fiscal 2003, as compared with the corresponding period
of fiscal 2002, the marginal decrease in international net revenues was
primarily the result of decreases in net revenues in Japan, Southern Europe
Africa Middle East (SEAME), Northern Europe and the United Kingdom, partially
offset by increases in Germany, France, Korea and India. SEAME consists
primarily of Italy, Spain, Switzerland and other Mediterranean countries.
Northern Europe consists primarily of the Scandinavian countries, the
Netherlands, Belgium/Luxembourg, Eastern European countries and Russia.

In the first quarter of fiscal 2003, within the Americas-Other region, net
revenues increased by 10.9% as compared with the corresponding period of fiscal
2002, primarily because of increases in net revenues in Mexico and Canada.

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In the first quarter of fiscal 2003, within the EMEA region, net revenues
decreased by 1.2%, as compared with the corresponding period of fiscal 2002,
primarily because of decreases in net revenues in the SEAME region,
Northern Europe and United Kingdom, partially offset by increases in Germany
and France. During the first quarter of fiscal 2003, EMEA revenues benefited
from a favorable foreign exchange impact, as compared with the corresponding
period of fiscal 2002. For example, the value of the Euro during the first
quarter of fiscal 2003 was 12% higher than its value against the U.S. dollar
during the first quarter of fiscal 2002.

In the first quarter of fiscal 2003, within the APAC region, net revenues
decreased by 2.0% as compared with the corresponding period of fiscal 2002,
primarily because of decreases in net revenues in Japan. This decrease was
partially offset by increases in Korea and India. Economic conditions in Japan
have declined substantially in recent years and have adversely impacted our
sales in this region. If the economic trends in Japan significantly worsen in a
quarter or decline over an extended period of time, our results of operations
and cash flows could be further adversely affected.

Gross Margin
(dollars in millions)

|                      |                                    |   |                    |      |                    |   |        |      |   |  |         |   | 
|--------------------- | ---------------------------------- | - | ------------------ | ---- | ------------------ | - | ------ | ---- | - |  | ------- | - | 
|                      |                                    |   | Three Months Ended |      |                    |   |       
|                      |                                    |   |                    |      |                    |   |       
|                      |                                    |   | September 29, 2002 |      | September 30, 2001 |   | Change
|                      |                                    |   |                    |      |                    |   |       
|Products gross margin |                                    | $ | 787                |      |                    | $ | 770    |      |   |  | 2.2     | %
|                     
|                     
|                     
|                     
|                      | Percentage of products net revenue |   |                    | 41.9 | %                  |   |        | 37.4 | % |  | 4.5 pts
|                     
|                     
|                     
|                     
|Services gross margin |                                    | $ | 345                |      |                    | $ | 286    |      |   |  | 20.6    | %
|                     
|                     
|                     
|                     
|                      | Percentage of services net revenue |   |                    | 39.8 | %                  |   |        | 35.6 | % |  | 4.2 pts
|                     
|                     
|                     
|                     
|Total gross margin    |                                    | $ | 1,132              |      |                    | $ | 1,056  |      |   |  | 7.2     | %
|                     
|                     
|                     
|                     
|                      | Percentage of net revenues         |   |                    | 41.2 | %                  |   |        | 36.9 | % |  | 4.3 pts

Products Gross Margin

In the first quarter of fiscal 2003, products gross margin increased by 4.5
percentage points, as compared with the corresponding period of fiscal 2002.
The 4.5 percentage point increase in products gross margin was primarily a
result of: (1) lower purchased component costs; (2) lower platform transition
costs associated with the conversion of a majority of our product lines to the
UltraSPARC III microprocessor that were incurred during the first half of
fiscal 2002; (3) lower costs related to quality issues and (4) lower fixed
manufacturing costs. These favorable elements were partially offset by
reductions in product pricing (normal price list reductions and competitive
transaction pricing). The fiscal 2002 transition costs primarily consisted of
write-offs for excess and obsolete inventory and costs associated with rework.

Should the global macroeconomic conditions remain unfavorable or deteriorate
further, or the pricing pressures associated with competition intensify,
products gross margin could be adversely impacted.

Services Gross Margin

In the first quarter of fiscal 2003, the 4.2 percentage point increase in
services gross margin, as compared with the corresponding period of fiscal
2002, reflected the impact of: (1) improved operating efficiencies across all
lines of business, helped, in part, by lower overall headcount (947 fewer
services employees at September 29, 2002 than at September 30, 2001); and (2)
support services revenue increasing as a percentage of total services net
revenue (support services typically generates a higher gross margin than
professional services or educational
services). The impact of these favorable items on services gross margin in the
first quarter of fiscal 2003, as compared with the corresponding period of
fiscal 2002, was partially offset by increased fixed infrastructure costs.

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##### Table of Contents



Operating Expenses
(dollars in millions)

|                                              |                            |   |                    |      |                    |   |        |      |   |  |      |    | 
|--------------------------------------------- | -------------------------- | - | ------------------ | ---- | ------------------ | - | ------ | ---- | - |  | ---- | -- | 
|                                              |                            |   | Three Months Ended |      |                    |   |       
|                                              |                            |   |                    |      |                    |   |       
|                                              |                            |   | September 29, 2002 |      | September 30, 2001 |   | Change
|                                              |                            |   |                    |      |                    |   |       
|Research and development                      |                            | $ | 437                |      |                    | $ | 473    |      |   |  | (7.6 | )%
|                                             
|                                             
|                                             
|                                             
|                                              | Percentage of net revenues |   |                    | 15.9 | %                  |   |        | 16.5 | % |  |      |    | 
|                                             
|                                             
|                                             
|                                             
|Selling, general and administrative           |                            | $ | 882                |      |                    | $ | 961    |      |   |  | (8.2 | )%
|                                             
|                                             
|                                             
|                                             
|                                              | Percentage of net revenues |   |                    | 32.1 | %                  |   |        | 34.1 | % |  |      |    | 
|                                             
|                                             
|                                             
|                                             
|Restructuring Charges                         |                            | $ | 24                 |      |                    | $ | 14     |      |   |  | 71.4 | % 
|                                             
|                                             
|                                             
|                                             
|                                              | Percentage of net revenues |   |                    | 0.9  | %                  |   |        | 0.5  | % |  |      |    | 
|                                             
|                                             
|                                             
|                                             
|Purchased in-process research and
development |                            | $ |                   |      |                    | $ | 3      |      |   |  | N/M  |   
|                                             
|                                             
|                                             
|                                             
|                                              | Percentage of net revenues |   |                    |     |                    |   |        | 0.1  | % |  |      |    | 

Research and Development (R&D) Expenses

In the first quarter of fiscal 2003, R&D expenses, as a percentage of total net
revenues, decreased to 15.9% from 16.5% for the corresponding period of fiscal
2002. The decrease in the percentage of R&D expenses to total net revenues is
the result of a decrease in incurred expenses during the first quarter of
fiscal 2002, as compared with the level of expenses incurred during the first
quarter of fiscal 2002. In dollars, R&D expenses decreased by 7.6% to $437
million in the first quarter of fiscal 2003, as compared with $473 million in
the first quarter of fiscal 2002. In dollars, the decrease in R&D expenses for
the first quarter of fiscal 2003, as compared with the corresponding period of
fiscal 2002, was a result of: (1) lower costs incurred for prototype
development; (2) lower headcount-related costs due to our workforce reduction
that began in the second quarter of fiscal 2002 ; and (3) lower depreciation
costs. In general, fluctuations in R&D expenses will occur depending on the
timing of product introductions, among other factors.

Selling, General and Administrative (SG&A) Expenses

In the first quarter of fiscal 2003, SG&A expenses, as a percentage of total
net revenues, decreased to 32.1% from 34.1% in the corresponding period of
fiscal 2002. The decrease in the percentage of SG&A expenses to total net
revenues is the result of a decrease in SG&A expenses incurred during the first
quarter of fiscal 2003, as compared with the level of SG&A expenses incurred
during the first quarter of fiscal 2002. In dollars, SG&A expenses decreased
$79 million to $882 million in the first quarter of fiscal 2003, as compared
with $961 million in the first quarter of fiscal 2002, as a result of: (1)
lower headcount-related costs due to our workforce reduction that began in the
second quarter of fiscal 2002; and (2) reductions and/or delays in spending in
certain discretionary areas such as marketing and facilities management, some
of which reductions and/or delays are non-recurring. These reductions were
partially offset by a lower benefit from our mandatory July 2002 shutdown, as
compared with our mandatory July 2001 shutdown, due to fewer vacation days and
fewer employees in July 2002 as compared with July 2001.

21



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##### Table of Contents



Restructuring

The following discussion should be read in connection with Note 6 to the
Condensed Consolidated Financial Statements.

