<PAGE>   1

                       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 27, 1998
         or

[ ]      Transition report pursuant to Section 13 or 15(d) of the Securities
         Exchange Act of 1934 for the transition period from ______ to _______

                         Commission file number:0-15086

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

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


                    901 SAN ANTONIO ROAD PALO ALTO, CA 94303
             (Address of principal executive offices with zip code)

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

                                       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 ISSUERS INVOLVED IN
                          BANKRUPTCY PROCEEDINGS DURING
                            THE PRECEDING FIVE YEARS:

  Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.

                                 YES [ ] 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 practical date.

<TABLE>
<CAPTION>
             CLASS                             OUTSTANDING AT SEPTEMBER 27, 1998
<S>                                            <C>
 Common Stock - $0.00067 par value                         380,586,074
</TABLE>



<PAGE>   2

                                      INDEX




<TABLE>
<CAPTION>
                                                                              PAGE
                                                                              ----
<S>                                                                           <C>
COVER PAGE                                                                     1

INDEX                                                                          2

PART I - FINANCIAL INFORMATION

       Item 1 - Financial Statements
                Condensed Consolidated Balance Sheets                          3
                Condensed Consolidated Statements of Income                    4
                Condensed Consolidated Statements of Cash Flows                5
                Notes to Condensed Consolidated Financial Statements           7

       Item 2 - Management's Discussion and Analysis of
                Results of Operations and Financial Condition                 10

PART II - OTHER INFORMATION
       Item 1 - Legal Proceedings                                             21
       Item 5 - Other Information                                             21
       Item 6 - Exhibits and Reports on Form 8 - K                            22
       Item 7A - Quantitative and Qualitative Disclosures about
                 Market Risk                                                  22
SIGNATURES                                                                    23
</TABLE>



                                       2
<PAGE>   3

                         PART I - FINANCIAL INFORMATION

  ITEM 1 - FINANCIAL STATEMENTS

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


<TABLE>
<CAPTION>
                                                     September 27,           June 30,
                                                         1998                 1998
                                                     -----------           -----------
                                                     (unaudited)
<S>                                                  <C>                   <C>        
ASSETS
Current assets:
       Cash and cash equivalents                     $   755,364           $   822,267
       Short-term investments                            683,783               476,185
       Accounts receivable, net                        1,770,240             1,845,765
       Inventories                                       384,385               346,446
       Deferred tax assets                               373,405               371,841
       Other current assets                              356,901               285,021
                                                     -----------           -----------
            Total current assets                       4,324,078             4,147,525
Property, plant and equipment, at cost                 2,459,942             2,257,228
Accumulated depreciation and amortization             (1,060,166)             (956,616)
                                                     -----------           -----------
                                                       1,399,776             1,300,612
Other assets, net                                        332,806               262,925
                                                     -----------           -----------
                                                     $ 6,056,660           $ 5,711,062
                                                     ===========           ===========


LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
       Short-term borrowings                         $     1,990           $     7,169
       Accounts payable                                  554,603               495,603
       Accrued liabilities                             1,159,580             1,166,491
       Income taxes payable                              199,371               188,641
       Other current liabilities                         273,092               264,967
                                                     -----------           -----------
            Total current liabilities                  2,188,636             2,122,871
Deferred income taxes and other obligations               91,105                74,563
Total stockholders' equity                             3,776,919             3,513,628
                                                     -----------           -----------
                                                     $ 6,056,660           $ 5,711,062
                                                     ===========           ===========
</TABLE>



                             See accompanying notes



                                       3
<PAGE>   4

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


<TABLE>
<CAPTION>
                                                         Three Months Ended
                                                    ------------------------------
                                                    September 27,       September 28,
                                                       1998                1997
                                                    ----------          ----------
<S>                                                 <C>                 <C>       
Net revenues:
       Products                                     $2,156,118          $1,847,888
       Services                                        335,066             250,716
                                                    ----------          ----------
 Total net revenues                                  2,491,184           2,098,604
                                                    ----------          ----------

Cost and expenses:
       Cost of sales-products                          988,237             861,327
       Cost of sales-services                          228,100             166,107
       Research and development                        283,280             222,618
       Selling, general and administrative             711,588             615,493
       Purchased in-process research and
            development                                 80,000              52,184
                                                    ----------          ----------

           Total costs and expenses                  2,291,205           1,917,729
                                                    ----------          ----------
Operating income                                       199,979             180,875
Interest income, net                                    15,355              10,571
                                                    ----------          ----------
Income before income taxes                             215,334             191,446
Provision for income taxes                             101,460              83,013
                                                    ----------          ----------

Net income                                          $  113,874          $  108,433
                                                    ==========          ==========

Net income per common share - basic                 $     0.30          $     0.29
                                                    ==========          ==========
Net income per common share - diluted               $     0.29          $     0.27
                                                    ==========          ==========

Shares used in the calculation
       of net income per share - basic                 377,218             372,062
                                                    ==========          ==========
Shares used in the calculation
       of net income per share - diluted               397,602             395,099
                                                    ==========          ==========
</TABLE>



                             See accompanying notes.



                                       4
<PAGE>   5

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

<TABLE>
<CAPTION>
                                                                             Three Months Ended
                                                                       -----------------------------
                                                                       September 27,       September 28,
                                                                         1998                1997
                                                                       ---------           ---------
<S>                                                                    <C>                 <C>      
Cash flows from operating activities:
       Net income                                                      $ 113,874           $ 108,433
       Adjustments to reconcile net income
                to operating cash flows:
                Depreciation and amortization                            161,595              86,803
                Tax benefit of options exercised                          42,083              56,626
                Purchased in-process research and development             80,000              52,184
                Net decrease in accounts receivable                       79,241             215,814
                Net increase in inventories                              (37,939)            (28,890)
                Net increase (decrease) in accounts payable               58,039             (40,510)
                Net increase in other current
                         and non-current assets                          (86,389)            (61,277)
                Net decrease in other current
                         and non-current liabilities                      (5,472)           (164,839)
                                                                       ---------           ---------
Net cash provided from operating activities                              405,032             224,344
                                                                       ---------           ---------
Cash flows from investing activities:
       Acquisition of property, plant and equipment                     (210,305)           (161,817)
       Acquisition of spare parts and other assets                       (34,661)            (33,962)
       Payments for acquisitions, net of cash acquired                     5,437             (55,200)
       Acquisition of short-term investments                            (448,929)           (211,042)
       Sale of short-term investments                                    118,945             101,146
       Maturities of short-term investments                              108,263              89,128
                                                                       ---------           ---------
Net cash used by investing activities                                   (461,250)           (271,747)
                                                                       ---------           ---------
Cash flows from financing activities:
       Issuance of common stock, net                                      51,364              31,594
       Acquisition of treasury stock                                     (72,756)            (79,745)
       Proceeds from employee stock purchase plans                        25,156              23,204
       Net reduction of deferred taxes, short-term borrowings
        and other obligations                                            (14,449)            (73,975)
                                                                       ---------           ---------
Net cash used by financing activities                                    (10,685)            (98,922)
                                                                       ---------           ---------
Net decrease in cash and cash equivalents                                (66,903)           (146,325)
                                                                       ---------           ---------
Cash and cash equivalents, beginning of period                           822,267             660,170
                                                                       ---------           ---------
Cash and cash equivalents, end of period                               $ 755,364           $ 513,845
                                                                       =========           =========
</TABLE>



