##### 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 December 30, 2001

or

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

For the transition period from to

Commission file number: 0-15086

________________________

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

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

901 San Antonio Road, Palo Alto, CA 94303
(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 January 24, 2002
|                                 
|                                 
|                                 
|                                 
|Common Stock  $0.00067 par value |  | 3,248,420,088                  





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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 
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 14
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Item 3. Quantitative and Qualitative Disclosures About Market Risk                            |  | 31
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|PART II  OTHER INFORMATION                                                                  
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              |  |   
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Item 1. Legal Proceedings                                                                     |  | 32
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Item 4. Submission of Matters to a Vote of Security Holders                                   |  | 32
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Item 6. Exhibits and Reports on Form 8-K                                                      |  | 33
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|SIGNATURES                                                                                    |  | 34

2



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TABLE OF CONTENTS



|                                                                                              |                                                                             |  |  |  |  |  |  | 
|--------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I  FINANCIAL INFORMATION                                                               
|ITEM 1. FINANCIAL STATEMENTS                                                                 
|                                                                                              | SUN MICROSYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS     
|                                                                                              | SUN MICROSYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS               
|                                                                                              | SUN MICROSYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                                                                                              | SUN MICROSYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|PART II  OTHER INFORMATION                                                                  
|ITEM 1. LEGAL PROCEEDINGS                                                                    
|ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                                                                                   



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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 |       | Six Months Ended
|                                                                               |                                                                                           |                          |                         |       |                    |       |                 
|                                                                               |                                                                                           |                          |                         |       | December 30,       |       | December 31,     |       | December 30, |       | December 31,
|                                                                               |                                                                                           |                          |                         |       | 2001               |       | 2000             |       | 2001         |       | 2000        
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |             
|Net revenues:                                                                  |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |      
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Products                                                                                  |                          | $                       | 2,260 |                    |       | $                | 4,317 |              |       | $            | 4,317  |       |        | $     | 8,660 |       
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Services                                                                                  |                          |                         | 848   |                    |       |                  | 798   |              |       |              | 1,652  |       |        |       | 1,500 |       
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       
|                                                                               |                                                                                           | Total net revenues       |                         |       | 3,108              |       |                  |       | 5,115        |       |              |        | 5,969 |        |       |       | 10,160 |      
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|Cost of sales:                                                                 |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |      
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Cost of sales-products                                                                    |                          |                         | 1,437 |                    |       |                  | 2,153 |              |       |              | 2,724  |       |        |       | 4,306 |       
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Cost of sales-services                                                                    |                          |                         | 532   |                    |       |                  | 518   |              |       |              | 1,050  |       |        |       | 980   |       
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       
|                                                                               |                                                                                           | Total cost of sales      |                         |       | 1,969              |       |                  |       | 2,671        |       |              |        | 3,774 |        |       |       | 5,286  |      
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       
|                                                                               |                                                                                           |                          | Gross margin            |       |                    | 1,139 |                  |       |              | 2,444 |              |        |       | 2,195  |       |       |        | 4,874 | 
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|Operating expenses:                                                            |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |      
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Research and development                                                                  |                          |                         | 428   |                    |       |                  | 497   |              |       |              | 901    |       |        |       | 987   |       
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Selling, general and administrative                                                       |                          |                         | 966   |                    |       |                  | 1,194 |              |       |              | 1,927  |       |        |       | 2,423 |       
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Restructuring charges                                                                     |                          |                         | 511   |                    |       |                  |      |              |       |              | 525    |       |        |       |      |       
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Goodwill amortization                                                                     |                          |                         |      |                    |       |                  | 42    |              |       |              |       |       |        |       | 55    |       
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Purchased in-process research and development                                             |                          |                         |      |                    |       |                  | 71    |              |       |              | 3      |       |        |       | 71    |       
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       
|                                                                               |                                                                                           | Total operating expenses |                         |       | 1,905              |       |                  |       | 1,804        |       |              |        | 3,356 |        |       |       | 3,536  |      
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       
|                                                                               |                                                                                           |                          | Operating income (loss) |       |                    | (766  | )                |       |              | 640   |              |        |       | (1,161 | )     |       |        | 1,338 | 
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|Gain (loss) on equity investments, net                                         |                                                                                           |                          | (39                     | )     |                    |       | 1                |       |              |       | (58          | )      |       |        | 1     |      
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|Interest income, net                                                           |                                                                                           |                          | 68                      |       |                    |       | 91               |       |              |       | 175          |        |       |        | 166   |      
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       
|                                                                               | Income (loss) before income taxes and cumulative
effect of change in accounting principle |                          |                         | (737  | )                  |       |                  | 732   |              |       |              | (1,044 | )     |        |       | 1,505 |       
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|Provision (benefit) for income taxes                                           |                                                                                           |                          | (306                    | )     |                    |       | 309              |       |              |       | (433         | )      |       |        | 572   |      
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       
|                                                                               | Income (loss) before cumulative effect of change
in accounting principle                  |                          |                         | (431  | )                  |       |                  | 423   |              |       |              | (611   | )     |        |       | 933   |       
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|Cumulative effect of change in accounting principle, net                       |                                                                                           |                          |                        |       |                    |       |                 |       |              |       |             |        |       |        | (54   | )    
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       
|Net income (loss)                                                              |                                                                                           | $                        | (431                    | )     |                    | $     | 423              |       |              | $     | (611         | )      |       | $      | 879   |      
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       
|Net income (loss) per common share-basic:                                      |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |      
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Income (loss) before cumulative effect of change
in accounting principle                  |                          | $                       | (0.13 | )                  |       | $                | 0.13  |              |       | $            | (0.19  | )     |        | $     | 0.29  |       
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Cumulative effect of change in accounting principle                                       |                          |                         |      |                    |       |                  |      |              |       |              |       |       |        |       | (0.02 | )     
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       
|Net income (loss) per common share-basic                                       |                                                                                           | $                        | (0.13                   | )     |                    | $     | 0.13             |       |              | $     | (0.19        | )      |       | $      | 0.27  |      
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       
|Net income (loss) per common share-diluted:                                    |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |      
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Income (loss) before cumulative effect of change
in accounting principle                  |                          | $                       | (0.13 | )                  |       | $                | 0.12  |              |       | $            | (0.19  | )     |        | $     | 0.27  |       
|                                                                              
|                                                                              
|                                                                              
|                                                                              
|                                                                               | Cumulative effect of change in accounting principle                                       |                          |                         |      |                    |       |                  |      |              |       |              |       |       |        |       | (0.01 | )     
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       
|Net income (loss) per common share-diluted                                     |                                                                                           | $                        | (0.13                   | )     |                    | $     | 0.12             |       |              | $     | (0.19        | )      |       | $      | 0.26  |      
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       
|Shares used in the calculation of net income (loss) per
common share  basic   |                                                                                           |                          | 3,239                   |       |                    |       | 3,229            |       |              |       | 3,240        |        |       |        | 3,217 |      
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       
|Shares used in the calculation of net income (loss) per
common share  diluted |                                                                                           |                          | 3,239                   |       |                    |       | 3,430            |       |              |       | 3,240        |        |       |        | 3,433 |      
|                                                                               |                                                                                           |                          |                         |       |                    |       |                  |       |              |       |              |        |       |        |       |       |       

See accompanying notes.

3



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##### Table of Contents






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

|                                            |                                           |                           |        |                   |       |               |        |       |       | 
|------------------------------------------- | ----------------------------------------- | ------------------------- | ------ | ----------------- | ----- | ------------- | ------ | ----- | ----- | 
|                                            |                                           |                           |        | December 30, 2001 |       | June 30, 2001
|                                            |                                           |                           |        |                   |       |              
|                                            |                                           |                           |        | (unaudited)       |       |               |        |      
|ASSETS                                      |                                           |                           |        |                   |       |               |        |      
|                                           
|                                           
|                                           
|                                           
|Current assets:                             |                                           |                           |        |                   |       |               |        |      
|                                           
|                                           
|                                           
|                                           
|                                            | Cash and cash equivalents                 |                           | $      | 1,205             |       |               | $      | 1,472 |      
|                                           
|                                           
|                                           
|                                           
|                                            | Short-term investments                    |                           |        | 648               |       |               |        | 387   |      
|                                           
|                                           
|                                           
|                                           
|                                            | Accounts receivable, net                  |                           |        | 2,274             |       |               |        | 2,955 |      
|                                           
|                                           
|                                           
|                                           
|                                            | Inventories                               |                           |        | 624               |       |               |        | 1,049 |      
|                                           
|                                           
|                                           
|                                           
|                                            | Deferred and prepaid tax assets           |                           |        | 1,651             |       |               |        | 1,102 |      
|                                           
|                                           
|                                           
|                                           
|                                            | Prepaid expenses and other current assets |                           |        | 861               |       |               |        | 969   |      
|                                            |                                           |                           |        |                   |       |               |        |       |      
|                                            |                                           | Total current assets      |        |                   | 7,263 |               |        |       | 7,934 | 
|                                           
|                                           
|                                           
|                                           
|Property, plant and equipment, net          |                                           |                           | 2,596  |                   |       |               | 2,697  |      
|                                           
|                                           
|                                           
|                                           
|Long-term investments                       |                                           |                           | 4,431  |                   |       |               | 4,677  |      
|                                           
|                                           
|                                           
|                                           
|Goodwill                                    |                                           |                           | 2,180  |                   |       |               | 2,126  |      
|                                           
|                                           
|                                           
|                                           
|Other acquisition-related intangible assets |                                           |                           | 134    |                   |       |               | 185    |      
|                                           
|                                           
|                                           
|                                           
|Other assets, net                           |                                           |                           | 549    |                   |       |               | 562    |      
|                                            |                                           |                           |        |                   |       |               |        |       |      
|                                            |                                           | $                         | 17,153 |                   |       | $             | 18,181 |      
|                                            |                                           |                           |        |                   |       |               |        |       |      
|LIABILITIES AND STOCKHOLDERS EQUITY        |                                           |                           |        |                   |       |               |        |      
|                                           
|                                           
|                                           
|                                           
|Current liabilities:                        |                                           |                           |        |                   |       |               |        |      
|                                           
|                                           
|                                           
|                                           
|                                            | Short-term borrowings                     |                           | $      | 217               |       |               | $      | 3     |      
|                                           
|                                           
|                                           
|                                           
|                                            | Accounts payable                          |                           |        | 871               |       |               |        | 1,050 |      
|                                           
|                                           
|                                           
|                                           
|                                            | Accrued payroll-related liabilities       |                           |        | 405               |       |               |        | 488   |      
|                                           
|                                           
|                                           
|                                           
|                                            | Accrued liabilities and other             |                           |        | 1,742             |       |               |        | 1,778 |      
|                                           
|                                           
|                                           
|                                           
|                                            | Deferred revenues and customer deposits   |                           |        | 1,626             |       |               |        | 1,827 |      
|                                            |                                           |                           |        |                   |       |               |        |       |      
|                                            |                                           | Total current liabilities |        |                   | 4,861 |               |        |       | 5,146 | 
|                                           
|                                           
|                                           
|                                           
|Long-term debt and other obligations        |                                           |                           | 2,393  |                   |       |               | 2,449  |      
|                                           
|                                           
|                                           
|                                           
|Total stockholders equity                  |                                           |                           | 9,899  |                   |       |               | 10,586 |      
|                                            |                                           |                           |        |                   |       |               |        |       |      
|                                            |                                           | $                         | 17,153 |                   |       | $             | 18,181 |      
|                                            |                                           |                           |        |                   |       |               |        |       |      

See accompanying notes.