We committed to a restructuring plan in fiscal 2002 (Fiscal 2002 Restructuring
Plan) and a facility exit plan in fiscal 2001 (Fiscal 2001 Facility Exit Plan).
We recorded initial restructuring charges in fiscal 2002 and 2001 based on
assumptions and related estimates that were deemed appropriate for the economic
environment that existed at the time these estimates were made. However, due to
the continued deterioration of the commercial real estate market, primarily in
the U.S., we periodically review estimates and make any appropriate adjustments
to the initial restructuring charges recorded in fiscal 2002 and 2001. During
the first quarter of fiscal 2003, we recorded a net charge of $13 million
related to our Fiscal 2002 Restructuring Plan and a charge of $11 million for
the Fiscal 2001 Facility Exit Plan. At September 29, 2002, we had an accrued
liability of $243 million with respect to Fiscal 2002 Restructuring Plan and
Fiscal 2001 Facility Exit Plan.

Our accrued liability at September 29, 2002,
was net of approximately $207
million estimated sublease income to be generated form sublease
contracts not yet negotiated. Our ability to generate this
amount of sublease income, as well as our ability to terminate lease
obligations at the amounts we have estimated, is highly dependent upon the
economic conditions, particularly lease market conditions in certain
geographies, at the time we negotiate the lease termination and sublease
arrangements with third parties. While the amount we have accrued represents
our best estimate of the total remaining loss we expect to incur in connection
with these plans, estimates are subject to change and may require routine
adjustment as conditions and facts change through the implementation period. If
macroeconomic conditions, particularly as they pertain to the commercial real
estate market, continue to be negative, we may be required to increase our
estimated cost to exit certain facilities.

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##### Table of Contents



The following table sets forth an analysis of the restructuring accrual
activity (in millions):

|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |      |     |  
|------------------------------------------- | --------------------------------- | ------------------------------------------ | -- | ------------------- | --- | ----------- | --- | --------- | --- | ----- | -- | --- | -- | - | --- | ---- | --- | -
|                                            |                                   |                                            |    | FY'02 Restructuring |     |             |     |           |     |       |    |    
|                                            |                                   |                                            |    | Plan                |     |             |     |           |     |       |    |    
|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |    
|                                            |                                   |                                            |    | Severance           |     |             |     |           |     | FY'01 |    |     |    |  
|                                            |                                   |                                            |    | and                 |     | Facilities- |     | Facility  |     |       |    |    
|                                            |                                   |                                            |    | Benefits            |     | Related     |     | Exit Plan |     | Total
|                                            |                                   |                                            |    |                     |     |             |     |           |     |      
|Restructuring provision in fiscal 2001:     |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |     
|                                           
|                                           
|                                           
|                                           
|                                            | Accrued lease costs               |                                            |    |                     |     |             |     |           |     |       | $  | 46  |    |   | $   | 46   |    
|                                           
|                                           
|                                           
|                                           
|                                            | Property and equipment impairment |                                            |    |                     |     |             |     |           |     |       |    | 29  |    |   |     | 29   |    
|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |     
|                                            |                                   | Total restructuring charges in fiscal 2001 |    |                     |     |             |     |           |     |       |    |     | 75 |   |     |      | 75  |  
|                                           
|                                           
|                                           
|                                           
|                                            | Non-cash charges                  |                                            |    |                     |     |             |     |           |     |       |    | (29 | )  |   |     | (29  | )  
|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |     
|Balance of accrual as of June 30, 2001      |                                   |                                            |    |                     |     |             |     |           |     |       | 46 |     |    |   | 46  |     
|                                           
|                                           
|                                           
|                                           
|Restructuring provision in fiscal 2002:     |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |     
|                                           
|                                           
|                                           
|                                           
|                                            | Severance and benefits            |                                            | $  | 146                 |     |             |     |          |     |       |    |    |    |   |     | 146  |    
|                                           
|                                           
|                                           
|                                           
|                                            | Accrued lease costs               |                                            |    |                    |     |             | $   | 282       |     |       |    |    |    |   |     | 282  |    
|                                           
|                                           
|                                           
|                                           
|                                            | Property and equipment impairment |                                            |    |                    |     |             |     | 83        |     |       |    |    |    |   |     | 83   |    
|                                           
|                                           
|                                           
|                                           
|                                            | Provision adjustments             |                                            |    |                    |     |             |     | (20       | )   |       |    | 26  |    |   |     | 6    |    
|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |     
|                                            |                                   | Total restructuring charges in fiscal 2002 |    |                     | 146 |             |     |           | 345 |       |    |     | 26 |   |     |      | 517 |  
|                                           
|                                           
|                                           
|                                           
|                                            | Cash paid                         |                                            |    | (127                | )   |             |     | (93       | )   |       |    | (19 | )  |   |     | (239 | )  
|                                           
|                                           
|                                           
|                                           
|                                            | Non-cash charges                  |                                            |    |                    |     |             |     | (83       | )   |       |    |    |    |   |     | (83  | )  
|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |     
|Balance of accrual as of June 30, 2002      |                                   |                                            | 19 |                     |     |             | 169 |           |     |       | 53 |     |    |   | 241 |     
|                                           
|                                           
|                                           
|                                           
|                                            | Provision adjustments             |                                            |    | (1                  | )   |             |     | 14        |     |       |    | 11  |    |   |     | 24   |    
|                                           
|                                           
|                                           
|                                           
|                                            |                                   | Cash paid                                  |    |                     | (9  | )           |     |           | (7  | )     |    |     | (6 | ) |     |      | (22 | )
|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |     
|Balance of accrual as of September 29, 2002 |                                   | $                                          | 9  |                     |     | $           | 176 |           |     | $     | 58 |     |    | $ | 243 |     
|                                            |                                   |                                            |    |                     |     |             |     |           |     |       |    |     |    |   |     |     

The remaining cash expenditures relating to workforce reductions are expected
to be paid by the third quarter of fiscal 2003. The current estimates accrued
for abandoned leases (net of anticipated sublease proceeds) will be paid over
their respective lease terms through fiscal 2018. As of September 29, 2002, $80
million of the $243 million accrual was classified as current and the remaining
$163 million was classified as non-current.

The above restructuring charges are based on estimates that are subject to
change. Changes to the estimates have been reflected as Provision adjustments
on the above table in the period the changes in estimates were made.

As mentioned in our Note 11 to the Condensed Consolidated Financial Statements,
we committed to a new restructuring plan, starting in the second quarter of
fiscal 2003. Under this Fiscal 2003 Restructuring Plan, we anticipate a
reduction of our workforce by approximately 11% (based on the level of
headcount at July 1, 2002) across all employee levels, business functions,
operating units, and geographic regions and a consolidation of our facilities.
We expect to record a charge of approximately $300 million in the second
quarter of fiscal 2003, as it relates to this new plan.

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Purchased In-Process Research and Development (IPRD)

Overview

In the first quarter of fiscal 2003, we acquired Afara Websystems, Inc. In
connection with this transaction, there were no purchased in-process research
and development expenses (IPRD). There was $3.2 million of IPRD in the first
quarter of fiscal 2002, associated with the acquisition of Isopia, Inc.

Overall status of business combinations prior to fiscal 2003

With respect to acquisitions completed prior to fiscal 2003, we believe that
the projections we used in performing our valuations for each acquisition are
still valid in all material respects; however, we cannot assure you that the
projected results will be achieved. We continue to make substantial progress
related to the development and commercialization of acquired technologies.
Although we have experienced delays in the completion of certain of our
development efforts and their related commercialization, the expected total
costs to complete such technologies have not materially increased, individually
or in the aggregate. We periodically evaluate our product development timeline
and modify our overall business plan in response to various factors.
Modifications to our business plan include the reallocation of resources among
various alternative development projects. The impact of delays in the
realization of economic benefits related to acquired technologies, individually
or in the aggregate, has not been material to our overall consolidated
financial position or results of operations as of and for the quarter ended
September 29, 2002.

Loss on Equity Investments
(dollars in millions)

|                                |                            |   |                    |     |                    |   |        |     |   |  |       |    | 
|------------------------------- | -------------------------- | - | ------------------ | --- | ------------------ | - | ------ | --- | - |  | ----- | -- | 
|                                |                            |   | Three Months Ended |     |                    |   |       
|                                |                            |   |                    |     |                    |   |       
|                                |                            |   | September 29, 2002 |     | September 30, 2001 |   | Change
|                                |                            |   |                    |     |                    |   |       
|Loss on equity investments, net |                            | $ | (31                | )   |                    | $ | (19    | )   |   |  | (63.1 | )%
|                               
|                               
|                               
|                               
|                                | Percentage of net revenues |   |                    | 1.1 | %                  |   |        | 0.7 | % |  |       |    | 

Our equity investments portfolio, which primarily consists of investments in
publicly traded and privately-held technology companies contained within our
internally-managed venture capital fund, has continued to be negatively
impacted by the adverse global macroeconomic conditions of the technology
sector during the first quarter of fiscal 2003. The loss on equity investments
in the first quarter of fiscal 2003 of $31 million, as compared with the $19
million loss in the first quarter of fiscal 2002, was primarily related to a
decline in value of the portfolio that was considered other than temporary.