                                       5
<PAGE>   6

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

<TABLE>
<CAPTION>
                                                                      Three Months Ended
                                                                 --------------------------
                                                               September 27,     September 28,
                                                                   1998              1997
                                                                 --------          --------
<S>                                                            <C>               <C>
Supplemental disclosures of cash flow information:
   Cash paid during the period for:
       Interest                                                  $    168          $    160
       Income taxes                                              $ 42,745          $ 29,411
Supplemental schedule of non-cash investing activities:
   Stock issued in conjunction with an acquisition               $140,804
   Fair value of assets acquired                                                   $ 60,549
   Cash paid for assets                                                              55,443
   Liabilities assumed                                                             $  5,106
</TABLE>



                             See accompanying notes.



                                       6
<PAGE>   7

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



BASIS OF PRESENTATION

         The consolidated financial statements include the accounts of Sun
         Microsystems, Inc. ("Sun" or the "Company") and its wholly-owned
         subsidiaries. Intercompany accounts and transactions have been
         eliminated. Certain amounts from prior years have been reclassified to
         conform to current year presentation.

         While the quarterly financial information is unaudited, the financial
         statements included in this report reflect all adjustments (consisting
         of normal recurring accruals) that the Company considers necessary for
         a fair presentation of the results of operations for the interim
         periods covered and of the financial condition of the Company at the
         date of the interim balance sheet. The results for the interim periods
         are not necessarily indicative of the results for the entire year. The
         information included in this report should be read in conjunction with
         the 1998 Annual Report to Stockholders which is incorporated by
         reference in the Company's 1998 Form 10-K .

INVENTORIES (IN THOUSANDS)

<TABLE>
<CAPTION>
                    September 27, 1998   June 30, 1998
                    ------------------   -------------
<S>                 <C>                  <C>     
Raw materials            $124,959          $ 92,197

Work in process            23,148            58,765

Finished goods            236,278           195,484
                         --------          --------

                         $384,385          $346,446
                         ========          ========
</TABLE>


INCOME TAXES

The Company accounts for income taxes under the liability method of Statement of
Financial Accounting Standards No. 109. The provision for income taxes during
the interim periods considers anticipated annual income before taxes, earnings
of foreign subsidiaries permanently invested in foreign operations, and other
differences.

RECENT PRONOUNCEMENTS

 The Company adopted SOP 98-1 "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use" effective July 1, 1998. The adoption of
SOP 98-1 did not have a material effect on the Company's consolidated financial
position or operating results.

In June 1998, Financial Accounting Standard No. 133 ("FAS 133"), "Accounting for
Derivative Instruments and Hedging Activities" was issued and is effective for
all fiscal years beginning after June 15, 1999. FAS 133 requires the Company to
recognize all derivatives as either assets or liabilities and measure those
instruments at fair value. It further provides criteria for derivative
instruments to be designated as fair value, cash flow and 



                                       7
<PAGE>   8

foreign currency hedges and establishes respective accounting standards for
reporting changes in the fair value of the derivative instruments. Upon
adoption, the Company will be required to adjust hedging instruments to fair
value in the balance sheet and recognize the offsetting gains or losses as
adjustments to be reported in net income or other comprehensive income, as
appropriate. The Company is evaluating its expected adoption date and currently
expects to comply with the requirements of FAS 133 in fiscal year 2000. The
Company does not expect the adoption will be material to the Company's financial
position or results of operations.

COMPREHENSIVE NET INCOME

As of July 1, 1998, the Company adopted Financial Accounting Standards No. 130
("FAS 130") , "Reporting Comprehensive Income." FAS 130 establishes new rules
for the reporting and display of comprehensive net income and its components,
however, it has no impact on the Company's net income or stockholders' equity.
FAS 130 requires foreign currency translation adjustments and changes in fair
value for available for sale securities, which prior to adoption were reported
in stockholders' equity, to be included in comprehensive income.

The components of comprehensive net income, net of tax, are as follows:

<TABLE>
<CAPTION>
                                                         Three Months Ended
                                                         ------------------
                                                   September 27,       September 28,
                                                       1998                1997
                                                     ---------           ---------
<S>                                                <C>                 <C>      
Net income                                           $ 113,874           $ 108,433
Unrealized gain (loss) on securities                   (14,124)                186
Change in cumulative translation adjustment                242              (9,137)
                                                     ---------           ---------
Comprehensive net income                             $  99,992           $  99,482
                                                     =========           =========
</TABLE>

ACQUISITION

On August 28, 1998, the Company acquired all of the outstanding capital stock of
NetDynamics, Inc. ("NetDynamics") by means of a merger transaction pursuant to
which all the shares of NetDynamics capital stock were converted into the right
to receive shares of Sun common stock based upon an agreed-upon exchange ratio
which was calculated using an agreed-upon average market price for Sun common
stock. The Company issued 2,746,785 shares of Sun common stock (with a fair
market value of $48.26875 per share) as the consideration for the acquisition.
The transaction was accounted for as a purchase and the excess purchase price
over the estimated fair value of net tangible assets has been allocated to
various intangible assets, primarily consisting of developed technology ($20
million), goodwill ($36.2 million), customer base ($10 million) and assembled
workforce ($2 million). In addition to the intangible assets acquired, the
Company recorded an $80 million charge, representing the write-off of in-process
research and development ("IPRD").

For financial reporting purposes, the Company is required to determine the fair
value of all identified intangible assets and expense the fair value associated
with IPRD for which there is no alternative future use. The allocation of $80
million of the purchase price to IPRD projects represents the estimated fair
value based on risk adjusted cash flows related to incomplete projects. The
Company believes that such fair value does not exceed the amount a third party
would pay for it. At the date of the acquisition the projects associated with
the IPRD effort had not yet reached technological feasibility and the R&D in
progress had no alternative future uses. Accordingly, these costs were expensed.