4



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##### Table of Contents






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

|                                                       |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                   |       |      |        |  
|------------------------------------------------------ | ----------------- | ---------------------------------------------------------------------------------------- | ------------------------------------------------------ | -------------------------------------------------------------------------- | -- | ----------------- | ------ | ----------------- | ----- | ---- | ------ | -
|                                                       |                   |                                                                                          |                                                        |                                                                            |    | Six Months Ended 
|                                                       |                   |                                                                                          |                                                        |                                                                            |    |                  
|                                                       |                   |                                                                                          |                                                        |                                                                            |    | December 30, 2001 |        | December 31, 2000
|                                                       |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                  
|Cash flows from operating activities:                  |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Net income (loss) |                                                                                          | $                                                      | (611                                                                       | )  |                   | $      | 879               |      
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   | Adjustments to reconcile net income (loss) to net cash
provided by operating activities: |                                                        |                                                                            |    |                   |        |                   |       |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Depreciation and amortization                                              |    |                   | 478    |                   |       |      | 363    |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Amortization of goodwill (2000 only) and other
acquisition-related charges |    |                   | 55     |                   |       |      | 87     |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Tax benefits from employee stock plans                                     |    |                   | 41     |                   |       |      | 621    |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Loss (gain) on equity investments, net                                     |    |                   | 58     |                   |       |      | (1     | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Other                                                                      |    |                   | 3      |                   |       |      | 125    |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Changes in operating assets and liabilities:                               |    |                   |        |                   |       |      |        |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Accounts receivable, net                                                   |    |                   | 681    |                   |       |      | (516   | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Inventories                                                                |    |                   | 425    |                   |       |      | (233   | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Prepaids and other assets                                                  |    |                   | 173    |                   |       |      | (467   | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Accounts payable                                                           |    |                   | (179   | )                 |       |      | 292    |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Other liabilities                                                          |    |                   | (709   | )                 |       |      | 106    |  
|                                                       |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                   |      
|Net cash provided by operating activities              |                   |                                                                                          | 415                                                    |                                                                            |    |                   | 1,256  |                  
|                                                       |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                   |      
|Cash flows from investing activities:                  |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Purchases of investments                                                   |    |                   | (7,822 | )                 |       |      | (5,646 | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Proceeds from sales and maturities of investments                          |    |                   | 7,739  |                   |       |      | 4,676  |  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Acquisitions of property, plant and equipment                              |    |                   | (335   | )                 |       |      | (572   | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Acquisitions of spare parts and other assets                               |    |                   | (59    | )                 |       |      | (54    | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Payments for acquisitions, net of cash acquired                            |    |                   | (40    | )                 |       |      | (24    | )
|                                                       |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                   |      
|Net cash used in investing activities                  |                   |                                                                                          | (517                                                   | )                                                                          |    |                   | (1,620 | )                
|                                                       |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                   |      
|Cash flows from financing activities:                  |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          | Principal payments on borrowings and other obligations |                                                                            |    | (3                | )      |                   |       | (15  | )     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          | Proceeds from issuance of common stock, net            |                                                                            |    | 104               |        |                   |       | 244  |       
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          | Acquisition of treasury stock                          |                                                                            |    | (266              | )      |                   |       | (311 | )     
|                                                       |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                   |      
|Net cash used in financing activities                  |                   |                                                                                          | (165                                                   | )                                                                          |    |                   | (82    | )                
|                                                       |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                   |      
|Net decrease in cash and cash equivalents              |                   |                                                                                          | (267                                                   | )                                                                          |    |                   | (446   | )                
|                                                      
|                                                      
|                                                      
|                                                      
|Cash and cash equivalents, beginning of period         |                   |                                                                                          | 1,472                                                  |                                                                            |    |                   | 1,849  |                  
|                                                       |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                   |      
|Cash and cash equivalents, end of period               |                   | $                                                                                        | 1,205                                                  |                                                                            |    | $                 | 1,403  |                  
|                                                       |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                   |      
|Supplemental disclosures of cash flow information:     |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   | Cash paid during the period for:                                                         |                                                        |                                                                            |    |                   |        |                   |       |     
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   |                                                                                          |                                                        | Interest                                                                   |    | $                 | 57     |                   |       | $    | 56     |  
|                                                       |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                   |      
|                                                       |                   |                                                                                          |                                                        | Income taxes                                                               |    | $                 | 118    |                   |       | $    | 331    |  
|                                                       |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                   |      
|Supplemental schedule of noncash investing activities: |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       |                   | Stock and options issued in connection with acquisitions                                 |                                                        | $                                                                          | 29 |                   |        | $                 | 2,078 |     
|                                                       |                   |                                                                                          |                                                        |                                                                            |    |                   |        |                   |      

See accompanying notes.

5



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##### Table of Contents






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

1. DESCRIPTION OF BUSINESS

Sun Microsystems, Inc. (Sun or the Company) is a leading worldwide provider
of products, services and support solutions for building and maintaining
network computing environments. Sun sells scalable computer and storage
systems, high-speed microprocessors, and a complete line of high-performance
software for operating networks, computing equipment and storage products. Sun
also provides a full range of services including support, professional services
and education. The Company markets its products primarily to business,
governmental and educational customers and operates in various product
categories across geographically diverse markets.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Fiscal year

Suns first three quarters in fiscal 2002 end on September 30, December 30 and
March 31 (in fiscal 2001 the quarters ended on October 1, December 31 and April
1). The fourth quarter in all fiscal years ends on June 30.

Basis of presentation

The consolidated financial statements include the accounts of Sun and its
wholly owned subsidiaries. Intercompany accounts and transactions have been
eliminated. Certain amounts from prior year financial statements have been
reclassified to conform to the current year presentation.

While the quarterly financial information is unaudited, the financial
statements included in this report reflect all adjustments (consisting of
normal recurring adjustments) 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 condensed consolidated balance sheet as of
June 30, 2001 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 the Companys Annual Report on Form 10-K for fiscal 2001 and
its quarterly report on Form 10-Q for the fiscal quarter ended September 30,
2001 filed with the Securities and Exchange Commission on September 20, 2001
and November 14, 2001, respectively.

Computation of net income (loss) per common share

Basic net income (loss) per common share is computed using the weighted average
number of common shares outstanding (adjusted for treasury stock and common
stock subject to repurchase activity) during the period. Diluted net income
(loss) per common share is computed using the weighted average number of common
and dilutive common equivalent shares outstanding during the period; dilutive
common equivalent shares consist primarily of stock options. There were 201
million and 216 million dilutive common equivalent shares for the three and six
months ended December 31, 2000, respectively. For the three and six months
ended December 30, 2001, 112 million and 113 million common equivalent shares,
respectively, were excluded from the computation of diluted net income (loss)
per common share because they were anti-dilutive.

6



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##### Table of Contents



Change in accounting

The Company changed its revenue recognition policy effective July 1, 2000,
based on guidance provided in Securities and Exchange Commission (SEC) Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as
amended (SAB 101). The Companys adoption of SAB 101 resulted in a change in
accounting for certain product shipments where installation services were other
than perfunctory. The cumulative effect of the change on prior years retained
earnings resulted in a charge of $54 million (net of income taxes of $33
million) to fiscal 2001 income.

Recent pronouncements

On June 29, 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 141 (SFAS 141), Business
Combinations, which eliminates the pooling of interests method of accounting
for all business combinations initiated after June 30, 2001 and addresses the
initial recognition and measurement of goodwill and other intangible assets
acquired in a business combination. As of July 1, 2001, the Company adopted
this accounting standard.

In addition, as of July 1, 2001, the Company early adopted SFAS 142, Goodwill
and Other Intangible Assets, which addresses the financial accounting and
reporting standards for goodwill and other intangible assets subsequent to
their acquisition. This accounting standard requires that goodwill no longer be
amortized, and instead, be tested for impairment on a periodic basis.

In accordance with SFAS 142, the Company discontinued the amortization of
goodwill effective July 1, 2001. In addition, the Company recharacterized
acquired workforce (and its related deferred tax liabilities) as goodwill
because it is no longer defined as an acquired intangible asset under SFAS 141.
Accordingly, no acquired workforce amortization was recognized during the three
months and the six months ended December 30, 2001.

The provisions of SFAS 142 also require the completion of a transitional
impairment test within six months of adoption, with any impairments treated as
a cumulative effect of change in accounting principle. During the quarter ended
December 30, 2001, the Company completed the transitional impairment test,
which did not result in impairment of recorded goodwill.

For further discussion, see Note 5, Goodwill and Other Acquisition-Related
Intangible Assets.

7



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##### Table of Contents



A reconciliation of previously reported net income and earnings per share to
the amounts adjusted for the exclusion of goodwill and workforce amortization,
net of the related income tax effect, follows (in millions, except per share
amounts):

|                            |                                       |                        |      |                    |   |                  |     |              |      |              |      |       |   |   |     |      |      | 
|--------------------------- | ------------------------------------- | ---------------------- | ---- | ------------------ | - | ---------------- | --- | ------------ | ---- | ------------ | ---- | ----- | - | - | --- | ---- | ---- | 
|                            |                                       |                        |      | Three Months Ended |   | Six Months Ended
|                            |                                       |                        |      |                    |   |                 
|                            |                                       |                        |      | December 30,       |   | December 31,     |     | December 30, |      | December 31,
|                            |                                       |                        |      | 2001               |   | 2000             |     | 2001         |      | 2000        
|                            |                                       |                        |      |                    |   |                  |     |              |      |             
|Reported net income (loss)  |                                       | $                      | (431 | )                  |   | $                | 423 |              |      | $            | (611 | )     |   | $ | 879 |     
|                           
|                           
|                           
|                           
|                            | Add: Goodwill amortization            |                        |      |                   |   |                  |     | 42           |      |              |      |      |   |   |     | 55   |     
|                           
|                           
|                           
|                           
|                            |                                       | Workforce amortization |      |                    |  |                  |     |              | 1    |              |      |       |  |   |     |      | 1    | 
|                           
|                           
|                           
|                           
|                            |                                       | Tax impact             |      |                    |  |                  |     |              | 23   |              |      |       |  |   |     |      | 24   | 
|                            |                                       |                        |      |                    |   |                  |     |              |      |              |      |       |   |   |     |     
|Adjusted net income (loss)  |                                       | $                      | (431 | )                  |   | $                | 489 |              |      | $            | (611 | )     |   | $ | 959 |     
|                            |                                       |                        |      |                    |   |                  |     |              |      |              |      |       |   |   |     |     
|Basic earnings per share:   |                                       |                        |      |                    |   |                  |     |              |      |              |      |       |   |   |     |     
|                           
|                           
|                           
|                           
|                            | Reported earnings per share  basic   |                        | $    | (0.13              | ) |                  | $   | 0.13         |      |              | $    | (0.19 | ) |   | $   | 0.27 |     
|                           
|                           
|                           
|                           
|                            | Add: Goodwill amortization            |                        |      |                   |   |                  |     | 0.01         |      |              |      |      |   |   |     | 0.02 |     
|                           
|                           
|                           
|                           
|                            |                                       | Workforce amortization |      |                    |  |                  |     |              |     |              |      |       |  |   |     |      |     | 
|                           
|                           
|                           
|                           
|                            |                                       | Tax impact             |      |                    |  |                  |     |              | 0.01 |              |      |       |  |   |     |      | 0.01 | 
|                            |                                       |                        |      |                    |   |                  |     |              |      |              |      |       |   |   |     |     
|                            | Adjusted earnings per share  basic   |                        | $    | (0.13              | ) |                  | $   | 0.15         |      |              | $    | (0.19 | ) |   | $   | 0.30 |     
|                            |                                       |                        |      |                    |   |                  |     |              |      |              |      |       |   |   |     |     
|Diluted earnings per share: |                                       |                        |      |                    |   |                  |     |              |      |              |      |       |   |   |     |     
|                           
|                           
|                           
|                           
|                            | Reported earnings per share  diluted |                        | $    | (0.13              | ) |                  | $   | 0.12         |      |              | $    | (0.19 | ) |   | $   | 0.26 |     
|                           
|                           
|                           
|                           
|                            | Add: Goodwill amortization            |                        |      |                   |   |                  |     | 0.01         |      |              |      |      |   |   |     | 0.01 |     
|                           
|                           
|                           
|                           
|                            |                                       | Workforce amortization |      |                    |  |                  |     |              |     |              |      |       |  |   |     |      |     | 
|                           
|                           
|                           
|                           
|                            |                                       | Tax impact             |      |                    |  |                  |     |              | 0.01 |              |      |       |  |   |     |      | 0.01 | 
|                            |                                       |                        |      |                    |   |                  |     |              |      |              |      |       |   |   |     |     
|                            | Adjusted earnings per share  diluted |                        | $    | (0.13              | ) |                  | $   | 0.14         |      |              | $    | (0.19 | ) |   | $   | 0.28 |     
|                            |                                       |                        |      |                    |   |                  |     |              |      |              |      |       |   |   |     |     

On October 3, 2001, the FASB issued 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. At this
time, Sun is evaluating the impact of SFAS 144 on its financial position and
results of operations. The Company will adopt SFAS 144 for its fiscal year
beginning July 1, 2002.

3. BUSINESS COMBINATIONS

The Company completed two acquisitions in the first half of fiscal 2002. Suns
acquisition of ISOPIA, Inc. (Isopia) on July 26, 2001 is described below (the
second acquisition was insignificant). The consolidated financial statements
include the operating results of each business from the date of acquisition.
Pro forma results of operations have not been presented because the effects of
these acquisitions were not material on either an individual or an aggregate
basis.

The Company calculates amounts allocated to in-process research and development
(IPRD) using established valuation techniques in the high-technology industry
and expenses such amounts in the quarter that the related acquisition was
consummated if technological feasibility of the in-process technology has not
been achieved and no alternate future uses have been established. Research and
development costs to bring the products from the acquired companies to
technological feasibility are not expected to have a material impact on the
Companys future results of operations or cash flows. Intangible assets subject
to amortization are being amortized on a straight line basis over periods not
exceeding five years.