Our decision to liquidate marketable equity securities in the future will
depend upon numerous factors, including the condition of the stock market and
the status of the economy, many of which are not predictable nor within our
control.

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##### Table of Contents



Interest Income, net
(dollars in millions)

|                     |                            |   |                    |     |                    |   |        |     |   |  |       |    | 
|-------------------- | -------------------------- | - | ------------------ | --- | ------------------ | - | ------ | --- | - |  | ----- | -- | 
|                     |                            |   | Three Months Ended |     |                    |   |       
|                     |                            |   |                    |     |                    |   |       
|                     |                            |   | September 29, 2002 |     | September 30, 2001 |   | Change
|                     |                            |   |                    |     |                    |   |       
|Interest income, net |                            | $ | 39                 |     |                    | $ | 107    |     |   |  | (63.5 | )%
|                    
|                    
|                    
|                    
|                     | Percentage of net revenues |   |                    | 1.4 | %                  |   |        | 3.7 | % |  |       |    | 

In the first quarter of fiscal 2003, the 63.5% decrease in interest income,
net, as compared with the corresponding period of fiscal 2002, is primarily due
to a combination of lower interest rates and lower cash and marketable debt
securities balances. In addition, lower gains on the sale of certain marketable
debt securities were recorded in the first quarter of fiscal 2003 as compared
with the corresponding period of fiscal 2002.

The average duration of our portfolio of marketable securities decreased to
0.88 years in the first quarter of fiscal 2003 from 1.38 years in the
corresponding period of fiscal 2002. In general, we would expect the volatility
of this portfolio to decrease as its duration decreases.

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

Income Taxes
(dollars in millions)

|                     |                                 |   |                    |      |                    |   |        |      |   |  |       |    | 
|-------------------- | ------------------------------- | - | ------------------ | ---- | ------------------ | - | ------ | ---- | - |  | ----- | -- | 
|                     |                                 |   | Three Months Ended |      |                    |   |       
|                     |                                 |   |                    |      |                    |   |       
|                     |                                 |   | September 29, 2002 |      | September 30, 2001 |   | Change
|                     |                                 |   |                    |      |                    |   |       
|Income taxes benefit |                                 | $ | (92                | )    |                    | $ | (127   | )    |   |  | (27.6 | )%
|                    
|                    
|                    
|                    
|                     | Percentage of loss before taxes |   |                    | 45.5 | %                  |   |        | 41.5 | % |  |       |    | 

Our effective income tax benefit rate was 45.5% for the first quarter of fiscal
2003, as compared with an effective income tax benefit rate of 41.5% for the
corresponding period of fiscal 2002. The difference in our tax benefit rate
for the first quarters of fiscal 2003 and 2002 is primarily due to a change in
our estimate in projected statutory credits to be recognized in the current
fiscal year.

Because relatively small changes in our forecasted profitability for fiscal
2003 can significantly affect our projected annual effective tax rate, we
believe our quarterly tax benefit rate of 45.5% is currently the most reliable
estimate of our effective tax benefit rate. Accordingly, our quarterly tax rate for the
second quarter and the remainder of fiscal 2003 will be largely dependent on
our profitability and could fluctuate significantly.

25



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##### Table of Contents



Critical Accounting Policies

Please see the discussion of our critical accounting policies in our Annual
Report on Form 10-K for the fiscal year ended June 30, 2002. Material changes
subsequent to that report in our critical accounting policies are described
below:

Goodwill

In October 2002, based on a combination of factors, particularly: (1) our
current and projected operating results, (2) our decision to reduce our
workforce and eliminate excess facility space, and (3) our current market
capitalization, we concluded that there were sufficient indicators to require
us to perform an analysis to assess whether any portion of our recorded
goodwill balance of $2,182 million is impaired. We have completed the first
phase of the impairment analysis and have concluded that our recognized
goodwill is impaired. We have engaged independent valuation experts to assist
us in determining the amount of goodwill impairment we will recognize in the
second quarter of fiscal 2003; accordingly, until those valuations are
completed, we are unable to quantify the goodwill impairment charge to be
recognized. In addition, any goodwill impairment is expected to have a
significant impact on our second quarter fiscal 2003 tax benefit rate.

Other Intangible Assets

Pursuant to the considerations outlined in the preceding discussion on
goodwill, we concluded that there were sufficient indicators to require us to
perform an analysis to assess whether a portion of our other intangible asset
balance of approximately $245 million is impaired. We will conclude our
impairment assessment by the end of our second quarter ending December 29,
2002. As of September 29, 2002, other intangible assets consisted of $148
million related to intangible assets acquired through business combinations and
$97 million related to a revenue generating technology license.

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##### Table of Contents



LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION

(dollars in millions)

|                              |                                                             |                            |       |                    |      |               |       |        |      |   |      |           |   | 
|----------------------------- | ----------------------------------------------------------- | -------------------------- | ----- | ------------------ | ---- | ------------- | ----- | ------ | ---- | - | ---- | --------- | - | 
|                              |                                                             |                            |       | September 29, 2002 |      | June 30, 2002 |       | Change
|                              |                                                             |                            |       |                    |      |               |       |       
|Cash and cash equivalents     |                                                             | $                          | 1,636 |                    |      | $             | 2,024 |        |      | $ | (388 | )        
|                             
|                             
|                             
|                             
|Marketable debt securities    |                                                             |                            | 3,608 |                    |      |               | 3,840 |        |      |   | (232 | )        
|                              |                                                             |                            |       |                    |      |               |       |        |      |   |      |          
|                              | Total cash, cash equivalents and marketable
debt securities |                            | $     | 5,244              |      |               | $     | 5,864  |      |   | $    | (620      | )
|                              |                                                             |                            |       |                    |      |               |       |        |      |   |      |          
|                              |                                                             | Percentage of total assets |       |                    | 34.1 | %             |       |        | 35.5 | % |      | (1.4) pts
|                             
|                             
|                             
|                             
|Days sales outstanding (DSO)  |                                                             |                            | 70    |                    |      |               | 72    |        |      |   |      |          
|                             
|                             
|                             
|                             
|Inventory turns- product only |                                                             |                            | 7.8   |                    |      |               | 6.7   |        |      |   |      |          

|                                                |  |                    |      |                    |  |        |      |   |  |   |      |  
|----------------------------------------------- |  | ------------------ | ---- | ------------------ |  | ------ | ---- | - |  | - | ---- | -
|                                                |  | Three Months Ended |      |                    |  |       
|                                                |  |                    |      |                    |  |       
|                                                |  | September 29, 2002 |      | September 30, 2001 |  | Change
|                                                |  |                    |      |                    |  |       
|Cash provided by operating activities           |  | $                  | 182  |                    |  | $      | 333  |   |  | $ | (151 | )
|                                               
|                                               
|                                               
|                                               
|Cash provided by (used in) investing activities |  | $                  | 126  |                    |  | $      | (534 | ) |  | $ | 660  |  
|                                               
|                                               
|                                               
|                                               
|Cash used in financing activities               |  | $                  | (696 | )                  |  | $      | (250 | ) |  | $ | (446 | )
|                                               
|                                               
|                                               
|                                               
|Net decrease in cash and cash equivalents       |  | $                  | (388 | )                  |  | $      | (451 | ) |  | $ | 63   |  

Changes in Cash Flow

During the quarter ended September 29, 2002, our operating activities generated
cash flows of approximately $182 million. However, during this same period our
cash, cash equivalents and marketable debt securities decreased by $620
million. This decrease is primarily attributable to the $499 million purchase
of our common stock in the open market and $200 million in principal payment on
our issued fixed-rate unsecured senior debt securities (Senior Notes).

The decrease in cash flows provided by operating activities resulted from
decreases in accounts payable and other liabilities and were partially offset
by decreases in accounts receivable (net), and inventory. Accounts receivable
(net) decreased to $2,133 million at September 29, 2002 from $2,745 million at
June 30, 2002. The decrease in accounts receivable (net) was primarily due to
the lower volume of sales and a decrease in days of sales outstanding (DSO).
DSO measures both the age, in terms of days, of our accounts receivable and the
average time it takes to turn the receivable into cash. DSO is also an
indicator of a companys linearity of sales for a quarter. There are a number
of factors affecting DSO, including our payment terms and collection ability.
The decrease in DSO was primarily attributable to the timing of customer
payments.

Inventory decreased to $509 million at September 29, 2002 from $591 million at
June 30, 2002 and our inventory turns rate has increased to 7.8 at September
29, 2002 from 6.7 at June 30, 2002. Inventory turns is annualized and
represents the number of times it is replaced during the year. The increase in
the inventory turns rate is a function of the lower balance in inventory,
demand for our products, and our ability to efficiently manage our inventory to
meet customer demands. Inventory management will continue to be an area of
focus as we balance the need to maintain strategic inventory levels to help
ensure competitive lead times with the risk of inventory obsolescence because
of rapidly changing technology and customer requirements. Prepaid expenses and
other current assets increased to $923 million at September 29, 2002 from $847
million at June 30, 2002 due to an increase in Value Added Tax (VAT)
receivable.