In making its purchase price allocation, the Company relied upon an independent
third-party valuation which gave consideration to present value calculations of
income, an analysis of project accomplishments and completion costs, an
assessment of overall contribution, as well as project risk. The value assigned
to IPRD 



                                       8
<PAGE>   9

was determined by estimating the costs to develop the purchased in-process
technology into a commercially viable product, estimating the resulting net cash
flows from the project, excluding the cash flows related to the portion of the
project that was incomplete at the acquisition date, and discounting the
resulting net cash flows to their present value. These forecasts were based upon
future discounted cash flows, taking into account the state of development of
the in-process project, the cost to complete that project, the expected income
stream, the life cycle of the product ultimately developed, and the associated
risks. Projected future net cash flows attributable to the in-process
technology, assuming successful development of such technologies, were
discounted to their present value using a discount rate which was derived based
on the Company's estimated weighted average cost of capital plus a risk premium
to account for the inherent uncertainty surrounding the successful completion of
the project and the estimated cash flows.

 The value of developed technology was based upon future discounted cash flows
related to the existing product's projected income stream. The value of the
customer base was determined based upon the value of existing relationships and
the expected revenue stream. The value of the assembled workforce was based upon
the cost to replace that workforce. Intangible assets, including goodwill, are
being amortized over their estimated useful lives, generally two to five years.

The results of operations of NetDynamics from the date of acquisition through
September 27, 1998 are included in the Company's consolidated statement of
income and were not material to the Company.

SUBSEQUENT EVENTS

On September 28, 1998 the Company acquired all of the outstanding capital stock
of i-Planet, Inc. ("i-Planet") by means of a merger transaction pursuant to
which all the shares of i-Planet capital stock were converted into the right to
receive cash. The transaction will be accounted for as a purchase, and the
purchase price will be allocated to tangible and intangible assets and
in-process research and development based upon an independent third-party
valuation.

On October 15, 1998, the Company acquired all of the outstanding capital stock
of Beduin Communications, Inc. ("Beduin") by means of a share purchase
transaction pursuant to which all the shares of Beduin capital stock were
converted into the right to receive cash. The transaction will be accounted for
as a purchase, and the purchase price will be allocated to tangible and
intangible assets and in-process research and development based upon an
independent third-party valuation.



                                       9
<PAGE>   10

ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
                  OPERATIONS AND FINANCIAL CONDITION

The following table sets forth items from the Condensed Consolidated Statements
of Income as a percentage of total net revenues:

<TABLE>
<CAPTION>
                                              Three Months Ended,
                                              -------------------
                                          September 27,   September 28,
                                             1998            1997
                                             -----           -----
<S>                                       <C>             <C>
Net revenues:
         Products                             86.5%           88.1%
         Services                             13.5            11.9
                                             -----           -----
Total net revenues                           100.0           100.0
                                             -----           -----

Cost of sales:
         Products                             39.7            41.0
         Services                              9.1             8.0
                                             -----           -----
Total cost of sales                           48.8            49.0
                                             -----           -----
         Gross margin                         51.2            51.0
Research and development                      11.4            10.6
Selling, general and administrative           28.6            29.3
Purchased in-process research and
         development                           3.2             2.5
                                             -----           -----
Operating income                               8.0             8.6
Interest income, net                           0.6             0.5
                                             -----           -----
Income before income taxes                     8.6             9.1
Provision for income taxes                     4.1             3.9
                                             -----           -----

         Net income                            4.5%            5.2%
                                             =====           =====
</TABLE>

The following sections contain forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. These forward-looking
statements involve risks and uncertainties, and the cautionary statements set
forth below, specifically those contained in "Future Operating Results" identify
important factors that could cause actual results over the next few quarters to
differ materially from those predicted in any such forward-looking statements.
Such factors include, but are not limited to, adverse changes in general
economic conditions, including adverse changes in the specific markets for the
Company's products, adverse business conditions, decreased or lack of growth in
the computing industry, adverse changes in customer order patterns, increased
competition, lack of acceptance of new products, pricing pressures, lack of
success in technological advancements, risks associated with foreign operations
(including the downturn of economic trends and unfavorable currency movements in
the Asia Pacific marketplace), risks associated with the Company's efforts to
comply with Year 2000 requirements, risks associated with implementation of the
Company's new business practices, processes and information systems, and other
factors, including those listed below. Other facts that may affect such results
and financial condition are set forth in the Company's 1998 Annual Report to
Stockholders which is incorporated by reference in the Company's Form 10-K.



                                       10
<PAGE>   11

RESULTS OF OPERATIONS

NET REVENUES

Net revenues were $2,491.2 million for the first quarter of fiscal 1999,
representing an increase of 18.7% over the corresponding period of fiscal 1998.

Sun's products net revenues increased by $308.2 million or 16.7% to $2,156.1
million over the corresponding period of fiscal 1998. The growth in products
revenues resulted primarily from strong demand for workgroup, enterprise and
departmental servers and to lesser extent, the Company's storage products. Sun's
net revenues from services increased $84.3 million or 33.6% over the
corresponding period of fiscal 1998. The increase in services revenues is
primarily the result of a larger installed product base due to increased product
unit sales, as well as increased revenues associated with Sun's professional and
educational services.

Domestic net revenues increased by 20.3% while international net revenues
(including United States exports) grew 17.0% in the first quarter of fiscal 1999
compared with the corresponding period of fiscal 1998. In US dollars, European
net revenues increased 36.9%, Rest of World (ROW) net revenues increased 15.2%,
and Japanese net revenues decreased 20.1%, in the first quarter of fiscal 1999
when compared with the corresponding period of fiscal 1998. The increases in
Europe and the ROW are due primarily to continued market acceptance of Sun's
network computing products and services in the United Kingdom, Germany, France
and Latin America. The Company attributes the decrease in Japanese revenues to
current macroeconomic trends affecting the Japanese market, including currency
movements against the U.S. dollar. The Company does not expect these trends to
change materially in the near term. The foregoing is a forward-looking statement
that is subject to risks and uncertainties, and actual results may differ
materially from those set forth in such statement as the result of a number of
factors. In particular, if the economic trends in Japan significantly worsen in
a quarter or decline over an extended period of time, the Company's results from
operations and cash flows would be adversely affected.

A portion of the Company's operations consists of manufacturing and sales
activities in foreign jurisdictions. As a result, the Company's results could be
significantly adversely affected by factors such as changes in foreign currency
exchange rates or economic conditions in the foreign markets in which the
Company distributes its products. The Company is primarily exposed to changes in
exchange rates on the Japanese yen, British pound sterling, French franc and
German mark. When the U.S. dollar strengthens against these currencies, the U.S.
dollar value of non-U.S. dollar-based sales decreases. When the U.S. dollar
weakens against these currencies, the U.S. dollar value of non-U.S. dollar-based
sales increases. Correspondingly, the U.S. dollar value of non-U.S. dollar-based
costs increases when the U.S. dollar weakens and decreases when the U.S. dollar
strengthens. Overall the Company is a net receiver of currencies other than the
U.S. dollar and, as such, benefits from a weaker dollar, and is adversely
affected by a stronger dollar relative to major currencies worldwide.
Accordingly, changes in exchange rates, and in particular a strengthening of the
U.S. dollar, may adversely affect the Company's consolidated sales and gross
margins as expressed in U.S. dollars. 