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##### Table of Contents



On July 26, 2001, Sun acquired Isopia, a corporation located in Toronto,
Canada, by means of a plan of arrangement. Isopia develops on-line software
that enables the delivery of on-line training and end-to-end management of
training products via the Internet. Sun acquired Isopia to enhance its position
in the corporate education market. Sun issued approximately 1.84 million
exchangeable shares at a fair value of $15.235 per share, or $28.0 million in
the aggregate, and paid $36.2 million in cash, in exchange for all of Isopias
outstanding stock. Sun also assumed all of Isopias 1.4 million outstanding
options at an estimated fair value of $1.3 million, and incurred $1.3 million
in acquisition costs, resulting in an aggregate purchase price of approximately
$66.8 million. This transaction was accounted for as a purchase, with the
excess of the purchase price over the estimated fair value of the net tangible
assets ($0.6 million) being allocated to developed technology ($3.7 million),
IPRD ($3.2 million), goodwill ($39.0 million), and related deferred tax
liabilities ($4.8 million). In addition, $25.1 million of the purchase price
was allocated to deferred compensation, which primarily represents the pro-rata
portion of the intrinsic value of unvested exchangeable shares held by certain
key Isopia shareholders at the date of the acquisition.

4. BALANCE SHEET DETAILS

Inventories are comprised of the following (in millions):

|                |  |                   |     |               |  |   |       | 
|--------------- |  | ----------------- | --- | ------------- |  | - | ----- | 
|                |  | December 30, 2001 |     | June 30, 2001
|                |  |                   |     |              
|Raw materials   |  | $                 | 305 |               |  | $ | 600   | 
|               
|               
|               
|               
|Work in process |  |                   | 104 |               |  |   | 137   | 
|               
|               
|               
|               
|Finished goods  |  |                   | 215 |               |  |   | 312   | 
|                |  |                   |     |               |  |   |       | 
|                |  | $                 | 624 |               |  | $ | 1,049 | 
|                |  |                   |     |               |  |   |       | 

Long-term investments are comprised of the following (in millions):

|                           |  |                   |       |               |  |   |       | 
|-------------------------- |  | ----------------- | ----- | ------------- |  | - | ----- | 
|                           |  | December 30, 2001 |       | June 30, 2001
|                           |  |                   |       |              
|Marketable debt securities |  | $                 | 4,117 |               |  | $ | 4,312 | 
|                          
|                          
|                          
|                          
|Equity investments         |  |                   | 314   |               |  |   | 365   | 
|                           |  |                   |       |               |  |   |       | 
|                           |  | $                 | 4,431 |               |  | $ | 4,677 | 
|                           |  |                   |       |               |  |   |       | 

Long-term investments are comprised of marketable debt securities and equity
investments. Marketable debt securitiesconsist primarily of corporate bonds,
floating-rate notes, and asset-backed and mortgage-backed securities with
original maturities beyond three months. All marketable debt securities are
held in the Companys name and are held in custody with primarily one major
financial institution. The Companys policy is to protect the value of its
investment portfolio and minimize principal risk by earning returns based on
current interest rates.

Equity investmentsinclude marketable equity securities, which represent equity
holdings in publicly traded companies, and other equity holdings,which
represent equity holdings in non-publicly traded companies and third-party
investments in venture capital funds. Equity investments are contained within
our internally-managed venture capital fund. The Company monitors for potential
impairment of its equity investments and makes appropriate reductions in
carrying values when such impairments are determined to be
other-than-temporary. Gain (loss) on equity investments, net is comprised of
gains and losses realized on the disposal of equity investments and impairment
charges recognized on equity investments.

9



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##### Table of Contents



5. GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS

Changes in the carrying amount of goodwill for the six months ended December
30, 2001, are as follows (in millions):

|                                    |  |             |       |            |  |       |    |       |  |   |    |  |  |   |       | 
|----------------------------------- |  | ----------- | ----- | ---------- |  | ----- | -- | ----- |  | - | -- |  |  | - | ----- | 
|                                    |  | Computer    |       |            |  |       |    |       |  |   |    |  |  |  
|                                    |  | Systems     |       |            |  |       |    |       |  |   |    |  |  |  
|                                    |  | and Network |       | Enterprise |  |       |    |       |  |   |    | 
|                                    |  | Storage     |       | Services   |  | Other |    | Total
|                                    |  |             |       |            |  |       |    |      
|Balance as of July 1, 2001          |  | $           | 2,071 |            |  | $     | 9  |       |  | $ | 46 |  |  | $ | 2,126 | 
|                                   
|                                   
|                                   
|                                   
|Workforce reclassified as goodwill  |  |             | 10    |            |  |       | 1  |       |  |   | 1  |  |  |   | 12    | 
|                                   
|                                   
|                                   
|                                   
|Goodwill acquired during the period |  |             | 3     |            |  |       | 39 |       |  |   |   |  |  |   | 42    | 
|                                    |  |             |       |            |  |       |    |       |  |   |    |  |  |   |       | 
|Balance as of December 30, 2001     |  | $           | 2,084 |            |  | $     | 49 |       |  | $ | 47 |  |  | $ | 2,180 | 
|                                    |  |             |       |            |  |       |    |       |  |   |    |  |  |   |       | 

Information regarding the Companys other acquisition-related intangible assets
is as follows (in millions):

|                     |  |                         |     |                     |  |     |      |        |  |              |     |             |  |   |     |  |  |   |      |   |  |   |     | 
|-------------------- |  | ----------------------- | --- | ------------------- |  | --- | ---- | ------ |  | ------------ | --- | ----------- |  | - | --- |  |  | - | ---- | - |  | - | --- | 
|                     |  | As of December 30, 2001 |     | As of June 30, 2001
|                     |  |                         |     |                    
|                     |  | Gross                   |     |                     |  |     |      |        |  |              |     | Gross       |  |   |     |  |  |   |      |  
|                     |  | Carrying                |     | Accumulated         |  |     |      |        |  | Carrying     |     | Accumulated |  |   |     | 
|                     |  | Amount                  |     | Amortization        |  | Net |      | Amount |  | Amortization |     | Net        
|                     |  |                         |     |                     |  |     |      |        |  |              |     |            
|Developed technology |  | $                       | 296 |                     |  | $   | (196 | )      |  | $            | 100 |             |  | $ | 290 |  |  | $ | (169 | ) |  | $ | 121 | 
|                    
|                    
|                    
|                    
|Customer base        |  |                         | 57  |                     |  |     | (27  | )      |  |              | 30  |             |  |   | 57  |  |  |   | (19  | ) |  |   | 38  | 
|                    
|                    
|                    
|                    
|Other                |  |                         | 7   |                     |  |     | (3   | )      |  |              | 4   |             |  |   | 53  |  |  |   | (27  | ) |  |   | 26  | 
|                     |  |                         |     |                     |  |     |      |        |  |              |     |             |  |   |     |  |  |   |      |   |  |   |     | 
|                     |  | $                       | 360 |                     |  | $   | (226 | )      |  | $            | 134 |             |  | $ | 400 |  |  | $ | (215 | ) |  | $ | 185 | 
|                     |  |                         |     |                     |  |     |      |        |  |              |     |             |  |   |     |  |  |   |      |   |  |   |     | 

Amortization expense of other acquisition-related intangible assets was $18
million and $36 million for the three months and six months ended December 30,
2001, respectively, and $9 million and $12 million for the three months and six
months ended December 31, 2000, respectively.

Estimated amortization expense for the fiscal years
ending June 30, is as
follows (in millions):

|     |  |   |     | 
|---- |  | - | --- | 
|2002 |  | $ | 72  | 
|    
|    
|    
|    
|2003 |  |   | 68  | 
|    
|    
|    
|    
|2004 |  |   | 30  | 
|     |  |   |     | 
|     |  | $ | 170 | 
|     |  |   |     | 

6. AMENDMENT TO STRATEGIC DEVELOPMENT AND MARKETING AGREEMENT WITH AMERICA ONLINE, INC.

Sun and AOL-Time Warner (AOL) have a Strategic Alliance consisting of several
agreements between the parties, including a Strategic Development and Marketing
Agreement (SDMA). The SDMA has a term of three years ending March 2002.

On September 25, 2001, Sun and AOL modified certain terms of the agreements to
give Sun operational control of the Strategic Alliance during the remaining
term of the SDMA. The amendment also fixed and accelerated the payment
obligations that were otherwise due by the parties through March 2002 under the
various agreements. As a result of these payments, which were made prior to
September 30, 2001, Sun initially recognized a prepaid asset of approximately
$75 million which will be amortized over the remaining term of the SDMA. As of
December 30, 2001, $34 million of the prepaid asset remains unamortized.

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7. RESTRUCTURING CHARGES

Fiscal 2002 restructuring plan

In response to the continuing global economic slowdown, the Company began
implementing a workforce reduction and facility exit plan in the second quarter
of fiscal 2002. This restructuring resulted in a charge of $511 million. The
goal of the restructuring is to reduce costs and improve operating efficiencies
in order to adjust to the current business environment. Specifically, it is the
Companys intent to reduce its headcount by approximately 9% (or 3,900
employees and contractors) and to eliminate excess facility capacity in light
of revised facility requirements.

The Company recorded a workforce reduction charge of $146 million relating to
severance and related fringe benefits for employees. The restructuring will
result in the termination of approximately 3,400 employees across all employee
levels, business functions, operating units, and geographic regions. As of
December 30, 2001, approximately 3,000 employees had been terminated as a
result of the restructuring. The remaining identified employees are anticipated
to be terminated during the third and fourth quarters of fiscal 2002, depending
on the local employment laws that govern such employees.

In addition, the Company recorded a charge of $365 million relating to the
consolidation of excess facilities. The facility exit charges include:



| |  |  | $282 million of estimated future obligations for noncancelable lease
payments (net of estimated sublease income) or termination fees generated
by exiting excess rental facilities. The Company estimated the cost of
exiting and terminating the facility leases based on the contractual
terms of the agreements and then current real estate market conditions.
In addition, the Company intends to sublease certain leased facilities
and estimated the sublease income based on then current real estate
market conditions or, where applicable, amounts being negotiated;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | $66 million for the impairment of in-process construction costs related
to the termination of certain building construction projects;                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  |  | $17 million for the impairment of property and equipment (primarily
leasehold improvements) for which there are insufficient cash flows to
support the carrying cost. The property and equipment impairment was
determined based on the difference between the assets estimated fair
value and its carrying value as of December 30, 2001.                                                                                                                                                                                                                                    

The Company expects to exit the facilities relating to the amounts accrued
under the restructuring by no later than December 31, 2002.

Fiscal 2001 facility exit plan

In the fourth quarter of fiscal 2001, Sun elected to exit certain building
leases and building projects. The Company charged approximately $75 million for
facility exit costs associated with this decision, of which $46 million was
reflected as an accrual as of June 30, 2001. An additional $14 million was
charged in the first quarter of fiscal 2002 to reflect changes in Suns
sublease income assumptions.

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The following table sets forth an analysis of the restructuring accrual
activity for the six months ending December 30, 2001 (in millions):

|                                           |                                   |                                            |     |                          |     |             |     |             |     |   |    |                |    |   |     |     |     | 
|------------------------------------------ | --------------------------------- | ------------------------------------------ | --- | ------------------------ | --- | ----------- | --- | ----------- | --- | - | -- | -------------- | -- | - | --- | --- | --- | 
|                                           |                                   |                                            |     |                          |     |             |     |             |     |   |    | FY'01 Facility |    |   |     |    
|                                           |                                   |                                            |     | FY'02 Restructuring Plan |     | Exit Plan   |     | Total      
|                                           |                                   |                                            |     |                          |     |             |     |            
|                                           |                                   |                                            |     | Severance and            |     | Facilities- |     | Facilities- |     |   |    |               
|                                           |                                   |                                            |     | Benefits                 |     | related     |     | related     |     |   |    |               
|                                           |                                   |                                            |     |                          |     |             |     |             |     |   |    |               
|Balance of accrual as of June 30, 2001     |                                   | $                                          |    |                          |     | $           |    |             |     | $ | 46 |                |    | $ | 46  |    
|                                          
|                                          
|                                          
|                                          
|Restructuring provision:                   |                                   |                                            |     |                          |     |             |     |             |     |   |    |                |    |   |     |    
|                                          
|                                          
|                                          
|                                          
|                                           | Severance and benefits            |                                            |     | 146                      |     |             |     |            |     |   |    |               |    |   |     | 146 |    
|                                          
|                                          
|                                          
|                                          
|                                           | Accrued lease costs               |                                            |     |                         |     |             |     | 282         |     |   |    |               |    |   |     | 282 |    
|                                          
|                                          
|                                          
|                                          
|                                           | Property and equipment impairment |                                            |     |                         |     |             |     | 83          |     |   |    |               |    |   |     | 83  |    
|                                          
|                                          
|                                          
|                                          
|                                           | Provision adjustments             |                                            |     |                         |     |             |     |            |     |   |    | 14             |    |   |     | 14  |    
|                                           |                                   |                                            |     |                          |     |             |     |             |     |   |    |                |    |   |     |    
|                                           |                                   | Total restructuring charges in fiscal 2002 |     |                          | 146 |             |     |             | 365 |   |    |                | 14 |   |     |     | 525 | 
|                                          
|                                          
|                                          
|                                          
|Cash paid                                  |                                   |                                            | (72 | )                        |     |             | (1  | )           |     |   | (8 | )              |    |   | (81 | )  
|                                          
|                                          
|                                          
|                                          
|Non-cash charges                           |                                   |                                            |    |                          |     |             | (83 | )           |     |   |   |                |    |   | (83 | )  
|                                           |                                   |                                            |     |                          |     |             |     |             |     |   |    |                |    |   |     |    
|Balance of accrual as of December 30, 2001 |                                   | $                                          | 74  |                          |     | $           | 281 |             |     | $ | 52 |                |    | $ | 407 |    
|                                           |                                   |                                            |     |                          |     |             |     |             |     |   |    |                |    |   |     |    

The remaining cash expenditures relating to workforce reductions and
termination of lease agreements are expected to be substantially paid by the
fourth quarter of fiscal 2002. 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 December 30, 2001, $233
million of the $407 million accrual was classified as current and the remaining
$174 million was classified as noncurrent.