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Accounts payable decreased to $798 million at September 29, 2002 from $1,044
million at June 30, 2002. This decrease was primarily due to lower inventory
levels and decreases in related operating activities, partially offset by an
increase in VAT payable. Our accrued payroll-related liabilities decreased to
$449 million at September 29, 2002 from $538 million at June 30, 2002, as a
result of a reduction in accrued incentive compensation costs. Accrued
liabilities decreased to $1,147 at September 29, 2002 from $1,201 at June 30,
2002, as a result of the overall decrease in our sales and related operations.
Other non-current liabilities increased marginally to $1,753 million at
September 29, 2002 from $1,664 million at June 30, 2002 primarily due to
increases in the interest rate swap valuation of our Senior Notes.

Liquidity

We expect significant investing and financing cash outlays for the fiscal year
ending June 30, 2003 including capital expenditures for investment in our
product development and initiatives, funding of liabilities associated with the
reduction in force and the consolidation of facilities in connection with the
Fiscal 2003 Restructuring Plan and, depending on various factors including
stock price and cash flows, purchase of our common stock. Our board of
directors has approved programs authorizing management to repurchase shares of
our common stock in the open market at anytime. However, the timing and the
actual number of shares to repurchase are at the discretion of our management
and are contingent on numerous factors, including our share price and cash
flow. Also, we have $1.3 billion of Senior Notes that are due at various times
between August 2004 and August 2009. The Senior Notes are subject to compliance
with certain covenants that do not contain financial ratios. We are currently
in compliance with the covenants. If we failed to be in compliance with these
covenants, the trustee of the Senior Notes or holders of not less than 25% in
principal amount of the Senior Notes would have the ability to demand immediate
payment of all amounts outstanding.

Capital Resources and Financial Condition

Our long-term strategy is to maintain a minimum amount of cash and cash
equivalents in subsidiaries for operational purposes and to invest the
remaining amount of our cash in interest bearing and highly liquid cash
equivalents and marketable debt securities. Accordingly, in addition to the
$1,636 million in cash and cash equivalents we currently have for shorter-term
requirements, we have approximately $3,608 million in marketable debt
securities that are available for future operating, financing and investing
activities, for a total cash and investments position of $5,244 million.
However, part of this balance (approximately $1,463 million at June 30, 2002)
represents cash generated from operations domiciled in foreign tax
jurisdictions that are designated as permanently invested in the respective tax
jurisdictions. While we do not currently believe there is a need to repatriate
these funds to the U.S. in the short-term, if these funds are required for our
operations in the U.S., we would be required to accrue and pay additional taxes
to repatriate these funds.

In addition, Sun and its subsidiaries had uncommitted lines of credit
aggregating approximately $585 million. No amounts were drawn from these lines
of credit as of September 29, 2002. Interest rates and other terms of borrowing
under these lines of credit vary from country to country depending on local
market conditions at the time of borrowing. There is no guarantee that the
banks would approve our request for funds under these uncommitted lines of
credit.

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

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NON-AUDIT SERVICES OF INDEPENDENT AUDITORS

Our auditors, Ernst & Young LLP, perform the following non-audit services that
have been approved by our Audit Committee of the Board of Directors: statutory
audits; expatriate tax services; international and U.S. tax planning and
compliance services; and tax due diligence for acquisitions.

RISK FACTORS

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

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

Our competitors are some of the largest, most successful companies in the
world. They include International Business Machines Corporation (IBM),
Hewlett-Packard Company, which now owns Compaq Computer Corporation (HP), EMC
Corporation (EMC), Fujitsu and the Fujitsu-Siemens joint venture. Our future
competitive performance depends on a number of factors, including our ability
to: (1) continually develop and introduce new products and services with better
prices and performance than those offered by our competitors; (2) offer a wide
range of products and solutions from small single processor systems to large
complex enterprise level systems; (3) offer solutions to customers that operate
effectively within a computing environment that includes hardware and software
from multiple vendors; (4) offer products that are reliable and that ensure the
security of data and information; (5) create products for which third party
software vendors will develop a wide range of applications; and (6) offer high
quality products and services. Certain of our competitors, including IBM and
now HP (following the merger with Compaq) have financial and human resources
and scale that is greater than ours, which increases the competitive pressures
we face.

We also compete with systems manufacturers and resellers of systems based on
microprocessors from Intel Corporation (Intel) and the Windows family of
operating systems software from Microsoft Corporation (Microsoft). These
competitors include Dell Computer Corporation (Dell) and HP, in addition to
Intel and Microsoft. Certain of these competitors compete aggressively on price
and seek to maintain very low cost structures. Some of these competitors are
seeking to increase their market share in the enterprise server market. This
competition creates increased pressure, including pricing pressure, on our
workstation and lower-end server product lines, particularly, we are seeing
increased competition and pricing pressures from Linux and other open source
software vendors. We expect this competitive pressure to continue during the
remainder of fiscal year 2003, with the anticipated releases of new software
products from Microsoft and new microprocessors from Intel.

Fujitsu Limited and its subsidiaries (Fujitsu) have, for many years, been a
key strategic channel partner for Sun, distributing substantial quantities of
our products throughout the world. However, Fujitsu is also a competitor of Sun
and, as a licensee of various technologies from Sun and others, it has
developed products that compete directly with our products. While we currently
believe that Fujitsu intends to continue as our strategic channel partner, it
is likely that the level of competition between Fujitsu and Sun will further
intensify. While we intend to compete vigorously with Fujitsu, our inability to
compete successfully with Fujitsu would have an adverse impact on our revenues
and margins.

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Over the last several years, we have invested significantly in our storage
products business with a view to increasing the sales of these products both on
a stand-alone basis to customers using the systems of our competitors, and as
part of the systems that we sell. The intelligent storage products business is
intensely competitive. EMC is currently the leader in this market. During
fiscal 2001, we entered into an OEM agreement with Hitachi Data Systems under
which we agreed to collaborate to provide high-end hardware, software and
support solutions. To the extent we are unable to continue to penetrate this
market and compete effectively, our business and operating results could be
adversely affected.

The pricing policies of our competitors impact the overall demand for our
products and services. Some of our competitors are capable of operating at
significant losses for extended periods of time, increasing pricing pressure on
our products and services. If we do not maintain competitive pricing, the
demand for our products and services, as well as our market share, may decline,
having an adverse effect on our business. From time to time, in responding to
competitive pressures, we lower the prices of our products and services. When
this happens, if we are unable to reduce our component costs or improve
operating efficiencies, our revenues and margins will be adversely affected.

We maintain higher selling, general and administrative and research and
development costs, as a percentage of revenues, than many of our competitors.

One of our business strategies is to derive a competitive advantage and a
resulting enhancement of our gross margins from our investments in innovative
new technologies. As a result, as a percentage of revenues, we incur higher
fixed R&D costs than many of our competitors. In addition, as a result of
investing in a significant direct sales force we incur higher fixed selling
costs as a percentage of revenue. To the extent that we are unable to develop
and sell products with attractive gross margins in sufficient volumes, our
earnings may be materially adversely affected by our cost structure.

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

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

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The manufacture and introduction of our new hardware and software products is
also a complicated process. Once we have developed a new product we face
several challenges in the manufacturing process. We must be able to manufacture
new products in high enough volumes so that we can have an adequate supply of
new products to meet customer demand. We must be able to manufacture the new
products at acceptable costs. This requires us to be able to accurately
forecast customer demand so that we can procure the appropriate
components at optimal costs. Forecasting demand requires us to predict order
volumes, the correct mixes of our software and hardware products, and the
correct configurations of these products. We must manage new product
introductions, like the continued deployments of systems which incorporate our
new UltraSPARC III architecture, to minimize the impact of customer-delayed
purchases of existing products in anticipation of new product releases. We must
also try to reduce the levels of older product and component inventories to
minimize inventory write-offs. If we have excess inventory, it may be necessary
to reduce our prices and write down inventory, which could result in lower
gross margins. Additionally, our customers may delay orders for existing
products in anticipation of new product introductions. As a result, we may
decide to adjust prices of our existing products during this process to try to
increase customer demand for these products. If we are introducing new products
at the same time or shortly after the price adjustment, this will complicate
our ability to anticipate customer demand for our new products. We continuously
evaluate the competitiveness of our product and service offerings. These
evaluations could also result in repricing actions in the near term. Our future
operating results would be adversely affected if such repricing actions were to
occur and we were unable to mitigate the resulting margin pressure by
maintaining a favorable mix of systems, software, service and other products,
or if we were unsuccessful in achieving component cost reductions, operating
efficiencies and increasing sales volumes.