To mitigate the short-term effect of changes in currency exchange rates on the
Company's non-US dollar-based sales, product procurement, and operating
expenses, the Company regularly hedges its net non-U.S. dollar-based exposures
by entering into foreign exchange forward and option contracts to hedge
transactions. Currently, hedge contracts do not extend beyond three months.
Given the short-term nature of the Company's foreign exchange forward and
options contracts, the Company's exposure to risk associated with currency
market movement on these instruments is not material.



                                       11
<PAGE>   12

GROSS MARGIN

Total gross margin was 51.2% for the first quarter of fiscal 1999, compared with
51.0% for the corresponding period of fiscal 1998.

Products gross margin was 54.2% in the first quarter of fiscal 1999 compared
with 53.4% for the corresponding period of fiscal 1998. The modest increase in
the products gross margin reflects the effects of increased volumes of higher
margin servers, partially offset by lower margin low-end workstations. Services
gross margin was 31.9% in the first quarter of fiscal 1999 compared with 33.7%
for the corresponding period of fiscal 1998. The decrease in services gross
margin reflects the increased investment by the Company in its services
business.

  The Company continuously evaluates the competitiveness of its product
offerings. These evaluations could result in repricing actions in the near term.
Sun's future operating results would be adversely affected if such repricing
actions were to occur and the Company were unable to mitigate the resulting
margin pressure by maintaining a favorable mix of systems, software, service,
and other products and by achieving component cost reductions, operating
efficiencies and increasing volumes.

RESEARCH AND DEVELOPMENT

Research and development (R&D) expenses increased to $283.3 million in the first
quarter of fiscal 1999, compared with $222.6 million for the corresponding
period of fiscal 1998. As a percentage of net revenues, R&D expenses increased
to 11.4% for the first quarter of fiscal 1999 compared with 10.6% in the
corresponding period of fiscal 1998. Both the dollar and percentage increase in
R&D expenses in the first quarter of fiscal 1999 over the corresponding period
in fiscal 1998 primarily reflects increased expenditures focused on the
development of hardware and software products which utilize the Java
architecture and new server and storage products. The remaining increase in R&D
expenses is due primarily to continued development of ULTRASparc systems,
further development of products acquired through acquisitions, and increased
compensation due primarily to higher levels of R&D staffing. The increase in
research and development expenses reflects the Company's belief that to maintain
its competitive position in a market characterized by rapid rates of
technological advancement, the Company must continue to invest significant
resources in new systems, software products and microprocessor development, as
well as enhancements to existing products. The Company currently expects the
level of R&D expenses to be in the range of 10 to 11% of revenue for fiscal
1999.

SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative (SG&A) expenses increased to $711.6 million
in the first quarter of fiscal 1999 compared with $615.5 million for the same
period of fiscal 1998. As a percentage of net revenues, SG&A expenses decreased
to 28.6% in the first quarter of fiscal 1999 from 29.3% in the corresponding
period of fiscal 1998. Overall SG&A spending increased by approximately $96
million or 15.6% in the first quarter of fiscal 1999 in comparison with the same
period of fiscal 1998. The dollar increase in fiscal 1999 is primarily
attributable to increased compensation resulting from higher levels of
headcount, principally in the sales organization, annual salary adjustments and
marketing costs related to promotional programs. The dollar increase also
reflects investments aimed at improving Sun's own business processes. The
Company expects to continue to hire personnel, although at a lower rate than in
fiscal 1998, to further expand its demand creation programs and support
organizations.

PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT



                                       12
<PAGE>   13

On August 28, 1998, the Company acquired all of the outstanding capital stock of
NetDynamics, Inc. ("NetDynamics") by means of a merger transaction pursuant to
which all the shares of NetDynamics capital stock were converted into the right
to receive shares of Sun common stock based upon an agreed-upon exchange ratio
which was calculated using an agreed-upon average market price for Sun common
stock. The Company issued 2,746,785 shares of Sun common stock (with a fair
market value of $48.26875 per share) as the consideration for the acquisition.
The transaction was accounted for as a purchase and the excess purchase price
over the estimated fair value of net tangible assets has been allocated to
various intangible assets, primarily consisting of developed technology ($20
million), goodwill ($36.2 million), customer base ($10 million) and assembled
workforce ($2 million). In addition to the intangible assets acquired, the
Company recorded an $80 million charge, representing the write-off of in-process
research and development (IPRD).

The allocation of $80 million of the purchase price to IPRD projects represents
the estimated fair value based on risk adjusted cash flows related to incomplete
projects. The Company believes that such fair value is reasonable and does not
exceed the amount a third party would pay for it. At the date of the acquisition
the projects associated with the IPRD effort had not yet reached technological
feasibility and the R&D in progress had no alternative future uses. Accordingly,
these costs were expensed.

At the acquisition date, NetDynamics was conducting development, engineering,
and testing activities associated with the completion of a new enterprise
application platform product scheduled to be released in mid calendar 1999. It
is anticipated that his new product offering ("New Product Offering") will
employ a new server-side component model, based on the Enterprise Java Beans
("EJB") architecture, which will allow business logic to reside in the middle
tier of the enterprise computing model independent of the client presentation
layer and independent of legacy and database systems. This architecture is
significantly different than the business logic architecture in NetDynamics'
existing product offering which is tightly integrated with the presentation
interface. The EJB architecture will allow for the development of more robust
and scaleable applications, better connectivity to a wide variety of data
sources, and a more-industry standard interface through the use of Java
enterprise application programming interfaces. Other new features include
significant security enhancements and performance improvements and the addition
of new platform adaptor components.

At the acquisition date, NetDynamics was in mid-stages of development and
substantial progress had been made in the areas of specifications, design, and
implementation. Remaining efforts necessary to complete the New Product Offering
relate primarily to coding, testing, and addressing additional implementation
issues. The Company anticipates that the New Product Offering will be complete
by the end of the Company's fiscal year ending June 30, 1999, after which the
Company expects to begin generating economic benefits from the value of the
completed development associated with the IPRD. Expenditures to complete the New
Product Offering are expected to total approximately $5.7 million in fiscal
1999.