The above restructuring charges are based on certain estimates which are
subject to change. Changes to the estimates will be reflected as a provision
adjustment on the above table in the period the changes in estimates are made.

8. COMPREHENSIVE INCOME (LOSS)

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

|                                                                      |  |                    |      |                  |  |              |      |              |  |   |      |   |  |   |     |  
|--------------------------------------------------------------------- |  | ------------------ | ---- | ---------------- |  | ------------ | ---- | ------------ |  | - | ---- | - |  | - | --- | -
|                                                                      |  | Three Months Ended |      | Six Months Ended
|                                                                      |  |                    |      |                 
|                                                                      |  | December 30,       |      | December 31,     |  | December 30, |      | December 31,
|                                                                      |  | 2001               |      | 2000             |  | 2001         |      | 2000        
|                                                                      |  |                    |      |                  |  |              |      |             
|Net income (loss)                                                     |  | $                  | (431 | )                |  | $            | 423  |              |  | $ | (611 | ) |  | $ | 879 |  
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Change in unrealized value of investments, net                        |  |                    | (29  | )                |  |              | (126 | )            |  |   | (6   | ) |  |   | (76 | )
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Change in unrealized fair value of foreign
exchange hedging contracts |  |                    | 11   |                  |  |              | (10  | )            |  |   | (17  | ) |  |   | 7   |  
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Translation adjustments, net                                          |  |                    | (17  | )                |  |              | (13  | )            |  |   | 36   |   |  |   | (19 | )
|                                                                      |  |                    |      |                  |  |              |      |              |  |   |      |   |  |   |     |  
|                                                                      |  | $                  | (466 | )                |  | $            | 274  |              |  | $ | (598 | ) |  | $ | 791 |  
|                                                                      |  |                    |      |                  |  |              |      |              |  |   |      |   |  |   |     |  

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

|                                                                |  |                   |     |               |  |   |     |  
|--------------------------------------------------------------- |  | ----------------- | --- | ------------- |  | - | --- | -
|                                                                |  | December 30, 2001 |     | June 30, 2001
|                                                                |  |                   |     |              
|Unrealized gains on investments, net                            |  | $                 | 47  |               |  | $ | 53  |  
|                                                               
|                                                               
|                                                               
|                                                               
|Unrealized gains (losses) on
foreign exchange hedging contracts |  |                   | (2  | )             |  |   | 15  |  
|                                                               
|                                                               
|                                                               
|                                                               
|Cumulative translation adjustments                              |  |                   | (61 | )             |  |   | (97 | )
|                                                                |  |                   |     |               |  |   |     |  
|                                                                |  | $                 | (16 | )             |  | $ | (29 | )
|                                                                |  |                   |     |               |  |   |     |  

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9. OPERATING SEGMENTS

The following table presents revenues, interdivision revenues and operating
income (loss) for the Companys segments. The Other segment consists of certain
operating product groups that did not meet the requirements for a reportable
segment, such as Suns Software Systems Group and iPlanet, and other
miscellaneous functions, such as Corporate and Global Sales Operations. It is
not unusual for the Company to have minor reorganizations from time-to-time
during the year; under such circumstances, the historical information is
updated to reflect the changes in business:

|                                 |  |                     |       |            |  |       |     |       |  |   |        |   |  |   |       |  
|-------------------------------- |  | ------------------- | ----- | ---------- |  | ----- | --- | ----- |  | - | ------ | - |  | - | ----- | -
|                                 |  | Computer Systems    |       | Enterprise |  |       |     |       |  |   |        |  
|Three Months Ended (in millions) |  | and Network Storage |       | Services   |  | Other |     | Total
|                                 |  |                     |       |            |  |       |     |      
|December 30, 2001                |  |                     |       |            |  |       |     |       |  |   |        |   |  |   |       |  
|                                
|                                
|                                
|                                
|Revenues                         |  | $                   | 2,111 |            |  | $     | 848 |       |  | $ | 149    |   |  | $ | 3,108 |  
|                                
|                                
|                                
|                                
|Interdivision revenues           |  |                     |      |            |  |       | 121 |       |  |   | (121   | ) |  |   |      |  
|                                
|                                
|                                
|                                
|Operating income (loss)          |  |                     | 266   |            |  |       | 206 |       |  |   | (1,238 | ) |  |   | (766  | )
|                                
|                                
|                                
|                                
|                                
|                                
|                                
|                                
|December 31, 2000                |  |                     |       |            |  |       |     |       |  |   |        |   |  |   |       |  
|                                
|                                
|                                
|                                
|Revenues                         |  |                     | 4,140 |            |  |       | 798 |       |  |   | 177    |   |  |   | 5,115 |  
|                                
|                                
|                                
|                                
|Interdivision revenues           |  |                     |      |            |  |       | 118 |       |  |   | (118   | ) |  |   |      |  
|                                
|                                
|                                
|                                
|Operating income (loss)          |  | $                   | 1,484 |            |  | $     | 168 |       |  | $ | (1,012 | ) |  | $ | 640   |  

|                               |  |                     |       |            |  |       |       |       |  |   |        |   |  |   |        |  
|------------------------------ |  | ------------------- | ----- | ---------- |  | ----- | ----- | ----- |  | - | ------ | - |  | - | ------ | -
|                               |  | Computer Systems    |       | Enterprise |  |       |       |       |  |   |        |  
|Six Months Ended (in millions) |  | and Network Storage |       | Services   |  | Other |       | Total
|                               |  |                     |       |            |  |       |       |      
|December 30, 2001              |  |                     |       |            |  |       |       |       |  |   |        |   |  |   |        |  
|                              
|                              
|                              
|                              
|Revenues                       |  | $                   | 4,020 |            |  | $     | 1,652 |       |  | $ | 297    |   |  | $ | 5,969  |  
|                              
|                              
|                              
|                              
|Interdivision revenues         |  |                     |      |            |  |       | 251   |       |  |   | (251   | ) |  |   |       |  
|                              
|                              
|                              
|                              
|Operating income (loss)        |  |                     | 466   |            |  |       | 388   |       |  |   | (2,015 | ) |  |   | (1,161 | )
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|                              
|December 31, 2000              |  |                     |       |            |  |       |       |       |  |   |        |   |  |   |        |  
|                              
|                              
|                              
|                              
|Revenues                       |  |                     | 8,332 |            |  |       | 1,500 |       |  |   | 328    |   |  |   | 10,160 |  
|                              
|                              
|                              
|                              
|Interdivision revenues         |  |                     |      |            |  |       | 226   |       |  |   | (226   | ) |  |   |       |  
|                              
|                              
|                              
|                              
|Operating income (loss)        |  | $                   | 3,029 |            |  | $     | 294   |       |  | $ | (1,985 | ) |  | $ | 1,338  |  

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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 relating to our
expectations as to product demand and products net revenue, our expectations
regarding product mix trends, our expectations regarding services net revenue,
revenues, results of operations, cash flows and products gross margin, our
expectations to invest in our services business, our expectations to continue
developing systems and software products, our belief that to maintain our
competitive position, we must continue to invest in new systems, software and
microprocessor development as well as enhancing existing products, our
expectations regarding the dollar amount of R&D expenses and managements
long-term objectives to invest 10-11% of its net revenues in R&D, our plans
relating to certain variable costs and performance-based incentives and
selling, general and administrative expenses, our continual focus on efforts to
achieve additional operating efficiencies and to review and improve our
business processes, our continual focus on our cost structure, our expectations
to continue investing in technology, to provide customers with an integrated
portfolio of services, our intent to reduce headcount by approximately 9%, and
the timing of termination for the remaining employees to be terminated and
facilities to be exited under our restructuring plan, our intent to sublease
certain leased facilities, our expectations regarding the volatility of our
marketable debt securities portfolio and interest income, our expected
effective income tax benefit rate, our intentions as to stock repurchase
activity, our belief that we have sufficient capital to meet our requirements
for at least the next twelve months, our expectations regarding the timing of
payments to be made related to workforce and facility reductions, our intent to
focus on inventory management, and as set forth in the section entitled
Purchased in-process research and development expenses: statements regarding
our belief of 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
changes in general economic conditions in the U.S. and internationally,
including adverse changes in the specific markets for our products, adverse
business conditions, adverse changes in customer order patterns, inability to
successfully manage inventory levels, lack of acceptance of new products,
pricing pressures, lack of success in technological advancements, risks
associated with foreign operations, 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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##### Table of Contents



RESULTS OF OPERATIONS

Net revenues
(dollars in millions)

|                     |                                  |   |                    |      |                  |   |        |      |      |  |              |    |              |   |       |      |   |   |        |      |   |  |       |    | 
|-------------------- | -------------------------------- | - | ------------------ | ---- | ---------------- | - | ------ | ---- | ---- |  | ------------ | -- | ------------ | - | ----- | ---- | - | - | ------ | ---- | - |  | ----- | -- | 
|                     |                                  |   | Three Months Ended |      | Six Months Ended
|                     |                                  |   |                    |      |                 
|                     |                                  |   | December 30,       |      | December 31,     |   |        |      |      |  | December 30, |    | December 31, |   |       |      |  
|                     |                                  |   | 2001               |      | 2000             |   | Change |      | 2001 |  | 2000         |    | Change      
|                     |                                  |   |                    |      |                  |   |        |      |      |  |              |    |             
|Products net revenue |                                  | $ | 2,260              |      |                  | $ | 4,317  |      |      |  | (47.6        | )% |              | $ | 4,317 |      |   | $ | 8,660  |      |   |  | (50.1 | )%
|                    
|                    
|                    
|                    
|                     | Percentage of total net revenues |   |                    | 72.7 | %                |   |        | 84.4 | %    |  |              |    |              |   |       | 72.3 | % |   |        | 85.2 | % |  |       |    | 
|                    
|                    
|                    
|                    
|Services net revenue |                                  | $ | 848                |      |                  | $ | 798    |      |      |  | 6.3          | %  |              | $ | 1,652 |      |   | $ | 1,500  |      |   |  | 10.1  | % 
|                    
|                    
|                    
|                    
|                     | Percentage of total net revenues |   |                    | 27.3 | %                |   |        | 15.6 | %    |  |              |    |              |   |       | 27.7 | % |   |        | 14.8 | % |  |       |    | 
|                    
|                    
|                    
|                    
|Total net revenues   |                                  | $ | 3,108              |      |                  | $ | 5,115  |      |      |  | (39.2        | )% |              | $ | 5,969 |      |   | $ | 10,160 |      |   |  | (41.2 | )%

Products net revenue

Products net revenue consists of revenue generated from the sale of our
scalable computer systems and storage products, high-speed microprocessors, and
our high-performance software for operating network computing equipment.
Products net revenue in the second quarter as well as in the first half of
fiscal 2002 as compared with the corresponding periods of fiscal 2001, was
negatively impacted by weak global macroeconomic conditions and the resulting
reduction in information technology (IT) spending. In addition, we believe the
September 11, 2001 terrorist attacks exacerbated the negative effects the weak
economy had on our products net revenue in the U.S. during the first six months
of fiscal 2002, however, we have been unable to quantify such effects.

Over 90% of our products net revenue in the second quarter as well as in the
first half of both fiscal 2002 and 2001 was generated by Computer Systems and
Network Storage. Computer Systems and Network Storage consists primarily of
servers, storage and desktop computers. Substantially all of the decrease in
products net revenue during the second quarter and the first half of fiscal
2002, when compared with the corresponding periods of fiscal 2001, was
attributable to a decrease in revenues generated by our server and storage
products due to reductions in IT spending resulting from weaker global
macroeconomic conditions during these periods. However, revenues from our
storage product line declined at a lower rate than revenues from our server
product line. Revenues from the sale of desktop systems represented
approximately 11% and 8% of products net revenue in the second quarter of
fiscal 2002 and 2001, respectively, and 10% and 9% of products net revenue in
the first half of fiscal 2002 and 2001, respectively. While our product mix
fluctuates from quarter to quarter, we expect over the long-term an increasing
percentage of products net revenue will be from server and storage products and
a decreasing percentage of products net revenue will be from desktop systems.