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

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

We depend on many suppliers for the necessary parts and components to
manufacture our products. There are a number of vendors producing the parts and
components that we need. However, there are some components that can only be
purchased from a single vendor due to price, quality, or technology reasons.
For example, we depend on Texas Instruments for our SPARC microprocessors, Sony
for various monitors and several other companies for custom integrated
circuits. If we were unable to purchase the necessary parts and components on
acceptable terms from a particular vendor and we had to find a new supplier for
such parts and components, our new and existing product shipments could be
delayed, adversely affecting our business and operating results.

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

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

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

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

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

Generally, the computer systems we sell to customers incorporate hardware and
software products that we sell, such as UltraSPARC microprocessors, the various
software elements, from the Solaris Operating Environment, to the Java platform
and the Sun ONE middleware products, and Sun StorEdge array products. Any
delay in the development of the software and hardware included in our systems
could delay our shipment of these systems. Delays in the development and
introduction of our products may occur for various reasons.

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

Our products may contain defects and errors.

Software and hardware products such as ours may contain known as well as
undetected errors, including defects in the design or manufacture of components
we buy from third parties which may be beyond our control. These defects may be
found following introduction and shipment of new products or enhancements to
existing products. Although we attempt to fix errors that we believe would be
considered critical by our customers prior to shipment, we may not be able to
detect or fix all such errors, and this could result in lost revenues and
delays in customer acceptance, and could be detrimental to our business and
reputation. In addition, fixing these errors with existing customers can be
expensive and could adversely impact our financial results.

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

Currently more than half of our revenues come from international sales. In
addition, a portion of our operations consists of manufacturing and sales
activities outside of the U.S. Our ability to sell our products and conduct our
operations internationally is subject to a number of risks. Local economic,
political and labor conditions in each country could adversely affect demand
for our products and services or disrupt our operations in these markets.
Currency fluctuations could also adversely affect our business in a number of
ways. Although we take steps to reduce or eliminate certain foreign currency
exposures that can be identified or quantified, we may incur currency
translation losses as a result of our international operations. Further, in the
event that currency fluctuations cause our products to become more expensive in
overseas markets in local currencies, there could be a reduction in demand for
our products or we could lower our pricing in some or all of these markets
resulting in reduced revenue and margins. Alternatively, a weakening dollar
could result in greater costs to us for our overseas operations. Changes to and
compliance with a variety of foreign laws and regulations may increase our cost
of doing business in these jurisdictions. Trade protection measures and import
and export licensing requirements subject us to additional regulation and may
prevent us from shipping products to a particular market, and increase our
operating costs. In addition, we could be subject to regulations, fines and
penalties for violations of import and export regulations such as, our products
being shipped directly or through a third party to certain countries. Such
violations could result in penalties, including prohibiting us from exporting
our products to one or more countries, and could adversely affect our business.
See Item 3. Legal Proceedings for further discussion.

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

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

Seasonality. Our sequential quarterly operating results usually fluctuate
downward in the first quarter of each fiscal year when compared with the
immediately preceding fourth quarter.

Linearity. Our first and third fiscal quarterly sales have historically
reflected a pattern in which a disproportionate percentage of such quarters
total sales occur in the last month and weeks and days of the quarter. This
pattern makes prediction of revenues, earnings and working capital for each
financial period especially difficult and uncertain and increases the risk of
unanticipated variations in quarterly results and financial condition. In
addition, over the last two fiscal years, linearity has been an issue in all of
our quarters.

Investments. We have an investment portfolio that includes minority equity and
debt investments. In most cases, we do not attempt to reduce or eliminate our
market exposure on these investments and may incur losses related to the
impairment of these investments. Our risk exposure in our marketable securities
investments is concentrated across a relatively small number of entities and
could be subject to substantial volatility if any of these entities experiences
material changes to its business or securities. In addition, we have made and
continue to evaluate and make, strategic equity investments in privately held
technology companies. Because these companies are typically early-stage
ventures with either unproven business models, products that are not yet fully
developed or products that have not yet achieved market acceptance, these
investments are inherently risky due to factors beyond our control.

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Goodwill. In October 2002, based on a combination of factors, particularly: (1)
our current and projected operating results, (2) our decision to reduce our
workforce and eliminate excess facility space, and (3) our current market
capitalization, we concluded that there were sufficient indicators to require
us to perform an
analysis to assess whether any portion of our recorded goodwill balance of
$2,182 million is impaired. We have completed the first phase of the impairment
analysis and have concluded that our recognized goodwill is impaired. We have
engaged independent valuation experts to assist us in determining the amount of
goodwill impairment we will recognize in the second quarter of fiscal 2003;
accordingly, until those valuations are completed, we are unable to quantify
the goodwill impairment charge to be recognized. This analysis may result in a non-cash goodwill impairment
charge, of up to $2,182
million, depending on the estimated value of the businesses to which the
goodwill relates and the value of the other assets and liabilities at that
time. Any such impairment charges could prove adverse to our future results.

Significant Customers. Sales to General Electric Company (GE) and its
subsidiaries in the aggregate accounted for approximately 12%, 13% and 19% of
our fiscal 2002, 2001 and 2000 net revenues, respectively. Our Chairman of the
board of directors, President and Chief Executive Officer, Scott McNealy, is a
member of GEs board of directors. However, he will resign from GEs board of
directors effective January 1, 2003. More than 90% of the revenue attributed to
GE was generated through GE subsidiaries acting as either a reseller or
financier of our products. Sales through MRA Systems, Inc., a master reseller
and a GE subsidiary, consisted of 8%, 10% and 16% of net revenues in 2002, 2001
and 2000, respectively, and sales to GE Capital, a finance/leasing company and
a GE subsidiary, consisted of 2%, 2%, and 3% of net revenues in fiscal 2002,
2001 and 2000, respectively. As a master reseller, MRA Systems, Inc. acts as a
distributor of our products to resellers who in turn sell those products to
end-users. Revenue is generated from GE Capital whenever our customers elect to
lease equipment through GE Capital; in such cases, we sell the equipment to GE
Capital, which in turn, leases that equipment to customers. Our business could
be adversely affected if GE or another significant customer terminated its
business relationship with us or significantly reduced the amount of business
it did with us.

Adverse Business Conditions in Specific Industries. We depend on the
telecommunications, financial services and manufacturing industries for a
significant portion of our revenues. Significant reduction in technology
capital spending in these industries, such as we experienced over the last two
quarters of fiscal 2001 and during fiscal 2002, may continue to result in
decreased revenues and earnings. Our revenues are dependent on the level of
technology capital spending in the U.S. and international economies. A number
of telecommunications companies have recently filed for bankruptcy protection,
and others have announced significant reductions and deferrals in capital
spending. If the current adverse economic conditions continue, we would expect
that the significant diminishing of capital spending would continue. If capital
spending continues to decline in these industries over an extended period of
time, our business will continue to be adversely affected. We are implementing
a strategy to reduce our dependence on these industries, but no assurance can
be given that this strategy will be successful.

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

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

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Our acquisition and alliance activities could disrupt our ongoing business.

We intend to continue to make investments in companies, products, and
technologies, either through acquisitions or investment alliances. For example,
we have purchased several companies in the past and have also formed alliances,
such as our recent OEM relationship with HDS for the collaboration on, and
delivery of, a broad range of storage products and services. We also rely on IT
services partners and independent software development to enhance the value to
our customers of our products and services. Acquisitions and alliance
activities often involve risks, including: (1) difficulty in assimilating the
acquired operations and employees; (2) difficulty in managing product
co-development activities with our alliance partners; (3) retaining the key
employees of the acquired operation; (4) disruption of our ongoing business;
(5) inability to successfully integrate the acquired technology and operations
into our business and maintain uniform standards, controls, policies, and
procedures; and (6) lacking the experience to enter into new product or
technology markets. In addition, from time to time, our competitors acquire or
enter into exclusive arrangements with companies with whom we do business or
may do business in the future. Reductions in the number of partners with whom
we may do business in a particular context may reduce our ability to enter into
critical alliances on attractive terms or at all, and the termination of an
existing alliance by a business partner may disrupt our operations. For
example, as we partnered with PWC Consulting to provide professional services,
the acquisition of PWC Consulting by IBM could reduce potential business for
us. Failure to manage our alliance activities effectively and to integrate
entities or assets that we acquire could affect our operating results or
financial condition.

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

Our employees are vital to our success, and our key management, engineering,
and other employees are difficult to replace. We generally do not have
employment contracts with our key employees. Further, we do not maintain key
person life insurance on any of our employees. Because our compensation
packages include equity-based incentives, pressure on our stock price could
affect our ability to continue to offer competitive compensation packages to
current employees. In addition, we must continue to motivate employees and keep
them focused on our strategies and goals, which may be difficult due to morale
challenges posed by the workforce reduction and general uncertainty about the
economy. Should these conditions continue, we may not be able to retain highly
qualified technical employees in the future. These factors could adversely
affect our business.