An independent third-party valuation which utilized forecasts of future results
that management believes are likely to occur was the basis for assigning value
to IPRD. The value assigned to IPRD was determined by estimating the costs to
develop the purchased in-process technology into a commercially viable product,
estimating the resulting net cash flows from the project, excluding the cash
flows related to the portion of the project that was incomplete at the
acquisition date, and discounting the resulting net cash flows to their present
value. These forecasts were based upon future discounted cash flows, taking into
account the state of development of the in-process project, the cost to complete
that project, the expected income stream, the life cycle of the product
ultimately developed, and the risks associated with successful development and
commercialization of the project. Projected future net cash flows attributable
to the in-process technology, assuming successful development of such
technologies, were discounted to their present value using a discount rate which
was derived based on the Company's estimated weighted average cost of capital
plus a risk premium to account for the inherent uncertainty surrounding the
successful completion of the project and the estimated cash flows. These
estimates are subject to change, given the uncertainties of the development
process, and no assurance can be given that deviations from these estimates will
not occur. Management expects to continue its 



                                       13
<PAGE>   14

development of these efforts and believes that there is a reasonable chance of
successfully completing such development. However, there is risk associated with
the completion of the in-process projects and there can be no assurance that any
project will meet with either technological or commercial success. Failure to
successfully develop and commercialize these in-process projects would result in
the loss of the expected economic return inherent in the fair value allocation.
The foregoing statements in this paragraph and the preceding two paragraphs are
forward-looking statements that are subject to risks and uncertainties, and
actual results may differ materially from those set forth in such statements as
the result of a number of factors.

Purchased in-process research and development of $52.2 million in the first
quarter of fiscal 1998 represents the write-off of purchased in-process research
and development associated with the Company's acquisitions of Diba, Inc. and
Integrity Arts, Inc.

INTEREST INCOME, NET

Net interest income was $15.4 million for the first quarter of fiscal 1999,
compared with $10.6 million in net interest income for the corresponding period
in fiscal 1999. The increase in 1999 is primarily the result of higher interest
earnings due to a larger average portfolio of cash and short-term investments.

INCOME TAXES

The Company's effective income tax rate for the first quarter of fiscal 1999 was
33% before a $30.4 million tax charge resulting from a non-recurring write-off
of in-process research and development associated with the acquisition of
NetDynamics Inc. The effective income tax rate for the first quarter of fiscal
1998 was 33% before a $19.8 million tax charge resulting from a non-recurring
write-off of in-process research and development associated with the
acquisitions of Diba Inc. and Integrity Arts, Inc. The Company currently expects
its effective tax rate to remain at 33% for the remainder of fiscal 1999,
exclusive of any acquisition- related charges.

FUTURE OPERATING RESULTS

COMPETITION

The markets for Sun's products and services are intensely competitive and
subject to continuous, rapid technological change, short product life cycles and
frequent product performance improvements and price reductions. Due to the
breadth of the Company's product lines and the scalability of its products and
network computing model, Sun competes in many segments of the network computing
market across a broad spectrum of customers. The Company expects the markets for
its products, technologies, and services, as well as its competitors within such
markets, will continue to change as the rightsizing trend shifts customer buying
patterns to network-based systems which often employ solutions from multiple
vendors. Competition in these markets will also continue to intensify as Sun and
its competitors, principally Hewlett-Packard Company, International Business
Machines Corporation, Compaq Computer Corporation, and Silicon Graphics, Inc.,
aggressively position themselves to benefit from this shifting of customer
buying patterns and demand. The Company is also facing competition from certain
systems manufacturers, including Dell Computer Corporation and certain of its
competitors listed above, whose products are based on microprocessors from Intel
Corporation coupled with Windows NT operating system software from Microsoft
Corporation. These products demonstrate the viability of certain networked
personal computer solutions and have increased the competitive pressure,
particularly in the Company's workstation and lower-end server product lines.
Finally, the timing of introductions of new products and services by Sun's
competitors may negatively impact the future operating results of the Company,
particularly when such introductions occur in periods leading up to the
Company's introduction of its own new enhanced products. The Company expects
this pressure to continue and intensify throughout fiscal 1999. While many other
technical, service and support capabilities affect a customer's buying 



                                       14
<PAGE>   15

decision, the Company's future operating results will depend, in part, on its
ability to compete with these technologies.

PRODUCT DEVELOPMENT

The Company's future operating results will depend to a considerable extent on
its ability to rapidly and continuously develop, introduce, and deliver in
quantity new systems, software, and service products, as well as new
microprocessor technologies, that offer its customers enhanced performance at
competitive prices. The development of new high-performance computer products,
such as the Company's recent development of the UltraSPARC microprocessor is a
complex and uncertain process requiring high levels of innovation from the
Company's designers and suppliers, as well as accurate anticipation of customer
requirements and technological trends. Once a hardware product is developed, the
Company must rapidly bring such products to volume manufacturing, a process that
requires accurate forecasting of volumes, mix of products and configurations,
among other things, in order to achieve acceptable yields and costs. Future
operating results will depend to a considerable extent on the Company's ability
to closely manage product introductions in order to minimize unfavorable
patterns of customer orders, to reduce levels of older inventory and to ensure
that adequate supplies of new products can be delivered to meet customer demand.
The ability of the Company to match supply and demand is further complicated by
the Company's need to adjust prices to reflect changing competitive market
conditions as well as the variability and timing of customer orders with respect
to the Company's older products. As a result, the Company's operating results
could be materially adversely affected if the Company is not able to correctly
anticipate the level of demand for the mix of products. Because the Company is
continuously engaged in this product development, introduction, and transition
process, its operating results may be subject to considerable fluctuation,
particularly when measured on a quarterly basis.

MANUFACTURING AND SUPPLY

Sun uses many standard parts and components in its products and believes there
are a number of competent vendors for most parts and components. However, a
number of important components are developed by and purchased from single
sources due to price, quality, technology or other considerations. In some
cases, those components are available only from single sources. In particular,
Sun is dependent on Sony Corporation for various monitors and on Texas
Instruments Incorporated for different implementations of SPARC microprocessors.
Certain custom silicon parts are designed by and produced on a contractual basis
for Sun. The process of substituting a new producer of such parts could
materially adversely affect Sun's operating results. Some suppliers of certain
components, including color monitors and custom silicon parts, require long lead
times such that it can be difficult for the Company to plan inventory levels of
components to consistently meet demand for Sun's products. Certain other
components, especially memory integrated circuits such as DRAMs, SRAMs, and
VRAMs, have from time to time been subject to industry wide shortages. Future
shortages of components could negatively affect the Company's ability to match
supply and demand, and therefore could materially adversely impact the Company's
future operating results.