If the current adverse macroeconomic conditions continue to negatively impact
demand, products net revenue in the third quarter of fiscal 2002 will be less
than products net revenue in the comparable period in fiscal 2001. See Net
revenues by geographic area for further discussion and analysis regarding
specific regions.

Services net revenue

Services net revenue consists of Support Services, Professional Services and
Educational Services. The 6.3% and 10.1% growth in services net revenue in the
second quarter and first half of fiscal 2002, respectively, as compared with
the corresponding periods of fiscal 2001, was primarily due to an increase in
revenue from Support Services. Support Services revenue represents maintenance
contract revenue which is recognized ratably over the contractual period.
Support Services revenue growth was a result of: (1) a better mix of platinum,
gold, silver and bronze service level contracts in our portfolio; and (2) our
improved ability to renew existing contracts and to add new contracts to our
maintenance contract portfolio.

15



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##### Table of Contents



Because a significant portion of our services net revenue is generated by
contracts related to product sales, our services net revenue could be
negatively impacted by the adverse macroeconomic conditions which have been and
are currently impacting our products net revenue.

Net revenues by geographic area
(dollars in millions)

|                                          |                            |                            |       |                    |      |                  |       |        |      |      |       |              |  |              |       |      |      |   |        |      |      |   |       |    |  | 
|----------------------------------------- | -------------------------- | -------------------------- | ----- | ------------------ | ---- | ---------------- | ----- | ------ | ---- | ---- | ----- | ------------ |  | ------------ | ----- | ---- | ---- | - | ------ | ---- | ---- | - | ----- | -- |  | 
|                                          |                            |                            |       | Three Months Ended |      | Six Months Ended
|                                          |                            |                            |       |                    |      |                 
|                                          |                            |                            |       | December 30,       |      | December 31,     |       |        |      |      |       | December 30, |  | December 31, |       |      |      |  
|                                          |                            |                            |       | 2001               |      | 2000             |       | Change |      | 2001 |       | 2000         |  | Change      
|                                          |                            |                            |       |                    |      |                  |       |        |      |      |       |              |  |             
|U.S                                       |                            | $                          | 1,405 |                    |      | $                | 2,438 |        |      |      | (42.4 | )%           |  | $            | 2,726 |      |      | $ | 5,137  |      |      |   | (46.9 | )%
|                                         
|                                         
|                                         
|                                         
|Americas-Other (Canada and Latin
America) |                            |                            | 170   |                    |      |                  | 263   |        |      |      | (35.4 | )%           |  |              | 298   |      |      |   | 455    |      |      |   | (34.5 | )%
|                                          |                            |                            |       |                    |      |                  |       |        |      |      |       |              |  |              |       |      |      |   |        |      |      |   |       |   
|Americas-Total                            |                            |                            | 1,575 |                    |      |                  | 2,701 |        |      |      | (41.7 | )%           |  |              | 3,024 |      |      |   | 5,592  |      |      |   | (45.9 | )%
|                                         
|                                         
|                                         
|                                         
|                                          | Percentage of net revenues |                            |       | 50.7               | %    |                  |       | 52.8   | %    |      |       |              |  |              |       | 50.7 | %    |   |        | 55.0 | %    |   |       |    | 
|                                         
|                                         
|                                         
|                                         
|EMEA (Europe, Middle East and
Africa)     |                            |                            | 963   |                    |      |                  | 1,571 |        |      |      | (38.7 | )%           |  |              | 1,825 |      |      |   | 2,941  |      |      |   | (37.9 | )%
|                                         
|                                         
|                                         
|                                         
|                                          |                            | Percentage of net revenues |       |                    | 31.0 | %                |       |        | 30.7 | %    |       |              |  |              |       |      | 30.6 | % |        |      | 29.0 | % |       |    |  | 
|                                         
|                                         
|                                         
|                                         
|APAC (Asia, Australia and New
Zealand)    |                            |                            | 570   |                    |      |                  | 843   |        |      |      | (32.4 | )%           |  |              | 1,120 |      |      |   | 1,627  |      |      |   | (31.2 | )%
|                                         
|                                         
|                                         
|                                         
|                                          |                            | Percentage of net revenues |       |                    | 18.3 | %                |       |        | 16.5 | %    |       |              |  |              |       |      | 18.7 | % |        |      | 16.0 | % |       |    |  | 
|                                         
|                                         
|                                         
|                                         
|Total net revenues                        |                            | $                          | 3,108 |                    |      | $                | 5,115 |        |      |      | (39.2 | )%           |  | $            | 5,969 |      |      | $ | 10,160 |      |      |   | (41.2 | )%

|                   |                            |   |                    |      |                  |   |        |      |      |  |              |    |              |   |       |      |   |   |        |      |   |  |       |    | 
|------------------ | -------------------------- | - | ------------------ | ---- | ---------------- | - | ------ | ---- | ---- |  | ------------ | -- | ------------ | - | ----- | ---- | - | - | ------ | ---- | - |  | ----- | -- | 
|                   |                            |   | Three Months Ended |      | Six Months Ended
|                   |                            |   |                    |      |                 
|                   |                            |   | December 30,       |      | December 31,     |   |        |      |      |  | December 30, |    | December 31, |   |       |      |  
|                   |                            |   | 2001               |      | 2000             |   | Change |      | 2001 |  | 2000         |    | Change      
|                   |                            |   |                    |      |                  |   |        |      |      |  |              |    |             
|U.S                |                            | $ | 1,405              |      |                  | $ | 2,438  |      |      |  | (42.4        | )% |              | $ | 2,726 |      |   | $ | 5,137  |      |   |  | (46.9 | )%
|                  
|                  
|                  
|                  
|                   | Percentage of net revenues |   |                    | 45.2 | %                |   |        | 47.7 | %    |  |              |    |              |   |       | 45.7 | % |   |        | 50.6 | % |  |       |    | 
|                  
|                  
|                  
|                  
|International      |                            | $ | 1,703              |      |                  | $ | 2,677  |      |      |  | (36.4        | )% |              | $ | 3,243 |      |   | $ | 5,023  |      |   |  | (35.4 | )%
|                  
|                  
|                  
|                  
|                   | Percentage of net revenues |   |                    | 54.8 | %                |   |        | 52.3 | %    |  |              |    |              |   |       | 54.3 | % |   |        | 49.4 | % |  |       |    | 
|                  
|                  
|                  
|                  
|Total net revenues |                            | $ | 3,108              |      |                  | $ | 5,115  |      |      |  | (39.2        | )% |              | $ | 5,969 |      |   | $ | 10,160 |      |   |  | (41.2 | )%

Late in the second quarter of fiscal 2001, there was an unexpected and
significant reduction in capital spending in many industries, which negatively
impacted demand in the U.S. for our products and resulted in a decline in our
products net revenue. The year-over-year decline in revenue continued in the
second quarter of fiscal 2002, resulting in a 42.4% decrease in U.S. net
revenues as compared with the corresponding period of fiscal 2001. It also
contributed to a 46.9% decrease in our U.S. net revenues for the first half of
fiscal 2002 as compared with the corresponding period of fiscal 2001. The weak
U.S. economic situation evolved into adverse macroeconomic conditions
worldwide, resulting in reductions in capital spending in many countries within
the international regions in which we do significant business. This negatively
impacted our non-U.S. revenues beginning in the fourth quarter of fiscal 2001
and continued through the second quarter of fiscal 2002. As a result, our
second quarter and our first half of fiscal 2002 revenues were lower in the
majority of the countries within these international regions as compared with
the corresponding periods of fiscal 2001.

Within the EMEA region, net revenues decreased by 38.7% and 37.9% (primarily
contributed by the United Kingdom, Northern Europe and Germany) during the
second quarter and the first half of fiscal 2002, respectively, as compared
with the corresponding periods of fiscal 2001. Northern Europe is comprised
primarily of the Scandinavian countries, the Netherlands, Belgium/Luxembourg,
Eastern European countries and Russia. Within the APAC region, net revenues
decreased by 32.4% and 31.2% (primarily contributed by Japan, Korea and Greater
China) during the second quarter and the first half of fiscal 2002,
respectively, as compared with the corresponding periods of fiscal 2001. Net
revenues in the United Kingdom, Northern Europe, Germany, Japan,
Korea and Greater China collectively accounted for approximately 65% and 75% of
the total decrease in international net revenues for

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the second quarter and the first half of fiscal 2002, respectively, as compared
with the corresponding periods of fiscal 2001.

If the worldwide adverse macroeconomic conditions persist, our revenues, and
potentially our results of operations and cash flows, will continue to be
adversely affected.

Gross margin
(dollars in millions)

|                      |                                    |   |                    |      |                  |   |        |      |      |  |              |    |              |   |       |      |   |   |       |      |   |  |       |    | 
|--------------------- | ---------------------------------- | - | ------------------ | ---- | ---------------- | - | ------ | ---- | ---- |  | ------------ | -- | ------------ | - | ----- | ---- | - | - | ----- | ---- | - |  | ----- | -- | 
|                      |                                    |   | Three Months Ended |      | Six Months Ended
|                      |                                    |   |                    |      |                 
|                      |                                    |   | December 30,       |      | December 31,     |   |        |      |      |  | December 30, |    | December 31, |   |       |      |  
|                      |                                    |   | 2001               |      | 2000             |   | Change |      | 2001 |  | 2000         |    | Change      
|                      |                                    |   |                    |      |                  |   |        |      |      |  |              |    |             
|Products gross margin |                                    | $ | 823                |      |                  | $ | 2,164  |      |      |  | (62.0        | )% |              | $ | 1,593 |      |   | $ | 4,354 |      |   |  | (63.4 | )%
|                     
|                     
|                     
|                     
|                      | Percentage of products net revenue |   |                    | 36.4 | %                |   |        | 50.1 | %    |  |              |    |              |   |       | 36.9 | % |   |       | 50.3 | % |  |       |    | 
|                     
|                     
|                     
|                     
|Services gross margin |                                    | $ | 316                |      |                  | $ | 280    |      |      |  | 12.9         | %  |              | $ | 602   |      |   | $ | 520   |      |   |  | 15.8  | % 
|                     
|                     
|                     
|                     
|                      | Percentage of services net revenue |   |                    | 37.3 | %                |   |        | 35.1 | %    |  |              |    |              |   |       | 36.4 | % |   |       | 34.7 | % |  |       |    | 
|                     
|                     
|                     
|                     
|Total gross margin    |                                    | $ | 1,139              |      |                  | $ | 2,444  |      |      |  | (53.4        | )% |              | $ | 2,195 |      |   | $ | 4,874 |      |   |  | (55.0 | )%
|                     
|                     
|                     
|                     
|                      | Percentage of net revenues         |   |                    | 36.6 | %                |   |        | 47.8 | %    |  |              |    |              |   |       | 36.8 | % |   |       | 48.0 | % |  |       |    | 

Products gross margin

In the second quarter and first half of fiscal 2002, products gross margin
decreased by 13.7 and 13.4 percentage points, respectively, as compared with
the corresponding periods of fiscal 2001. The vast majority of the gross margin
percentage decline in the second quarter and first half of fiscal 2002 was due
to price reductions in products sold and higher product costs due to lower
volumes of products manufactured. In response to the decline in demand for our
products since the second half of fiscal 2001, we reduced the volume of
products manufactured. This reduction in volume adversely impacts our gross
margin because certain of our manufacturing costs are fixed and have been set
for higher capacities. Certain vendor component cost improvements did, however,
partially offset the impact of the pricing actions and reduced product volumes
in the second quarter and first half of fiscal 2002 as compared with the
comparable periods in fiscal 2001.

Should the global macroeconomic conditions continue to deteriorate further,
products gross margin could continue to be adversely impacted.

Services gross margin

The 2.2 and 1.7 percentage point increases in services gross margin in the
second quarter and the first half of fiscal 2002, respectively, as compared
with the corresponding periods of fiscal 2001, reflect the impact of: (1)
variable costs decreasing as a result of discretionary spending controls; (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); and (3) headcount-related costs
decreasing due to the restructuring in the second quarter of fiscal 2002. The
impact of these favorable items on services gross margin in the second quarter
and the first half of fiscal 2002 as compared with the corresponding periods of
fiscal 2001 was partially offset by: (1) increased fixed infrastructure costs;
and (2) increased third party costs necessary to support global customer
service expectations, new product introductions and expected future growth in
the service business.

While our services gross margins have increased during the second quarter and
first half of fiscal 2002 as compared with the corresponding periods in fiscal
2001, we will continue to make the necessary long-term
technology investments to provide our customers with an integrated portfolio of
proactive mission-critical services.