Proposed regulations related to equity compensation could adversely affect our
ability to attract and retain key personnel.

Since our inception, we have used stock options and other long-term equity
incentives as a fundamental component of our employee compensation packages. We
believe that stock options and other long-term equity incentives directly
motivate our employees to maximize long-term stockholder value and, through the
use of vesting, encourage employees to remain with Sun. The Financial
Accounting Standards Board (FASB), among other agencies and entities, is
currently considering changes to US GAAP that, if implemented, would require us
to record a charge to earnings for employee stock option grants. This proposal
would negatively impact our earnings. For example, recording a charge for
employee stock options under SFAS 123, Accounting for Stock-Based
Compensation would have increased after tax loss by $647 million for fiscal
year 2002 and reduced after tax income by $533 million and $317 million for
fiscal years 2001 and 2000, respectively. In addition, new regulations proposed
by The Nasdaq National Market requiring shareholder approval for all stock
option plans as well as new regulations proposed by the New York Stock Exchange
prohibiting NYSE member
organizations from giving a proxy to vote on equity-compensation plans unless
the beneficial owner of the shares has given voting instructions could make it
more difficult for us to grant options to employees in the future. To the
extent that new regulations make it more difficult or expensive to grant
options to employees, we may incur increased cash compensation costs or find it
difficult to attract, retain and motivate employees, either of which could
materially and adversely affect our business.

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Business interruptions could adversely affect our business.

Our operations are vulnerable to interruption by fire, earthquake, power loss,
telecommunications failure, terrorist attacks and other events beyond our
control. A substantial portion of our facilities, including our corporate
headquarters and other critical business operations, are located near major
earthquake faults. In addition, some of our facilities are located on filled
land and, therefore, may be more susceptible to damage if an earthquake occurs.
We do not carry earthquake insurance for direct earthquake-related losses. Our
facilities in the State of California, including our corporate headquarters and
other critical business operations, may be subject to electrical blackouts as a
consequence of a shortage of available electrical power. In the event these
blackouts occur, they could disrupt the operations of our affected facilities.
In addition, we do not carry business interruption insurance nor do we carry
financial reserves against business interruptions arising from earthquakes, and
certain electrical blackouts. If a business interruption occurs, our business
could be seriously harmed.

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

In response to the continuing global economic slowdown, we implemented a
facility exit plan as part of our efforts to consolidate excess facilities. The
general adverse economic conditions in the United States and in many of the
countries in which we have significant leased properties have resulted in a
surplus of business facilities making it difficult to sublease properties. If
the adverse economic conditions continue, we may be unable to sublease our
excess properties, or we may not meet our expected estimated levels of
subleasing income, and our results of operations could be negatively affected.

Environmental regulations and costs could result in significant liabilities for
us.

Some of our operations are subject to regulation under various federal, state
and international laws governing the environment and hazardous substances.
While we endeavor to be in compliance with environmental laws at all times, any
failure to so comply can subject us to material liability. Also, particularly
in Europe, we may be subject to compliance with developing product content
requirements relating to recycling as well as product take back requirements
that would make us responsible for recycling and/or disposing of products we
have sold. These and other environmental laws may become stricter over time and
require us to incur substantial costs for compliance. In addition, we could be
subject to liability for investigation and remediation of hazardous substances
if our operations have caused contamination or any of our owned properties are
found to be contaminated. Although costs relating to environmental matters have
not resulted in a material adverse effect on us to date, there can be no
assurance that we will not be required to incur such costs in the future.

Our equity securities are subject to equity price risk and their value may
fluctuate.

From time to time, we make equity investments for the promotion of business and
strategic objectives in publicly traded and privately-held companies. The
market price and valuation of the securities that we hold in these companies
may fluctuate due to market conditions and other circumstances over which we
have little or no control. Many of the companies in which we have invested have
experienced significant volatility in their
stock prices. We typically do not attempt to reduce or eliminate this equity
price risk, through hedging or similar techniques, and market price and
valuation fluctuations could impact our financial results. To the extent that
the fair value of these securities was less than our cost over an extended
period of time, our net income would be reduced. See Item 3 of
Part I 
Quantitative and Qualitative Disclosures about Market Risk for further
discussion.

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Our stock price can be volatile.

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

Our credit rating is subject to downgrade.

Standards & Poors, a credit agency that follows Sun, recently downgraded us
from triple-B-plus to triple-B rating. In addition, Standards & Poors and
Moodys Investor Services, another credit agency, continued to place the
Company on negative outlook. This reflects those credit agencies expectations
that continued economic weakness and reduced IT spending will continue over at
least the near-term to challenge Suns sales and profitability. The downgrade
by Standards & Poors could increase our costs of
obtaining, or make it more
difficult to obtain new debt financing or issuing new debt, either of which
could adversely affect our business and financial condition.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk related to changes in interest rates, foreign
currency exchange rates, and equity security prices. To mitigate some of these
risks, we utilize derivative financial instruments to hedge these exposures. We
do not use derivative financial instruments for speculative or trading
purposes. All of the potential changes noted below are based on sensitivity
analyses performed on our financial position at September 29, 2002. Actual
results may differ materially.

Interest Rate Sensitivity

Our investment portfolio consists primarily of fixed income instruments with an
average duration of 0.88 years as of September 29, 2002. The primary objective
of our investments in debt securities is to preserve principal while maximizing
yields, without significantly increasing risk. These available-for-sale
securities are subject to interest rate risk. The fair market value of these
securities may fluctuate with changes in interest rates. A sensitivity analysis
was performed on this investment portfolio based on a modeling technique that
measures the hypothetical fair market value changes (using a three month
horizon) that would result from a parallel shift in the yield curve of plus 150
basis points (BPS). Based on this analysis, for example, a hypothetical 150 BPS
increase in interest rates would result in an approximate $49 million decrease
in the fair value of our investments in debt securities as of September 29,
2002.

We also entered into various interest-rate swap agreements to modify the
interest characteristics of the Senior Notes so that the interest payable on
the Senior Notes effectively becomes variable and thus matches the variable
interest rate received from our cash and marketable securities. Accordingly,
interest rate fluctuations impact the fair value of our Senior Notes
outstanding, which will be offset by corresponding changes in the fair value of
the swap agreements. However, by entering into these swap agreements, we have a
cash flow exposure related to the risk that interest rates may increase. For
example, a hypothetical 150 BPS increase in interest rates would result in an
approximate $23 million decrease in cash over a year.

Foreign Currency Exchange Risk

The majority of our revenue, expense, and capital purchasing activities are
transacted in U.S. dollars. However, since a portion of our operations consists
of manufacturing and sales activities outside of the U.S., we enter into
transactions in other currencies, primarily the Japanese yen, the British pound
and the euro. As a result, we purchase currency options and forward contracts
to reduce or eliminate certain foreign currency exposures that can be
identified and quantified. Suns hedges are primarily intended to protect
changes in the value of the U.S. dollar.

Based on our foreign currency exchange instruments outstanding at September 29,
2002, we estimate a maximum potential one-day loss in fair value of
approximately $8 million, as compared with $8 million as of June 30, 2002,
using a Value-at-Risk (VAR) model. The VAR model estimates were made assuming
normal market conditions and a 95% confidence level. We used a Monte Carlo
simulation type model that valued foreign currency instruments against three
thousand randomly generated market price paths. Anticipated transactions, firm
commitments, receivables, and accounts payable denominated in foreign
currencies were excluded from the model. The VAR model is a risk estimation
tool, and as such is not intended to represent actual losses in fair value that
will be incurred by us. Additionally, as we utilize foreign currency
instruments for hedging anticipated and firmly committed transactions, a loss
in fair value for those instruments is generally offset by increases in the
value of the underlying exposure. Foreign currency fluctuations did not have a
material impact on our results of operations and financial position during the
three month period ended September 29, 2002.

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Equity Security Price Risk

We are exposed to price fluctuations on the marketable portion of equity
securities included in our portfolio of equity investments. These investments
are generally in companies in the high-technology industry sector, many of
which are small capitalization stocks. We typically do not attempt to reduce or
eliminate the market exposure on these securities. A 20% adverse change in
equity prices would result in an approximate $2 million decrease in the fair
value of our available-for-sale equity investments as of September 29, 2002. At
September 29, 2002, three equity securities represented approximately $10
million of the $12 million total fair value of the marketable equity
securities.




ITEM 4. CONTROLS AND PROCEDURES

During the 90 day period prior to the filing of this quarterly report, we
performed an evaluation under the supervision and with the participation of
Suns management, including Suns Chief Executive Officer (CEO) and Chief
Financial Officer (CFO), of the effectiveness of the design and operation of
Suns disclosure controls and procedures (as defined in Rules 13a-14(c) and
15d-14(c) under the Securities Exchange Act of 1934, as amended). Following
that evaluation, Suns management, including the CEO and CFO, concluded that
based on the evaluation, the design and operation of Suns disclosure
controls and procedures were effective at that time. Since the evaluation,
there have been no significant changes in Suns internal controls or in factors
that could significantly affect internal controls, including, because we have
not identified any significant deficiencies or material weaknesses in our
internal controls, any corrective actions with regard to significant
deficiencies and material weaknesses.