The Company is increasingly dependent on the ability of its suppliers to design,
manufacture, and deliver advanced components required for the timely
introduction of new products. The failure of any of these suppliers to deliver
components on time or in sufficient quantities, or the failure of any of the
Company's own designers to develop advanced innovative products on a timely
basis, could result in a material adverse impact on the Company's operating
results. The inability to secure enough components to build products, including
new products, in the quantities and configurations required, or to produce, test
and deliver sufficient products to meet demand in a timely manner, would
materially adversely affect the Company's net revenues and operating results. To
secure components for development, production, and introduction of new products,
the Company frequently makes advanced payments to certain suppliers and often
enters into noncancelable purchase commitments with vendors early in the design
process. Due to the variability of material requirement specifications during
the design process, the Company must closely manage material purchase
commitments 



                                       15
<PAGE>   16

and respective delivery schedules. In the event of a delay or flaw in the design
process, the Company's operating results could be materially adversely affected
due to the Company's obligations to fulfill such noncancelable purchase
commitments.

SALES, DISTRIBUTION AND MARKETING

Generally, the computer systems sold by Sun, such as products based on
UltraSPARC processors, are the result of hardware and software development, such
that delays in the software development can delay the ability of the Company to
ship new hardware products. In addition, adoption of a new release of an
operating system may require effort on the part of the customer and porting by
software vendors providing applications. As a result, the timing of conversion
to a new release is inherently unpredictable. Moreover, delays by customers in
adopting a new release of an operating system can limit the acceptability of
hardware products tied to that release. Such delays could materially adversely
affect the future operating results of the Company.

A significant portion of the Company's revenues is derived from international
sales and is therefore subject to inherent risks related thereto, including the
general economic and political conditions in each country, currency exchange
rate fluctuations, the effect of the tax structures of various jurisdictions,
changes to and compliance with a variety of foreign laws and regulations, trade
protection measures and import and export licensing requirements. There can be
no assurance that the economic crisis and currency issues currently being
experienced in certain parts of Asia will not have an adverse effect on the
Company's revenue or revenue growth rates in the future. The impact of any of
the foregoing factors could have a material adverse effect on the Company's
future financial condition and operating results.

Seasonality also affects the Company's operating results, particularly in the
first and third quarter of each fiscal year. In addition, the Company's
operating expenses are increasing as the Company continues to expand its
operations, and future operating results will be adversely affected if revenues
do not increase accordingly. Additionally, the Company plans to continue to
evaluate and, when appropriate, make acquisitions of complementary technologies,
products or businesses. As part of this process, the Company will continue to
evaluate the changing value of its assets, and when necessary, make adjustments
thereto. Acquisitions may involve amortization of acquired intangible assets in
periods following such acquisitions. In addition, acquisition transactions are
accompanied by a number of risks, including, among other things, those
associated with integrating operations, personnel, and technologies acquired,
and the potential for unknown liabilities of the acquired business.

One customer accounted for more than 10% of revenues in fiscal 1998. Any
termination by a significant customer of its relationship with the Company or
material reduction in the amount of business such a customer does with the
Company could materially adversely effect the Company's business, financial
condition or operating results.

BUSINESS PRACTICES, PROCESSES AND INFORMATION SYSTEMS

In order to remain competitive in a rapidly changing industry, the Company is
continually improving and changing its business practices, processes, and
information systems. In this regard, the Company has begun to implement a number
of new business practices and a series of related information systems across the
enterprise that affect numerous operational and financial systems and processes.
Such activities are expected to be fully operational by the end of the second
fiscal quarter. The time period in which the new business practices and related
information systems will be fully implemented are forward-looking statements
subject to risks and uncertainties, and actual results may differ materially
from those set forth above as a result of a number of risk factors. In
particular, the timing and duration of the implementation of the new business
practices and information systems are subject to a number of risks, including
the complexity of the conversion process and the new systems themselves, the
transfer of business data and information from the previous system to the new



                                       16
<PAGE>   17

system and the need for substantial and comprehensive employee training in
connection with the adoption of such new business practices and information
systems. While the Company has tested these new systems and processes in advance
of beginning their implementation, there were inherent limitations in the
Company's ability to simulate a full-scale operating environment in advance of
such implementation. The implementation of these systems required the Company to
be without certain capabilities critical to normal operation of its business
(such as processing orders and shipping products) for a period of time as the
Company shifted to the new systems. The Company is increasing and will continue
to increase its order processing and shipping volumes over the remaining
duration of this implementation phase, with a majority of its orders and
shipments taking place in a shortened period of time toward the end of its
second fiscal quarter. Interruption in the use and availability of
enterprise-wide information systems nor the concentration of orders and
shipments of products near the end of the Company's second fiscal quarter may
have a material adverse effect on the Company's business and operating results.
In addition, to the extent that the Company encounters problems after full
implementation of these new systems and practices that prevent or limit their
full utilization, there could be a material adverse impact on the Company's
operating results.

YEAR 2000 COMPLIANCE

Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. As the Year 2000
approaches, these code fields will need to be able to distinguish years
beginning with "19" from those beginning with "20." As a result, in less than
two years, computer systems and/or software products used by many companies may
need to be upgraded to comply with such Year 2000 requirements. The Company is
currently expending resources to review its products and services, as well as
its internal use software in order to identify and modify those products,
services and systems that are not Year 2000 compliant. The Company believes that
the vast majority of these costs are not incremental to the Company but
represent a reallocation of existing resources and include regularly scheduled
system upgrades and maintenance. In addition, the Company's internal system
implementation (as described in the above paragraph) is principally being
conducted to improve operating efficiencies and, when fully implemented, will be
Year 2000 compliant. Although the Company believes that the costs associated
with the aforementioned Year 2000 efforts are not material, the Company
currently estimates that such costs will be approximately $35 million. These
cost estimates do not include any potential costs related to any customer or
other claim. In addition, these cost estimates are based on the current
assessment of the ongoing activities described above, and are subject to change
as the Company continuously monitors these activities. The Company believes any
modifications deemed necessary will be made on a timely basis and does not
believe that the cost of such modifications will have a material adverse effect
on the Company's operating results. The Company currently expects the
aforementioned evaluation of its products, services, and systems and any
remediation necessary will be completed by the end of fiscal year 1999. The
Company's expectations as to the extent and timeliness of any modifications
required in order to achieve Year 2000 compliance and the costs related thereto
are forward-looking statements subject to risks and uncertainties. Actual
results may vary materially as a result of a number of factors, including, among
others, those described in this paragraph and the four paragraphs below. There
can be no assurance however, that the Company will be able to successfully
modify on a timely basis such products, services and systems to comply with Year
2000 requirements, which failure could have a material adverse effect on the
Company's operating results.