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Operating expenses
(dollars in millions)

|                                              |                            |   |                    |      |                  |   |        |      |      |  |              |    |              |   |       |      |   |   |       |      |   |  |       |    | 
|--------------------------------------------- | -------------------------- | - | ------------------ | ---- | ---------------- | - | ------ | ---- | ---- |  | ------------ | -- | ------------ | - | ----- | ---- | - | - | ----- | ---- | - |  | ----- | -- | 
|                                              |                            |   | Three Months Ended |      | Six Months Ended
|                                              |                            |   |                    |      |                 
|                                              |                            |   | December 30,       |      | December 31,     |   |        |      |      |  | December 30, |    | December 31, |   |       |      |  
|                                              |                            |   | 2001               |      | 2000             |   | Change |      | 2001 |  | 2000         |    | Change      
|                                              |                            |   |                    |      |                  |   |        |      |      |  |              |    |             
|Research and development                      |                            | $ | 428                |      |                  | $ | 497    |      |      |  | (13.9        | )% |              | $ | 901   |      |   | $ | 987   |      |   |  | (8.7  | )%
|                                             
|                                             
|                                             
|                                             
|                                              | Percentage of net revenues |   |                    | 13.8 | %                |   |        | 9.7  | %    |  |              |    |              |   |       | 15.1 | % |   |       | 9.7  | % |  |       |    | 
|                                             
|                                             
|                                             
|                                             
|Selling, general and administrative           |                            | $ | 966                |      |                  | $ | 1,194  |      |      |  | (19.1        | )% |              | $ | 1,927 |      |   | $ | 2,423 |      |   |  | (20.5 | )%
|                                             
|                                             
|                                             
|                                             
|                                              | Percentage of net revenues |   |                    | 31.1 | %                |   |        | 23.3 | %    |  |              |    |              |   |       | 32.3 | % |   |       | 23.9 | % |  |       |    | 
|                                             
|                                             
|                                             
|                                             
|Restructuring charges                         |                            | $ | 511                |      |                  | $ |       |      |      |  | N/M          |    |              | $ | 525   |      |   | $ |      |      |   |  | N/M   |   
|                                             
|                                             
|                                             
|                                             
|                                              | Percentage of net revenues |   |                    | 16.4 | %                |   |        |     | %    |  |              |    |              |   |       | 8.8  | % |   |       |     | % |  |       |    | 
|                                             
|                                             
|                                             
|                                             
|Goodwill amortization                         |                            | $ |                   |      |                  | $ | 42     |      |      |  | (100         | )% |              | $ |      |      |   | $ | 55    |      |   |  | (100  | )%
|                                             
|                                             
|                                             
|                                             
|                                              | Percentage of net revenues |   |                    |     | %                |   |        | 0.8  | %    |  |              |    |              |   |       |     | % |   |       | 0.5  | % |  |       |    | 
|                                             
|                                             
|                                             
|                                             
|Purchased in-process research and
development |                            | $ |                   |      |                  | $ | 71     |      |      |  | (100         | )% |              | $ | 3     |      |   | $ | 71    |      |   |  | (95.8 | )%
|                                             
|                                             
|                                             
|                                             
|                                              | Percentage of net revenues |   |                    |     | %                |   |        | 1.4  | %    |  |              |    |              |   |       | 0.1  | % |   |       | 0.7  | % |  |       |    | 

Research and development expenses

R&D expenses, as a percentage of total net revenues, increased to 13.8% in the
second quarter and 15.1% in the first half of fiscal 2002 from 9.7% in each of
the corresponding periods of fiscal 2001. The increases in the percentage of
R&D expenses to total net revenues are the result of a decrease in revenues in
the second quarter and first half of fiscal 2002 as compared with the
corresponding periods of fiscal 2001. In dollars, R&D expenses decreased by
13.9% to $428 million in the second quarter of fiscal 2002, as compared with
$497 million for the corresponding period of fiscal 2001, and by 8.7% to $901
million in the first half of fiscal 2002, as compared with $987 million for the
corresponding period of fiscal 2001. The decrease in R&D expenses for the
second quarter and first half of fiscal 2002 as compared with the corresponding
periods in fiscal 2001, was due to: (1) a reduction in incentive
compensation costs; (2) a reduction of R&D headcount-related costs
due to the restructuring in the second quarter of fiscal 2002; and
(3) significant cost cutting measures in discretionary spending. Fluctuations in
R&D expenses will occur depending on the timing of product introductions, among
other factors. Our R&D spending reflects our continued development of a broad
line of scalable and reliable systems, including servers, desktop systems,
storage technologies and SPARC microprocessors, as well as software products
that utilize the Java platform, Solaris Operating Environment software and
Jini network technology. We believe that to maintain our competitive position
in a market characterized by rapid rates of technological advancement, we must
continue to invest significant resources in new systems, software, and
microprocessor development, as well as continue to enhance existing products.
We anticipate the dollar amount of R&D expenses for the third quarter of fiscal
2002 will be higher than the amount of R&D expenses incurred during the second
quarter of fiscal 2002. It is managements long-term objective to invest 10 -
11% of its net revenues in R&D.

Selling, general and administrative expenses

SG&A expenses, as a percentage of total net revenues, increased by 7.8 and 8.4
percentage points in the second quarter and first half of fiscal 2002,
respectively, as compared with the corresponding periods of fiscal 2001. This
increase is a result of the decline in revenue in the second quarter and first
half of fiscal 2002 as compared with the corresponding periods of fiscal 2001.
In dollars, SG&A expenses decreased $228 million to $966 million in the second
quarter of fiscal 2002 as compared with $1,194 million in the second quarter of
fiscal 2001. Also, for the first half of fiscal 2002, SG&A expenses decreased
by $496 million to $1,927 million as compared with $2,423 million in the
corresponding period of fiscal 2001. As previously stated, late in the second
quarter of fiscal 2001
we experienced a sharp decline in product demand, and we responded by reducing
discretionary SG&A costs. During

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the second quarter and first half of fiscal 2002, our SG&A expenses were lower
than the corresponding periods of fiscal 2001, which was primarily the result
of: (1) significant cost cutting measures in the areas of travel, advertising,
marketing, facilities and other types of discretionary spending; (2) lower
variable compensation such as commissions and bonuses; and (3) lower
headcount-related costs as a result of our restructuring in the second quarter
of fiscal 2002.

We are continuing to focus our efforts on achieving additional future operating
efficiencies by reviewing and improving upon existing business processes and
evaluating our cost structure. However, because we are planning an increase in
certain variable costs and company performance-based incentives in the second
half of fiscal 2002, we anticipate the dollar amount of SG&A expenses for the
remainder of fiscal 2002 will increase as compared with the amount incurred
during the second quarter of fiscal 2002.

Restructuring charges

In response to the continuing global economic slowdown, the Company began
implementing a workforce reduction and facility exit plan in the second quarter
of fiscal 2002. This restructuring resulted in a charge of $511 million. The
goal of the restructuring is to reduce costs and improve operating efficiencies
in order to adjust to the current business environment. Specifically, it is the
Companys intent to reduce headcount by approximately 9% (or 3,900 employees
and contractors) and to eliminate excess facility capacity in light of revised
facility requirements.

See Note 7, Restructuring Charges in the Notes to Condensed Consolidated
Financial Statements (Unaudited) for further discussion. Also, for the impact
of the restructuring on our future cash flows, see discussion under Liquidity
and Capital Resources.

Worldwide workforce reduction

The Company recorded a workforce reduction charge of $146 million relating to
severance and related fringe benefits for employees. The restructuring will
result in the termination of approximately 3,400 employees across all employee
levels, business functions, operating units, and geographic regions.As of
December 30, 2001, approximately 3,000 employees had been terminated as a
result of the restructuring. The remaining identified employees are anticipated
to be terminated during the third and fourth quarters of fiscal 2002, depending
on the local employment laws that govern such employees.

Consolidation of excess facilities

The Company recorded a charge of $365 million relating to the consolidation of
excess facilities. The facility exit charges include:



| |  |  | $282 million of estimated future obligations for non-cancelable lease
payments (net of estimated sublease income) or termination fees generated
by exiting excess rental facilities. The Company estimated the cost of
exiting and terminating the facility leases based on the contractual
terms of the agreements and then current real estate market conditions.
In addition, the Company intends to sublease certain leased facilities
and estimated the sublease income based on then current real estate
market conditions or, where applicable, amounts being negotiated;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | $66 million for the impairment of in-process construction costs related
to the termination of certain building construction projects;                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  |  | $17 million for the impairment of property and equipment (primarily
leasehold improvements) for which there are insufficient cash flows to
support the carrying cost. The property and                                                                                                                                                                                                                                                                                                                                                                                          

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| |                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------
| | equipment impairment was determined based on the difference between the
assets' estimated fair value and its carrrying value as of December 30,
2001.

The Company expects to exit the facilities relating to the amounts accrued
under the restructuring by no later than December 31, 2002.

Goodwill amortization

On July 1, 2001, we early adopted SFAS 142. In accordance with SFAS 142,
goodwill is no longer amortized. There was no impairment of goodwill upon
adoption of SFAS 142. We are required to perform goodwill impairment tests on
an annual basis, and on an interim basis in certain circumstances. There can be
no assurance that future goodwill impairments tests will not result in a charge
to earnings. See Note 2, Summary of Significant Accounting Policies in the
Notes to Condensed Consolidated Financial Statements (Unaudited) for further
discussion. The $42 million and $55 million goodwill amortization for the
second quarter and first six months of fiscal 2001, respectively, was primarily
attributable to the acquisitions of Cobalt Networks, Inc. (acquired in December
2000), Star Division Corporation and certain assets of Star Division Software
Entwicklung und Vertriebs GmbH, and MAXSTRAT Corporation.

Purchased in-process research and development expenses

Overview

In the first half of fiscal 2002, we acquired Isopia, Inc. (Isopia). Purchased
in-process research and development expenses (IPRD) of $3.2 million in the
first quarter of fiscal 2002 represented the write-off of in-process
technologies associated with Isopia. There was no purchased IPRD in the second
quarter of fiscal 2002. During fiscal 2001, there was no purchased IPRD in the
first quarter and $71 million in the second quarter. At the date of the Isopia
acquisition, the projects associated with the IPRD efforts had not yet reached
technological feasibility and the IPRD had no alternative future uses.
Accordingly, the amount was expensed on the acquisition date.

Valuation of IPRD

We used independent third-party sources to calculate the amounts allocated to
IPRD. In calculating IPRD, the independent third party used established
valuation techniques accepted in the high-technology industry. These
calculations gave consideration to relevant market sizes and growth factors,
expected industry trends, the anticipated nature and timing of new product
introductions by us and our competitors, individual product sales cycles, and
the estimated lives of each of the products underlying technology. The value
of the IPRD reflects the relative value and contribution of the acquired
research and development. In determining the value assigned to IPRD, we
considered the R&Ds stage of completion, the complexity of the work completed
to date, the difficulty of completing the remaining development, costs already
incurred, and the projected cost to complete the project.

The values assigned to developed technologies related to each acquisition were
based upon discounted cash flows related to the existing products projected
income stream. Elements of the projected income stream included revenues, cost
of sales (COS), SG&A expenses, and R&D expenses. The discount rates used in the
present value calculations were generally derived from a weighted average cost
of capital, adjusted upward to reflect the additional risks inherent in the
development life cycle, including the useful life of the technology,
profitability levels of the technology, and the uncertainty of technology
advances that are known at the date of each acquisition. Because each acquired
entitys IPRD is unique, the discount rate, revenue, COS, R&D and
SG&A assumptions used varied on a case-by-case basis. We did not expect to
achieve a material amount of

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expense reductions or synergies, therefore the valuation assumptions did not
include significant anticipated cost savings.

Valuation assumptions

The following table summarizes the significant assumptions underlying the
valuation related to the IPRD for the six months ended December 30, 2001
(dollars in millions):

|                 |  |      |     |             |  |             |     |             |  |             |    |      |  |             |    |         |  |                       |    |   |  |               |    |   |  |  |   |   |  |  |    |  
|---------------- |  | ---- | --- | ----------- |  | ----------- | --- | ----------- |  | ----------- | -- | ---- |  | ----------- | -- | ------- |  | --------------------- | -- | - |  | ------------- | -- | - |  |  | - | - |  |  | -- | -
|                 |  |      |     |             |  |             |     |             |  |             |    |      |  |             |    |         |  | Percentage of Revenue
|                 |  |      |     |             |  |             |     |             |  |             |    |      |  |             |    |         |  |                      
|                 |  |      |     |             |  | Estimated   |     |             |  |             |    |      |  |             |    |         |  |                       |    |   |  |               |    |   |  |  |   |   |  | 
|                 |  |      |     |             |  | Cost to     |     | Percentage  |  |             |    |      |  |             |    |         |  |                       |    |   |  |               |    |   |  |  |   |  
|                 |  |      |     |             |  | Complete    |     | Complete    |  |             |    |      |  |             |    |         |  |                       |    |   |  |               |    |   |  |  |   |  
|                 |  |      |     |             |  | Technology  |     | at Time     |  | Average     |    |      |  |             |    |         |  |                       |    |   |  |               |    |   |  | 
|                 |  |      |     |             |  | at Time of  |     | of          |  | Revenue     |    |      |  |             |    | Average |  |                       |    |   |  | Discount Rate
|Acquired Company |  | IPRD |     | Acquisition |  | Acquisition |     | Growth Rate |  | Average COS |    | SG&A |  | Average R&D |    | Used   
|                 |  |      |     |             |  |             |     |             |  |             |    |      |  |             |    |        
|Isopia, Inc.     |  | $    | 3.2 |             |  | $           | 0.6 |             |  |             | 45 | %    |  |             | 58 | %       |  |                       | 13 | % |  |               | 35 | % |  |  | 2 | % |  |  | 26 | %

Overview of significant purchased IPRD in the six months ended December 30, 2001

Included below are further details regarding the nature of the purchased
technology acquired during the six months ended December 30, 2001.