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PART II  OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS

On February 11, 2002, Eastman Kodak Company (Kodak) filed a civil lawsuit
against us, Eastman Kodak Company v. Sun Microsystems, Inc., Civil Action No.
02-CV-6074, in the United States District Court for the Western District of New
York. Kodak filed a First Amended Complaint on March 22, 2002. In the First
Amended Complaint Kodak asserts that our products, including those relating to
Java technology, infringe one or more claims of U.S. Patent No. 5,206,951, U.S.
Patent No. 5,421,012, and U.S. Patent No. 5,226,161 (collectively, the Kodak
Patents) and seeks injunctive relief against future infringement, unspecified
damages for past infringement, as well as costs and attorneys fees. On May 24,
2002, we filed an Answer to First Amended Complaint and Counterclaims, denying
infringement of any valid and enforceable claim of any of the Kodak Patents. In
the Answer and Counterclaims, we are also seeking declaratory judgment of
noninfringement, invalidity and/or unenforceability of the Kodak Patents, we
further allege that Kodaks claims are barred in whole or in part by the
doctrines of estoppel, laches and patent exhaustion, and that we have license
and/or sublicense rights to the Kodak Patents. We also sought declaratory
judgment of noninfringement, invalidity and/or unenforceability of four other
patents that Kodak cited in letters to us but which were not included in
Kodaks First Amended Complaint (the Additional Kodak Patents). On August 23,
2002, the Court dismissed our counterclaims regarding the Additional Kodak
Patents on the grounds that we had no reasonable apprehension that we would be
sued for infringement of those patents, and that accordingly, the Court lacked
jurisdiction to hear counterclaims with respect to those patents. Based on
discussions over many months with Kodak, we believe that this suit is without
merit, and, accordingly, we will defend ourselves and pursue our counterclaims
vigorously. We cannot forecast at this time with reasonable certainty the
potential costs associated with an adverse outcome of this matter.

On March 8, 2002, we filed suit against Microsoft Corporation (Microsoft) in
the United States District Court for the Northern District of California
pursuant to United States and State of California antitrust laws alleging
illegal efforts to acquire, maintain and expand a number of monopolies; illegal
tying arrangements; exclusive dealings; copyright infringement; unreasonable
restraint of trade; and unfair competition. Sun is seeking remedies that
include: (1) preliminary injunctions that require Microsoft to distribute our
binary implementation of the Java Run-time Environment as part of Windows XP
and Internet Explorer and to stop the unlicensed distribution of Microsofts
Virtual Machine for Java in violation of a January 23, 2001 settlement
agreement; (2) a permanent injunction to restore competition to the markets in
which Microsoft is unlawfully attempting to acquire, maintain and expand a
number of monopolies; and (3) compensation for losses we suffered as a result
of Microsofts unlawful actions. On August 9, 2002, the Judicial Panel on
Multidistrict Litigation issued an order transferring Suns lawsuit to the
District of Maryland for inclusion in the central pretrial proceedings in the
Microsoft Corp. Windows Operating System Antitrust Litigation, MDL-1332. We
filed an amended complaint on August 26, 2002, alleging additional illegal
tying arrangements and acts of illegal monopoly maintenance. An evidentiary
hearing on our pending motion for preliminary injunctions will be conducted by
the District of Maryland beginning December 3, 2002. On October 4, 2002,
Microsoft filed motions to dismiss some of the claims in our complaint. We
filed our response to those motions to dismiss on November 5, 2002. At the
conclusion of the pretrial proceedings in MDL-1332, the lawsuit will return for
trial to the Northern District of California.

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In early February 2002, Sun and two of its subsidiaries received several
charging letters from the United States Department of Commerce, Bureau of
Industry and Security, Office of Export Enforcement (BIS) claiming that we had
violated export control regulations. The letters relate to sales in 1998 in
Egypt and in 1997 to a reseller in Hong Kong for subsequent resale in the
Peoples Republic of China. The letters specify, and the export statute
authorizes the imposition of monetary penalties, denial of export privileges
and exclusion from practice
before the BIS if a violation is found. Sun representatives and outside counsel
have been in settlement discussions with authorities at the BIS regarding
penalties and remedies. In order to facilitate these discussions, the BIS
granted us an extension until November 1, 2002 to respond to the charging
letters. A subsequent extension was granted until January 31, 2003. In
addition, the BIS informed us verbally that additional charges would be added
to the current claims against us. Based on settlement discussions with the BIS,
we believe that it is reasonably likely that we will reach a negotiated
resolution of these charging letters that will not have a material adverse
effect on our operations. However, absent a negotiated resolution, an
administrative hearing would be set at some date after January 31, 2003. In
such case, we would assert a vigorous defense. We believe that any monetary
penalties imposed would not have a material adverse effect on our financial
condition or operating results. In addition, while we do not believe the
evidence would support the extreme sanction of a denial of export privileges or
exclusion from practice before the BIS, any such penalties would have a
material adverse effect on our business.




ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

During the first quarter of fiscal 2003, we issued unregistered shares of our
common stock in connection with our acquisition of Afara. The following chart
provides information regarding the issuance of these unregistered shares to the
stockholders of Afara in exchange for all of the stockholders ownership
interests in this company.

|                         |  |                     |  |                   |           |                     |  |                   |         |                     |  |                   |  |  |  | 
|------------------------ |  | ------------------- |  | ----------------- | --------- | ------------------- |  | ----------------- | ------- | ------------------- |  | ----------------- |  |  |  | 
|                         |  |                     |  |                   |           |                     |  |                   |         | Number of           |  |                   |  | 
|                         |  |                     |  |                   |           | Number of Shares of |  | warrants Issued   |         |                     |  |                  
|                         |  |                     |  |                   |           | Sun Common Stock    |  | (rounded to       |         |                     |  |                  
|                         |  |                     |  |                   |           | Issued (rounded to  |  | nearest           |         | Basis for Exemption
|Name of Company Acquired |  | Date of Acquisition |  | nearest thousand) |           | thousand)           |  | from Registration
|                         |  |                     |  |                   |           |                     |  |                  
|                        
|                        
|                        
|                        
|Afara Websystems, Inc    |  | July 22, 2002       |  |                   | 4,867,000 |                     |  |                   | 109,000 |                     |  | Section 3(a) (10)

No underwriters were used in connection with the transaction. Our common stock
and options and warrants to purchase our common stock were issued in exchange
for all the outstanding securities of Afara. Our common stock was issued after
the California Department of Corporations issued a permit that, among other
things, approved the terms and conditions of the transaction as being fair to
the persons to whom we issued our common stock. The permit was issued after the
California Department of Corporations held a fairness hearing open to everyone
to whom Sun common stock would be issued. Following the closing, the assumed
warrants are exercisable for the number of shares determined by multiplying the
original number of shares subject to the warrant by the transaction exchange
ratio. The per share exercise price is determined by dividing the original per
share exercise price by the transaction exchange ratio.




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



| | (a) |  | Exhibits                                       
| | --- |  | -----------------------------------------------
|
| |     |  | See Index to Exhibits on Pages 46 to 47 hereof.
|
| | (b) |  | Reports on Forms 8-K                           



| | (1) |  | On September 30, 2002, we filed a report on Form 8-K with the
Securities and Exchange Commission containing the Statements under Oath of
the Principal Executive Officer, Scott G. McNealy, and of the Principal
Financial Officer, Stephen T. McGowan, certifying the Companys Annual
Report on Form 10-K for the fiscal year ended June 30, 2002 and our 2002
Proxy Statement.
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | (2) |  | On August 9, 2002, we filed a report on Form 8-K with the Securities and
Exchange Commission containing a description of the loans outstanding or
granted to our executive officers and members of our Board of Directors during
fiscal years 2002 and 2003. Descriptions of loans for the following executive
officers and members of the Board of Directors were included in the report: (1)
Mark A. Canepa; (2) Masood A. Jabbar; (3) Robert L. Long; (4) Eva Sage-Gavin;
(5) Jonathan I. Schwartz; and (6) Patricia C. Sueltz.
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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SIGNATURES

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



| | SUN MICROSYSTEMS, INC.
| | ----------------------



| | BY
| | --



| | /s/        Stephen T. McGowanStephen T. McGowanChief Financial Officer and Executive Vice President,
Corporate Resources
(Principal Financial Officer)
| | ------------------------------------------------------------------------------------------------------------------------------------------------------



| | /s/        Kenneth A. BarkerKenneth A. BarkerVice President and Corporate Controller
(Principal Accounting Officer)
| | -------------------------------------------------------------------------------------------------------------------