The Company has established a program to assess whether certain of its products
are Year 2000 compliant. Under the program, the Company is in the process of
performing tests on its products listed on the Company's price lists. To monitor
this program and to help customers evaluate their Year 2000 issues the Company
has created a web site at http://sun.com/y2000/cpl.html which identifies the
following categories: products that were released Year 2000 compliant (or may
need a free modification after release); products that require modifications to
be Year 2000 compliant; products under review; products that are not Year 2000
compliant and need to be replaced with a Year 2000 compliant product; and
products that do not process or manipulate date data or have no date-related
technology. This list is periodically updated as analysis of additional products
is completed.

Based on the Company's assessment to date, most newly introduced products and
services of the Company are Year 2000 compliant, however, there can be no
assurance that the Company's current products do not contain undetected errors
or defects associated with Year 2000 functions

                                      17
<PAGE>   18
that may result in material costs to the Company. In addition, some of the
Company's customers are running products that are not Year 2000 compliant and
will require an upgrade or other remediation to become Year 2000 compliant. The
Company provides limited warranties as to Year 2000 compliance on certain of its
products and services. Except as specifically provided for in the limited
warranties, the Company does not believe it is legally responsible for costs
incurred by customers to achieve Year 2000 compliance. The Company has been
taking steps to identify affected customers, raise customer awareness related to
noncompliance of the Company's older products and encourage such customers to
migrate to current products or product versions. It is possible that the Company
may experience increased expenses in addressing migration issues for such
customers or customer dissatisfaction as a result of Year 2000 issues, which may
have a material adverse effect on the Company's operating results.

The Company also faces risks to the extent that suppliers of products, services
and systems purchased by the Company and others with whom the Company transacts
business on a worldwide basis do not have business systems or products that
comply with Year 2000 requirements. To the extent that Sun is not able to test
technology provided by third party hardware or software vendors, Sun is in the
process of obtaining Year 2000 compliance certifications from each of its major
vendors that their products and internal systems, as applicable, are Year 2000
compliant. In the event any such third parties cannot timely provide the Company
with products, services or systems that meet the Year 2000 requirements, the
Company's operating results could be materially adversely affected. Furthermore,
a reasonably likely worst case scenario would be if one of the Company's major
vendors experienced a material disruption in business, which caused the Company
to experience a material disruption in business, such a disruption would have a
material adverse effect on the Company's business, financial condition and
operating results. Should either the Company's internal systems or the internal
systems, products or services of one or more of the Company's major vendors fail
to achieve Year 2000 compliance, the Company's business, financial position or
results of operations could be materially adversely affected. The Company is
currently developing contingency plans to deal with potential Year 2000 problems
related to its internal systems and products and services provided by outside
vendors and expects these plans to be complete by the end of fiscal year 1999.

Although the Company believes that the cost of Year 2000 modifications for both
internal use software and systems, as well as the Company's products are not
material, there can be no assurance that various factors relating to the Year
2000 compliance issues will not have a material adverse effect on the Company's
business, operating results or financial position. For example, a significant
amount of litigation may arise out of Year 2000 compliance issues and there can
be no assurance as to the extent the Company may be affected by any such
litigation. Even though the Company does not believe that it is legally
responsible for its customer's Year 2000 compliance obligations, it is unclear
whether different governments or governmental agencies may decide to allocate
liability relating to Year 2000 compliance to the Company without regard to
specific warranties or warranty disclaimers. Such allocation of liability could
have a materially adverse effect on the Company's financial condition and
results of operations in any given quarter. Furthermore, it is unknown how
customer spending patterns may be impacted by Year 2000 issues. As customers
focus on preparing their businesses for the Year 2000, capital budgets may be
spent on remediation efforts, potentially delaying the purchase and

                                      18
<PAGE>   19
implementation of new systems, thereby creating less demand for the Company's
products and services. These as well as other factors could have a material
adverse effect on the Company's revenues or operating results.


EURO COMPLIANCE

Eleven of the fifteen member countries of the European Union are scheduled to
established fixed conversion rates between their existing sovereign currencies
and the Euro and to adopt the Euro as their common legal currency effective
January 1, 1999. The Euro will then trade on currency exchanges and be available
for non-cash transactions. The Company is currently expending resources to
review and modify its products to support the Euro's requirements, determine
pricing strategies in the new economic environment, analyze the legal and
contractual implications for contracts, evaluate system capabilities, and ensure
banking vendors can support the Company's operations with respect to Euro
transactions for the initial implementation as of January 1, 1999 and during the
transition period through to January 1, 2002. The Company does not expect that
the introduction and use of the Euro will materially affect the Company's
foreign exchange and hedging activities, expects that modifications will be made
to its business operations and systems on a timely basis and does not believe
that the cost of such modifications will have a material adverse impact on the
Company's operating results. The Company's expectations as to the extent and
timeliness of modifications required to accommodate the conversion to Euro
transactions is a forward-looking statement subject to risks and uncertainties.
Actuals results may vary materially, as a result of a number of factors,
including among others, those described in this paragraph. There can be no
assurance that the Company will be able to complete such modifications to comply
with Euro requirements, which could have a material adverse effect on the
Company's operating results. In addition, the Company faces risks to the extent
that vendors upon whom the Company relies and their suppliers are unable to make
appropriate modifications to support Euro transactions. The Company has not yet
completed its evaluation of the impact of the Euro upon its functional currency
designations.


While the Company cannot predict what effect these various factors may have on
its financial results, the aggregate effect of these and other factors could
result in significant volatility in the Company's future performance and stock
price.


LIQUIDITY AND CAPITAL RESOURCES

The Company's financial condition strengthened as of September 27, 1998 when
compared with June 30, 1998. During the first quarter of fiscal 1999, cash flows
from operating activities generated $405 million in cash and cash equivalents.
Non-cash expenses affecting cash provided by operating activities in the first
quarter of fiscal 1999 included depreciation and amortization expense of $161.6
million, tax benefits of options exercised of $42.1 million and a charge for
IPRD of $80 million in connection with the acquisition of NetDynamics. Favorably
impacting cash provided by operations was the decrease in accounts receivable of
$79.2 million which reflects seasonally lower revenue in the first quarter of
fiscal 1999 as compared to the fourth quarter of fiscal 1998. The increase in
accounts payable of $58.0 million which contributed to cash from operations,
reflects the timing of payments for inventory and other items. Offsetting these
items, inventory increased $37.9 million during the first quarter of fiscal 1999
which reflects the higher level of inventories in anticipation of the systems
conversion, partially offset by the impact of seasonally lower revenues in the
first quarter of fiscal 1999 as compared to the fourth quarter of fiscal 1998.
Additionally, other current assets increased due to the timing of payments for
insurance and other taxes. Other long-term assets increased primarily due to an
increase in intangible assets in connection with the acquisition of NetDynamics.