Given the uncertainties of the commercialization process, we cannot assure you
that deviations from our estimates will not occur. We believe there is a
reasonable chance of realizing the economic return expected from the acquired
in-process technology. However, there is risk associated with the realization
of benefits related to commercialization of an in-process project due to
rapidly changing customer needs, complexity of technology and growing
competitive pressures. Therefore, we cannot assure you that any project will
meet with commercial success. Failure to successfully commercialize an
in-process project would result in the loss of the expected economic return
inherent in the fair value allocation. Additionally, the value of our
intangible assets acquired may become impaired.

At the acquisition date, Isopia was engaged in development activity associated
with LearnTone, a web-based training content delivery technology. As of the
acquisition date, this technology was still under development and substantial
efforts needed to be completed prior to the release of a commercially viable
product.

Overall status of business combinations prior to fiscal 2002

With respect to acquisitions completed prior to fiscal 2002, 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
December 30, 2001.

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Gain (loss) on equity investments
(dollars in millions)

|                                       |                            |   |                    |      |                  |   |        |   |      |  |              |  |              |   |     |      |    |   |   |   |   |  |     |  | 
|-------------------------------------- | -------------------------- | - | ------------------ | ---- | ---------------- | - | ------ | - | ---- |  | ------------ |  | ------------ | - | --- | ---- | -- | - | - | - | - |  | --- |  | 
|                                       |                            |   | Three Months Ended |      | Six Months Ended
|                                       |                            |   |                    |      |                 
|                                       |                            |   | December 30,       |      | December 31,     |   |        |   |      |  | December 30, |  | December 31, |   |     |      |   
|                                       |                            |   | 2001               |      | 2000             |   | Change |   | 2001 |  | 2000         |  | Change      
|                                       |                            |   |                    |      |                  |   |        |   |      |  |              |  |             
|Gain (loss) on equity investments,
net |                            | $ | (39                | )    |                  | $ | 1      |   |      |  | N/M          |  |              | $ | (58 | )    |    | $ | 1 |   |   |  | N/M | 
|                                      
|                                      
|                                      
|                                      
|                                       | Percentage of net revenues |   |                    | (1.3 | )%               |   |        |  | %    |  |              |  |              |   |     | (1.0 | )% |   |   |  | % |  |     |  | 

Our equity investmentsportfolio, which is primarily comprised of publicly
traded and non-publicly traded technology companies contained within our
internally-managed venture capital fund, was negatively impacted by the decline
in The Nasdaq National Market and the adverse macroeconomic conditions of the
technology sector during the second quarter and first half of fiscal 2002, as
compared with the corresponding periods of fiscal 2001. The loss on equity
investments in the second quarter and first half of fiscal 2002 included
impairment losses on minority equity investments in publicly and privately
traded companies of $31 million and $52 million, respectively.

Our decision to sell equity investments 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 the control of Sun.

Interest income, net
(dollars in millions)

|                     |                            |   |                    |     |                  |   |        |     |      |  |              |    |              |   |     |     |   |   |     |     |   |  |     |   | 
|-------------------- | -------------------------- | - | ------------------ | --- | ---------------- | - | ------ | --- | ---- |  | ------------ | -- | ------------ | - | --- | --- | - | - | --- | --- | - |  | --- | - | 
|                     |                            |   | Three Months Ended |     | Six Months Ended
|                     |                            |   |                    |     |                 
|                     |                            |   | December 30,       |     | December 31,     |   |        |     |      |  | December 30, |    | December 31, |   |     |     |  
|                     |                            |   | 2001               |     | 2000             |   | Change |     | 2001 |  | 2000         |    | Change      
|                     |                            |   |                    |     |                  |   |        |     |      |  |              |    |             
|Interest income, net |                            | $ | 68                 |     |                  | $ | 91     |     |      |  | (25.3        | )% |              | $ | 175 |     |   | $ | 166 |     |   |  | 5.4 | %
|                    
|                    
|                    
|                    
|                     | Percentage of net revenues |   |                    | 2.2 | %                |   |        | 1.8 | %    |  |              |    |              |   |     | 2.9 | % |   |     | 1.6 | % |  |     |   | 

The decline in interest income (net of interest expense) in the second quarter
of fiscal 2002, as compared with the corresponding period of fiscal 2001, is
primarily due to a combination of lower interest rates and lower cash and
marketable debt securities balances. The growth of interest income (net of
interest expense) during the first half of fiscal 2002 as compared with the
corresponding period of fiscal 2001 is primarily the result of a $48 million
gain realized on the sale of certain fixed income marketable debt securities
during the first quarter of fiscal 2002. The gain was substantially offset by a
combination of lower interest rates and lower cash and marketable debt
securities balances.

The average duration of our portfolio of marketable debt securities increased
to 1.36 years as of December 30, 2001 from 1.28 years as of December 31, 2000.
In general, we would expect that the volatility of this portfolio would
increase as its duration increases. Our interest income and expenses are
sensitive primarily to changes in the general level of U.S. interest rates. In
this regard, changes in U.S. interest rates affect the interest earned on our
cash equivalents and marketable debt securities. To mitigate the impact of
fluctuations in U.S. interest rates on 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.

We expect our interest income, net in the third quarter of fiscal 2002 will
approximate our interest income, net earned in the second quarter of fiscal
2002.

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Income taxes
(dollars in millions)

|                                     |                                                                                                  |   |                    |      |                  |   |        |      |      |  |              |    |              |   |      |      |   |   |     |      |   |  |        |    | 
|------------------------------------ | ------------------------------------------------------------------------------------------------ | - | ------------------ | ---- | ---------------- | - | ------ | ---- | ---- |  | ------------ | -- | ------------ | - | ---- | ---- | - | - | --- | ---- | - |  | ------ | -- | 
|                                     |                                                                                                  |   | Three Months Ended |      | Six Months Ended
|                                     |                                                                                                  |   |                    |      |                 
|                                     |                                                                                                  |   | December 30,       |      | December 31,     |   |        |      |      |  | December 30, |    | December 31, |   |      |      |  
|                                     |                                                                                                  |   | 2001               |      | 2000             |   | Change |      | 2001 |  | 2000         |    | Change      
|                                     |                                                                                                  |   |                    |      |                  |   |        |      |      |  |              |    |             
|Provision (benefit) for income taxes |                                                                                                  | $ | (306               | )    |                  | $ | 309    |      |      |  | (199.0       | )% |              | $ | (433 | )    |   | $ | 572 |      |   |  | (175.7 | )%
|                                    
|                                    
|                                    
|                                    
|                                     | Percentage of income (loss) before taxes
and cumulative effect of change
in accounting principle |   |                    | 41.5 | %                |   |        | 42.2 | %    |  |              |    |              |   |      | 41.5 | % |   |     | 38.0 | % |  |        |    | 

Our effective income tax benefit rate was 41.5% for the second quarter and
first half of fiscal 2002, as compared with effective income tax provision
rates of 42.2% and 38.0%, respectively, for the corresponding periods of fiscal
2001. The change in our effective income tax benefit rate is due to a change in
our profitability and is partially offset by the absence in fiscal 2002 of
certain nondeductible accounting charges associated with our mergers and
acquisitions activities (i.e., IPRD and goodwill amortization). In addition,
the tax impact of our restructuring charge reduced our tax benefit rate by 2
percentage points in the first half of fiscal 2002.

We currently expect the effective income tax benefit rate to be at 43.5% for
the second half of fiscal 2002. Our expected effective income tax benefit rate
is based on current tax law and current estimates of taxable income, and is
subject to change.

LIQUIDITY AND CAPITAL RESOURCES
(dollars in millions)

|                                                       |                            |   |                   |      |               |   |        |      |   |   |      |     |  
|------------------------------------------------------ | -------------------------- | - | ----------------- | ---- | ------------- | - | ------ | ---- | - | - | ---- | --- | -
|                                                       |                            |   | December 30, 2001 |      | June 30, 2001 |   | Change
|                                                       |                            |   |                   |      |               |   |       
|Cash, cash equivalents, and marketable debt securities |                            | $ | 5,969             |      |               | $ | 6,171  |      |   | $ | (202 | )  
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Percentage of total assets |   |                   | 34.8 | %             |   |        | 33.9 | % |   |      | 2.6 | %
|                                                      
|                                                      
|                                                      
|                                                      
|Days sales outstanding (DSO)                           |                            |   | 66                |      |               |   | 67     |      |   |   | 1.5  | %  
|                                                      
|                                                      
|                                                      
|                                                      
|Inventory turns                                        |                            |   | 11.7              |      |               |   | 12.5   |      |   |   | (6.4 | )% 

|                                          |  |                   |      |                   |  |        |        |   |  |   |       |  
|----------------------------------------- |  | ----------------- | ---- | ----------------- |  | ------ | ------ | - |  | - | ----- | -
|                                          |  | Six Months Ended 
|                                          |  |                  
|                                          |  | December 30, 2001 |      | December 31, 2000 |  | Change
|                                          |  |                   |      |                   |  |       
|Cash provided by operating activities     |  | $                 | 415  |                   |  | $      | 1,256  |   |  | $ | (841  | )
|                                         
|                                         
|                                         
|                                         
|Cash used in investing activities         |  | $                 | (517 | )                 |  | $      | (1,620 | ) |  | $ | 1,103 |  
|                                         
|                                         
|                                         
|                                         
|Cash used in financing activities         |  | $                 | (165 | )                 |  | $      | (82    | ) |  | $ | (83   | )
|                                         
|                                         
|                                         
|                                         
|Net decrease in cash and cash equivalents |  | $                 | (267 | )                 |  | $      | (446   | ) |  | $ | 179   |  

During the first six months of fiscal 2002, cash, cash equivalents and
marketable debt securities decreased by $202 million from June 30, 2001. The
decrease in cash and cash equivalents (excluding investments) of $267 million
during the first six months of fiscal 2002 is primarily the result of the
following investing and financing uses: (1) capital spending of $335 million
for real estate development and equipment additions to support product
development and infrastructure initiatives; (2) net purchases of investments
for $83 million; and (3) acquisition of treasury stock for $266 million. The
use of cash and cash equivalents (excluding investments) for investing and
financing purposes was partially offset by cash provided by operating
activities of $415 million.

Cash flows provided by operating activities were generated primarily from net
income (as adjusted by noncash items) and decreases in accounts receivable
(net) and inventory; these cash influxes were partially offset by decreases in
accounts payable and other liabilities. Accounts receivable (net) decreased to
$2,274 million at December 30, 2001 from $2,955 million at June 30, 2001. The
decrease in accounts receivable (net) was primarily due to the lower volume of
sales and a decrease in days of sales outstanding (DSO). The decrease in DSO
was attributable to better linearity of sales. Inventory decreased to $624
million at December 30, 2001 from
$1,049 million at June 30, 2001. While we were successful in decreasing
inventory during the first six months of fiscal 2002, inventory turns slightly
declined. The decrease in inventory turns was a reflection of increased

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inventory for new product releases and lower
shipment volumes, and was impacted
further by the decrease in demand for our products due to adverse macroeconomic
conditions. 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. The accounts payable and
other liabilities decrease of $888 million in the first half of fiscal 2002 as
compared with June 30, 2001 is primarily due to the reduction in inventory
levels and operating expenses. In addition, we reduced our other liabilities by
$72 million in severance and benefits payments and $9 million in
facilities-related payments in connection with our restructuring.

Decisions related to how much cash is used for investing and financing purposes
are influenced by the expected amount of cash to be provided by operations. In
addition, Sun continually evaluates whether we will acquire our outstanding
common stock under our various stock repurchase programs by considering various
factors such as our projected cash flow requirements and Suns stock price on
the open market. The $266 million acquisition of treasury stock occurred during
the first quarter of fiscal 2002.

We have a $500 million revolving credit facility (Facility) with a syndicate
of commercial banks. The Facility is available subject to compliance with
certain covenants and expires August 2002. Sun was in compliance with the
financial covenants as of December 30, 2001. No amounts were outstanding under
the Facility at December 30, 2001.

As of December 30, 2001, our international subsidiaries had uncommitted lines
of credit aggregating approximately $560 million. The amounts drawn from these
lines of credit as of December 30, 2001 aggregate less than $1 million and are
reflected under short-term borrowings. 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.