Dated: November 13, 2002

43



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CERTIFICATION

I, Scott G. McNealy, certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Sun Microsystems,
Inc.;                                                                                                                                                                                                                                                 
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;                   
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:                                                                                                     



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to record,
process, summarize and report financial data and have identified for the
registrants auditors any material weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal
controls; and                                                                                                                                        



|6. |  | The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: November 13, 2002



| | /s/         Scott G. McNealy
Scott G. McNealy
Chief Executive Officer
| | ---------------------------------------------------------------------

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##### Table of Contents



CERTIFICATION

I, Stephen T. McGowan, certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Sun Microsystems,
Inc.;                                                                                                                                                                                                                                                 
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;                   
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:                                                                                                     



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to record,
process, summarize and report financial data and have identified for the
registrants auditors any material weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal
controls; and                                                                                                                                        



|6. |  | The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: November 13, 2002



| | /s/        Stephen T. McGowanStephen T. McGowan
Chief Financial Officer
| | -----------------------------------------------------------------------

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INDEX TO EXHIBITS

|           |  |                                                                                                                                                                                                                                                                                          
|---------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit    |  |                                                                                                                                                                                                                                                                                          
|Number     |  | Description                                                                                                                                                                                                                                                                              
|           |  |                                                                                                                                                                                                                                                                                          
|3.1(1)     |  | Registrants Restated Certificate of Incorporation.                                                                                                                                                                                                                                      
|          
|          
|          
|          
|3.2(2)     |  | Certificate of Amendment of the Restated Certificate of
Incorporation of Registrant dated November 8, 2000.                                                                                                                                                                              
|          
|          
|          
|          
|3.3(3)     |  | Amended and Restated Certificate of Designations dated December
13, 2000.                                                                                                                                                                                                                
|          
|          
|          
|          
|3.4(14)    |  | Bylaws of the Registrant, as amended September 17, 2002.                                                                                                                                                                                                                                 
|          
|          
|          
|          
|4.8(4)     |  | Third Amended and Restated Shares Rights Agreement dated July 25,
2002.                                                                                                                                                                                                                  
|          
|          
|          
|          
|4.10(5)    |  | Indenture, dated August 1, 1999 (the Indenture) between
Registrant and The Bank of New York, as Trustee.                                                                                                                                                                               
|          
|          
|          
|          
|4.11(5)    |  | Form of Subordinated Indenture.                                                                                                                                                                                                                                                          
|          
|          
|          
|          
|4.12(5)    |  | Officers Certificate Pursuant to Section 301 of the Indenture,
without exhibits, establishing the terms of Registrants Senior
Notes.                                                                                                                                                   
|          
|          
|          
|          
|4.13(5)    |  | Form of Senior Note.                                                                                                                                                                                                                                                                     
|          
|          
|          
|          
|10.64(6)   |  | Registrants 1988 Directors Stock Option Plan, as amended on
August 11, 1999.                                                                                                                                                                                                           
|          
|          
|          
|          
|10.65(7)   |  | Registrants 1990 Employee Stock Purchase Plan, as amended on
August 13, 1997.                                                                                                                                                                                                           
|          
|          
|          
|          
|10.66(8)   |  | Registrants 1990 Long-Term Equity Incentive Plan, as amended on
August 15, 2001.                                                                                                                                                                                                        
|          
|          
|          
|          
|10.66A(9)  |  | Representative form of agreement to Registrants 1990 Long-Term
Equity Incentive Plan (LTEIP).                                                                                                                                                                                           
|          
|          
|          
|          
|10.66B(9)  |  | French Sub-Plan to 1990 Long Term Equity Incentive Plan.                                                                                                                                                                                                                                 
|          
|          
|          
|          
|10.84(10)  |  | Registrants Non-Qualified Deferred Compensation Plan, as amended
June 30, 2002.                                                                                                                                                                                                         
|          
|          
|          
|          
|10.85(11)  |  | Registrants Section 162(m) Executive Officer Performance-Based
Bonus Plan, as amended and restated July 1, 2001.                                                                                                                                                                        
|          
|          
|          
|          
|10.87(14)  |  | Registrants Equity Compensation Acquisition Plan, as amended on
July 25, 2002.                                                                                                                                                                                                          
|          
|          
|          
|          
|10.89(12)  |  | Form of Change of Control Agreement executed by each executive
officer of Registrant.                                                                                                                                                                                                    
|          
|          
|          
|          
|10.90(12)  |  | Form of Change of Control Agreement executed by Chief Executive
Officer of Registrant.                                                                                                                                                                                                   
|          
|          
|          
|          
|10.94(10)  |  | Promissory Notes issued by Robert L. Long on November 12, 2001
and January 10, 2002 and related documents.                                                                                                                                                                               
|          
|          
|          
|          
|10.95(10)  |  | Promissory Notes issued by Masood A. Jabbar on November 7, 2001
and related documents.                                                                                                                                                                                                   
|          
|          
|          
|          
|10.96(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
dated July 18, 2002, and Promissory Note issued by Jonathan I.
Schwartz on July 19, 2002.
|          
|          
|          
|          
|10.97(14)  |  | Retirement Transition Agreement dated April 30, 2002, and
Resignation dated September 17, 2002, between the Registrant and
Michael Lehman.                                                                                                                                               
|          
|          
|          
|          
|10.98(14)  |  | Retirement Transition Agreement dated April 30, 2002 between the
Registrant and Edward Zander.                                                                                                                                                                                           
|          
|          
|          
|          
|10.99(14)  |  | Retirement Transition Agreement dated July 18, 2002 between the
Registrant and Masood Jabbar.                                                                                                                                                                                            
|          
|          
|          
|          
|10.100(14) |  | Retirement Transition Agreement dated July 25, 2002 between the
Registrant and John Shoemaker.                                                                                                                                                                                           
|          
|          
|          
|          
|10.101(14) |  | Employment Agreement dated January 3, 2001 between the Registrant
and David Yen, as amended May 17, 2001.                                                                                                                                                                                
|          
|          
|          
|          
|10.102(14) |  | Retention Bonus Agreement dated September 5, 2002 between the
Registrant and Patricia Sueltz.                                                                                                                                                                                            
|          
|          
|          
|          
|10.103(14) |  | Retention Bonus Agreement dated September 5, 2002 between the
Registrant and Eva Sage-Gavin.                                                                                                                                                                                             
|          
|          
|          
|          
|10.104(14) |  | Form of Indemnification Agreement executed by each executive
officer of Registrant.                                                                                                                                                                                                      
|          
|          
|          
|          
|15.1       |  | Letter of Awareness of Ernst & Young LLP, Independent Auditors.                                                                                                                                                                                                                          
|          
|          
|          
|          
|99.1       |  | Certification of Chief Executive Officer, Scott G. McNealy.                                                                                                                                                                                                                              

46



---



##### Table of Contents



|        |  |                                                              
|------- |  | -------------------------------------------------------------
|Exhibit |  |                                                              
|Number  |  | Description                                                  
|        |  |                                                              
|       
|       
|       
|       
|99.2    |  | Certification of Chief Financial Officer, Stephen T. McGowan.



|(1)  |  | Incorporated by reference to Registrants Quarterly Report on Form 10-Q
for fiscal quarter ended March 29, 1998.                  
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------
|    
|(2)  |  | Incorporated by reference as Exhibit 3.5 to Registrants Quarterly Report
on Form 10-Q for fiscal quarter ended December 31, 2000.
|    
|(3)  |  | Incorporated by reference as Exhibit 2.2 to Registrants Form 8-A/ A
filed December 20, 2000.                                     
|    
|(4)  |  | Incorporated by reference to the Registrants Form 8-A/ A filed
September 26, 2002.                                               
|    
|(5)  |  | Incorporated by reference to Registrants Current Report on Form 8-K
filed August 6, 1999.                                        
|    
|(6)  |  | Incorporated by reference to Registrants Annual Report on Form 10-K
for the fiscal year ended June 30, 1999.                     
|    
|(7)  |  | Incorporated by reference to Registrants Registration Statement on
Form S-8 filed on November 20, 1997.                          
|    
|(8)  |  | Incorporated by reference to Registrants Registration Statement on
Form S-8 filed November 13, 2001.                             
|    
|(9)  |  | Incorporated by reference to Registrants Annual Report on Form 10-K
for the fiscal year ended June 30, 2001.                     
|    
|(10) |  | Incorporated by reference to Registrants Quarterly Report on Form
10-Q for fiscal quarter ended March 31, 2002.                  
|    
|(11) |  | Incorporated by reference to Registrants Quarterly Report on Form
10-Q for fiscal quarter ended September 30, 2001.              
|    
|(12) |  | Incorporated by reference to Registrants Quarterly Report on Form
10-Q for fiscal quarter ended December 29, 1996.               
|    
|(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, 2002.                     

47