The Company's investing activities used $461.3 million of cash in the first
quarter of fiscal 1999, an increase of $189.5 million from the prior year's
comparable period. The increase resulted primary from capital spending 



                                       19
<PAGE>   20

for real estate development as well as capital additions to support increased
headcount, primarily in the Company's engineering, services and marketing
organizations. Also included in investing activities is increased investments in
short-term investments during the first quarter of fiscal 1999, as compared with
the prior year's comparable period.

At September 27, 1998, the Company's primary sources of liquidity consisted of
cash, cash equivalents and short-term investments of $1,439.1 million and a
revolving credit facility with banks aggregating $500 million, which was
available subject to compliance with certain covenants. On October 16, 1997, the
Company filed a Registration Statement with the Securities and Exchange
Commission relating to the registration for public offering of senior and
subordinated debt securities and common stock with an aggregate initial public
offering price of up to $1 billion. On October 24, 1997, the Registration
Statement became effective, so that the Company may now choose to offer, from
time to time, the securities pursuant to Rule 415 in one or more separate
series, in amounts, at prices and on terms to be set forth in the prospectus
contained in the Registration Statement and in one or more supplements to the
prospectus. The Company believes that the liquidity provided by existing cash
and short-term investment balances and the borrowing arrangements described
above will be sufficient to meet the Company's capital requirements through
fiscal 1999. However, the Company believes the level of financial resources is a
significant competitive factor in its industry and may choose at any time to
raise additional capital through debt or equity financing to strengthen its
financial position, facilitate growth and provide the Company with additional
flexibility to take advantage of business opportunities that may arise.



                                       20
<PAGE>   21

                           PART II - OTHER INFORMATION

ITEM 1 - LEGAL PROCEEDINGS

On October 7, 1997, the Company filed suit against Microsoft Corporation in the
United States District Court for the Northern District of California alleging
breach of contract, trademark infringement, false advertising, unfair
competition, interference with prospective economic advantage and inducing
breach of contract. The Company filed an amended complaint on October 14, 1997.
Microsoft Corporation filed its answer, affirmative defenses and counterclaims
to the amended complaint. The counterclaims include breach of contract, breach
of the covenant of good faith and fair dealing, violation of the California
Business & Professions Code and declaratory judgment. The Company believes that
the counterclaims are without merit and/or that the Company has affirmative
defenses and intends vigorously to defend itself with respect thereto. On March
24, 1998 the United States District Court judge ruled in favor of the Company
granting a preliminary injunction directing Microsoft Corporation to cease using
the Company's Java Compatible Logo(TM) on Microsoft products that failed to pass
the applicable test suites from Sun. In addition, on May 12, 1998, the Company
filed a second amended complaint alleging copyright infringement by Microsoft
and motions requesting further preliminary injunctive relief directed against
the planned release by Microsoft of additional products that failed to pass the
applicable test suites from Sun. The Court held hearings and arguments on such
motions on September 8, 9, and 10, 1998 and took the matter under advisement.
The Company believes that the outcome of this matter will not have a material
adverse impact on Sun's financial condition, results of operations or cash flows
in any given fiscal year.

ITEM 5 - OTHER INFORMATION

SCHEDULE OF SALES BY EXECUTIVE OFFICERS DURING THE QUARTER

      The following is a summary of all sales of the Company's Common Stock by
      the Company's executive officers and directors who are subject to Section
      16 of the Securities Exchange Act of 1934, as amended, during the fiscal
      quarter ended September 27,1998:

<TABLE>
<CAPTION>
OFFICER /                                                    NUMBER OF
DIRECTOR                           DATE           PRICE     SHARES SOLD
--------                           ----           -----     -----------
<S>                               <C>          <C>          <C>   
Kenneth M. Alvares                7/22/98      $ 48.9565     18,400
                                  7/23/98      $ 49.50       35,000

Masood Jabbar                     8/19/98      $ 50.25       29,000
                                  8/19/98      $ 50.3125      1,000

James Judson                      8/18/98      $ 50.0625      2,500

Michael E. Lehman                 8/7/98       $ 50.00        1,630
                                  8/18/98      $ 49.6875     18,370
                                  8/18/98      $ 49.8565     20,000

Robert L. Long                    8/18/98      $ 50.00        7,270

Marc L. Loupe                     7/22/98      $ 48.75        4,100
                                  7/22/98      $ 48.6875      4,900
</TABLE>



                                       21
<PAGE>   22

<TABLE>
<S>                               <C>          <C>          <C>   
Stephen T. McGowan                7/31/98      $ 50.00        4,000

Scott G. McNealy                  7/16/98      $ 50.00        4,000

Michael H. Morris                 8/6/98       $ 49.00       24,800
                                  8/17/98      $ 48.00        6,400

Alton D. Page                     8/19/98      $ 50.00        5,000

Gregory D. Papadopoulos           8/18/98      $ 49.8125     10,000
                                  8/19/98      $ 50.1250     26,000

Marissa Peterson                  8/19/98      $ 50.25       20,000
                                  8/19/98      $ 50.25          930

William J. Raduchel               7/31/98      $ 49.1321     35,000
                                  8/4/98       $ 46.9522     25,500
                                  8/5/98       $ 46.3750     19,500

George Reyes                      7/31/98      $ 50.0937     28,040
                                  7/31/98      $ 50.0914        747
                                  8/18/98      $ 49.00       10,000

Janpieter T. Scheerder            7/31/98      $ 49.00       20,000
                                  8/5/98       $ 48.0300     14,000
                                  8/10/98      $ 49.0030     53,200

Mark E. Tolliver                  8/11/98      $ 46.875       2,000
                                  8/17/98      $ 48.8125      3,000

Edward J. Zander                  8/5/98       $ 48.875      10,060
                                  8/6/98       $ 49.875      32,000
</TABLE>


  ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K

      a) EXHIBITS

           27.0  Financial Data Schedule for the period ended September 27, 1998


      b) REPORTS ON FORM 8-K

         No reports on Form 8-K were filed during the quarter ended September
27, 1998.


  ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

      The Company's market risk disclosures set forth in the 1998 Form 10-K have
      not changed significantly through the first quarter ended September 27,
      1998.



                                       22
<PAGE>   23

                                   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/ Michael E. Lehman
                                            ------------------------------------
                                            Michael E. Lehman
                                            Vice President, Corporate Resources
                                            and Chief Financial Officer



                                            /s/ George Reyes
                                            ------------------------------------
                                            George Reyes
                                            Vice President and Corporate 
                                            Controller, Chief Accounting Officer







  Dated:   November 9, 1998




                                       23
<PAGE>   24
                               INDEX TO EXHIBITS

Exhibit 
Number              Description
------              -----------

27.1                Financial Data Schedule