In August 1999, we issued $1.5 billion in unsecured debt securities in four
tranches (the Senior Notes). The Senior Notes are due at various times
between August 2002 and August 2009 ($200 million due on August 15, 2002 and
bearing interest at 7%). In addition, we currently have an effective shelf
registration statement on file with the Securities and Exchange Commission that
permit us to offer an additional $2.5 billion of debt securities and common and
preferred stock in one or more separate series, in amounts, at prices, and on
terms to be set forth in the prospectus contained in these registration
statements and in one or more supplements to the prospectus.

We believe that the liquidity provided by existing cash, cash equivalents,
marketable debt securities, our borrowing arrangements described above and cash
generated from operations, will provide sufficient capital to meet our
requirements for at least the next 12 months. We expect to substantially pay
the remaining cash expenditures relating to workforce reductions of
approximately $74 million by the fourth quarter of fiscal 2002. In addition,
approximately $233 million of the $407 million restructuring accrual is
expected to be paid within the next twelve months. The remaining restructuring
accrual of $174 million is expected to be paid over the respective facility
lease terms through fiscal 2018. The facility accrual includes estimates such
as expected sublease income or termination fees; actual results may materially
differ from our current estimates, resulting in a change in our expected cash
flow requirements. See Note 7, Restructuring Charges in the Notes to the Condensed
Consolidated Financial Statements (Unaudited) for further discussion. 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 through
debt or equity financing 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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RISK FACTORS

If we are unable to compete effectively with existing or new competitors, our
resulting loss of 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 (HP), Compaq Computer Corporation (Compaq), and EMC
Corporation (EMC). Our future competitive performance depends on a number of
factors, including our ability to: continually develop and introduce new
products and services with better prices and performance than those offered by
our competitors; offer a wide range of products and solutions from small single
processor systems to large complex enterprise level systems; offer solutions to
customers that operate effectively within a computing environment that includes
hardware and software from multiple vendors; offer products that are reliable
and that ensure the security of data and information; create products for which
third party software vendors will develop a wide range of applications; and
offer high quality products and services. Two of our competitors, HP
and Compaq, have announced plans to merge, which would create a
combined entity that is significantly larger than Sun. To the extent
that they complete the merger and can successfully integrate their
businesses, the combined company could have greater access to
resources, and our business and operating results could be adversely
affected by the increased competitive pressures.

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), HP, and Compaq, in
addition to Intel and Microsoft. This competition creates increased pressure,
including pricing pressure, on our workstation and lower-end server product
lines. We expect this competitive pressure to continue during fiscal year 2002,
with the anticipated releases of new software products from Microsoft and new
microprocessors from Intel.

The computer systems that we sell are made up of many products and components,
including workstations, servers, storage products, microprocessors, the Solaris
Operating Environment and other software products. In addition, we sell some of
these components separately and as add-ons to installed systems. If we are
unable to offer products and services that compete successfully with the
products and services offered by our competitors or that meet the complex needs
of our customers, our business and operating results could be adversely
affected. In addition, if in responding to competitive pressures, we are forced
to lower the prices of our products or services and we are unable to reduce our
component costs or improve operating efficiencies, our business and operating
results would be adversely affected.

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 standalone 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. To the
extent we are unable to penetrate this market and compete effectively, our
business and operating results could be adversely affected.

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

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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 which we will continue to deploy during
fiscal 2002, and other products. 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.

Software and hardware products such as ours may contain known as well as
undetected errors, and 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.

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 during fiscal 2002, 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, 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
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 and
on Sony for various monitors. If we were unable to purchase the necessary parts
and components 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.

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

We depend heavily on our suppliers to 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 and custom memory integrated circuits such as static random access
memories (SRAMS) and video random access memories (VRAMS), 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, dynamic random access memories (DRAMS) and
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.

Since we order our components (and in some cases commit to purchase) from
suppliers in advance of receipt of customer orders for our products which
include these components, we face a substantial inventory risk.

As part of our component inventory planning, we frequently pay certain
suppliers well in advance of receipt of customer orders. For example, we often
enter into noncancelable purchase commitments 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 the orders are based on
the forecasts of customer orders rather than actual orders. If we cannot change
or be released from the noncancelable purchase commitments, we could incur
significant costs from the purchase of unusable components, due to a delay in
the production of the components or as a result of inaccurately predicting
component orders in advance of customer orders. 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 Solaris
Operating Environment and Sun StorEdge storage 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. For example, delays in software
development could delay shipments of related new hardware products.

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.

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If we are unable to continue generating substantial revenues from international
sales our business could be adversely affected.

Currently, more than half of our revenues come from international sales. Our
ability to sell our products internationally is subject to a number of risks.
General economic and political conditions in each country could adversely
affect demand for our products and services in these markets. Currency exchange
rate fluctuations could result in lower demand for our products, as well as
currency translation losses. 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.

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.

Significant Customers and Industries.Sales to a single customer (General
Electric Company (GE)) accounted for approximately 13%, 19% and 15% of our
fiscal 2001, 2000 and 1999 net revenues, respectively. The major customer
revenues in fiscal 2001, 2000 and 1999 were primarily generated by two GE
subsidiaries: (1) MRA Systems, Inc., a reseller (10%, 16% and 14% of net
revenues in 2001, 2000 and 1999, respectively), acquired by GE in fiscal 1999;
and (2) GE Capital, a finance/leasing company (2%, 3% and 1% of net revenues in
fiscal 2001, 2000 and 1999, respectively). Revenue is generated with the
finance/leasing company whenever our customer elects to lease equipment; in
such cases, we sell the equipment to the leasing company. Our business could be
adversely affected if GE or any other significant customer terminated its
business relationship with us or significantly reduced the amount of business
it did with us.

Acquisitions/Alliances.If, in the future, we acquire technologies, products,
or businesses, or we form alliances with companies requiring technology
investments or revenue commitments we will face a number of risks to our
business. The risks we may encounter include those associated with integrating
or co-managing operations, personnel, and technologies acquired or licensed,
and the potential for unknown liabilities of the acquired or combined business.
Also, we early adopted the new Statement of Financial Accounting Standards No.
142 (SFAS 142) Goodwill and Other Intangible Assets, as of July 1, 2001.
Accordingly, our goodwill and other intangible assets that have an indefinite
useful life are no longer amortized but instead reviewed at least annually for
impairment. If general macroeconomic conditions continue to deteriorate,
affecting our business and operating results over the long-term, we could be
required to record impairment charges related to goodwill and other intangible
assets, which could adversely affect our financial results. In addition, our
business and operating results could be adversely affected if our acquisition
or alliance activities are not successful.

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 caused by worsening economic
conditions, such as we experienced over the last two quarters of fiscal 2001
and the first two quarters of fiscal 2002, may continue to result in decreased
revenues and earnings. Our revenues are dependent on the level of technology
capital spending in the United States and international economies. A number of
companies recently filed for bankruptcy protection, and others announced
significant reductions and deferrals in capital spending. If capital spending
continues to decline in these industries over an extended period of time, our
business will continue to be adversely affected.

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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 recently announced alliance with Hitachi for the collaboration on,
and delivery of, a broad range of storage products and services. Acquisitions
and alliance activities often involve risks, including: difficulty in
assimilating the acquired operations and employees; difficulty in managing
product codevelopment activities with our alliance partners; retaining the key
employees of the acquired operation; disruption of our ongoing business;
inability to successfully integrate the acquired technology and operations into
our business and maintain uniform standards, controls, policies, and
procedures; and lacking the experience to enter into new product or technology
markets.

Failure to manage these alliance activities effectively and to integrate
entities or assets that we acquire could adversely 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. The expansion of high technology
companies in Silicon Valley and Colorado, as well as in other regions, has
increased demand and competition for highly qualified technical personnel. We
may not be able to attract, assimilate, or retain highly qualified technical
employees in the future. These factors could adversely affect our business.

Business interruptions could adversely affect our business.

Our operations are vulnerable to interruption by fire, earthquake, power loss,
telecommunications failure and other events beyond our control. A substantial
portion of our facilities, including our corporate headquarters and other
critical business operations, is located near major earthquake faults. In
addition, many 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 or carry financial
reserves against business interruptions arising from earthquakes and certain
electrical blackouts. If a business interruption occurs, our business could be
adversely affected.

Our marketable 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 non-publicly traded 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. 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. In addition, general adverse macroeconomic and market conditions
unrelated to our performance may also adversely affect our stock price.

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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 December 30, 2001. Actual
results may differ materially.

Interest Rate Sensitivity

Our investment portfolio of marketable debt securities consists primarily of
fixed income instruments with an average duration of 1.36 years as of December
30, 2001. The primary objective of our investments in marketable 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, a hypothetical 150 BPS increase in interest rates would
result in an approximate $60 million decrease in the fair value of our
investments in marketable debt securities as of December 30, 2001.

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

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. We enter into foreign exchange forward and option contracts to
hedge certain balance sheet exposures and intercompany balances against future
movements in foreign exchange rates. Based on our foreign currency exchange
instruments outstanding at December 30, 2001, we estimate a maximum potential
one-day loss in fair value of approximately $11 million, 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 first three months and
the first half of fiscal 2002.

Euro Conversion

On January 1, 1999, certain member countries of the European Union established
fixed conversion rates between their existing currencies and the Euro. The
transition period for the introduction of the Euro ends June 30, 2002.

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Issues facing us as a result of the introduction of the Euro include converting
information technology systems, reassessing currency risk, negotiating and
amending licensing agreements and contracts, and processing tax and accounting
records. We continue to address these issues and do not currently expect the
Euro to have a material effect on our financial conditions or results of
operations.

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 $6 million decrease in the fair
value of our available-for-sale equity investments as of December 30, 2001. At
December 30, 2001, three equity securities represented approximately $16
million of the total fair value of the marketable equity securities of $30
million.




PART II  OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS

From time to time, Sun becomes involved in claims and legal proceedings that
arise in the ordinary course of its business. We are currently subject to
several such claims and legal proceedings. We do not believe that the
resolution of these legal proceedings will have a material adverse effect on
us.




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

On November 7, 2001, the Annual Meeting of Stockholders of the Company was held
in Santa Clara, California. The results of voting of the 2,713,080,462 shares
of common stock represented at the meeting or by proxy are described below.

An election of directors was held with the following individuals being elected
to the Board of Directors of the Company:

|                   |  |                  |               |                |  |  |             | 
|------------------ |  | ---------------- | ------------- | -------------- |  |  | ----------- | 
|Name               |  | Shares
Voted For |               | Votes
Withheld
|Scott G. McNealy   |  |                  | 2,397,675,481 |                |  |  | 315,404,981 | 
|                  
|                  
|                  
|                  
|James L. Barksdale |  |                  | 2,683,891,232 |                |  |  | 29,189,230  | 
|                  
|                  
|                  
|                  
|L. John Doerr      |  |                  | 2,631,423,885 |                |  |  | 81,656,577  | 
|                  
|                  
|                  
|                  
|Judith L. Estrin   |  |                  | 2,685,170,550 |                |  |  | 27,909,912  | 
|                  
|                  
|                  
|                  
|Robert J. Fisher   |  |                  | 2,685,197,902 |                |  |  | 27,882,560  | 
|                  
|                  
|                  
|                  
|Robert L. Long     |  |                  | 2,684,685,413 |                |  |  | 28,395,049  | 
|                  
|                  
|                  
|                  
|M. Kenneth Oshman  |  |                  | 2,685,086,620 |                |  |  | 27,993,842  | 
|                  
|                  
|                  
|                  
|Naomi O. Seligman  |  |                  | 2,683,957,117 |                |  |  | 29,123,345  | 

The eight nominees who received the highest number of votes (all of the above
individuals) were elected to the Board of Directors.

The stockholders approved an amendment to the Companys 1990 Long-Term Equity
Incentive Plan in order to increase the number of shares of common stock
authorized for issuance thereunder by 50,275,000 shares of
common stock to an aggregate of 1,167,475,000 shares. There were 1,651,563,964
votes cast for the amendment, 1,044,365,947 votes cast against the amendment,
17,150,551 abstentions and no broker non-votes.

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The stockholders approved the Companys Section 162(m) Executive Officer
Performance-Based Bonus Plan. There were 2,504,348,168 votes cast for approval
of the bonus plan, 190,520,479 votes cast against approval of the bonus plan,
18,211,815 abstentions and no broker non-votes.

The stockholders did not approve a shareholder proposal entitled US Business
Principles For Human Rights Workers in China. There were 214,033,489 votes
cast for the proposal, 1,275,327,017 votes cast against the proposal,
159,727,352 abstentions and 1,063,992,604 broker non-votes.




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits

No exhibits were filed during the second quarter of fiscal 2002.

(b)  Reports on Form 8-K

No reports on Form 8-K were filed during the second quarter of fiscal
2002.

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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/   Michael E. Lehman
Michael E. LehmanExecutive Vice President, Corporate Resources
and Chief Financial Officer
(Principal Financial Officer)
|                                                                                                                                                
|/s/    Michael L. Popov
Michael L. PopovVice President and Corporate Controller
(Chief Accounting Officer)                                      

Dated: February 12, 2002

34