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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 29, 2002or



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

For the transition period from _______ to _______

Commission file number: 0-15086



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SUN MICROSYSTEMS, INC.

(Exact name of registrant as specified in its charter)


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

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

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

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



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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
Common Stock  $0.00067 par value |  | Outstanding at February 6, 2003
3,194,908,497

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934).

YES (X)        NO (   )





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TABLE OF CONTENTS



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



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INDEX

|                                                                             |         |                                                      |                                                                                       |  |    |    |  |  | 
|---------------------------------------------------------------------------- | ------- | ---------------------------------------------------- | ------------------------------------------------------------------------------------- |  | -- | -- |  |  | 
|PART I  FINANCIAL INFORMATION                                               |         |                                                      |                                                                                       | 
|                                                                             | Item 1. |                                                      | Financial Statements:                                                                 |  |    |    | 
|                                                                             |         | Condensed Consolidated Statements of Operations      |                                                                                       |  | 3  |   
|                                                                             |         | Condensed Consolidated Balance Sheets                |                                                                                       |  | 4  |   
|                                                                             |         | Condensed Consolidated Statements of Cash Flows      |                                                                                       |  | 5  |   
|                                                                             |         | Notes to Condensed Consolidated Financial Statements |                                                                                       |  | 6  |   
|                                                                             |         | Independent Accountants' Review Report               |                                                                                       |  | 19 |   
|                                                                             | Item 2. |                                                      | Management's Discussion and Analysis of Financial Condition and Results of Operations |  |    | 20 | 
|                                                                             | Item 3. |                                                      | Quantitative and Qualitative Disclosures About Market Risk                            |  |    | 44 | 
|                                                                             | Item 4. |                                                      | Controls and Procedures                                                               |  |    | 45 | 
|                                                                            
|PART II  OTHER INFORMATION                                                  |         |                                                      |                                                                                       | 
|                                                                             | Item 1. |                                                      | Legal Proceedings                                                                     |  |    | 46 | 
|                                                                             | Item 2. |                                                      | Changes in Securities and Use of Proceeds                                             |  |    | 47 | 
|                                                                             | Item 4. |                                                      | Submission of Matters to a Vote of Security Holders                                   |  |    | 48 | 
|                                                                             | Item 6. |                                                      | Exhibits and Reports on Form 8-K                                                      |  |    | 49 | 
|                                                                            
|SIGNATURES                                                                   |         |                                                      | 50                                                                                    | 
|SECURITIES EXCHANGE ACT RULE 13a-14 AND 15d-14 CERTIFICATIONS OF CEO AND
CFO |         |                                                      | 51                                                                                    | 

2



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##### Table of Contents






PART I  FINANCIAL INFORMATION




ITEM 1. FINANCIAL STATEMENTS




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

|                                                                              |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                   |        |       |        |      |        |       |        |  
|----------------------------------------------------------------------------- | -------- | -------------------------------------------------- | ------------------------ | -------------- | ------ | ------------------ | ------ | ----------------- | ----- | ----------------- | ----- | ----------------- | ------ | ----- | ------ | ---- | ------ | ----- | ------ | -
|                                                                              |          |                                                    |                          |                |        | Three Months Ended |        | Six Months Ended 
|                                                                              |          |                                                    |                          |                |        |                    |        |                  
|                                                                              |          |                                                    |                          |                |        | December 29, 2002  |        | December 30, 2001 |       | December 29, 2002 |       | December 30, 2001
|                                                                              |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                  
|Net revenues:                                                                 |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                   |        |       |        |     
|                                                                              |          | Products                                           |                          | $              | 2,013  |                    |        | $                 | 2,260 |                   |       | $                 | 3,893  |       |        | $    | 4,317  |      
|                                                                              |          | Services                                           |                          |                | 902    |                    |        |                   | 848   |                   |       |                   | 1,769  |       |        |      | 1,652  |      
|                                                                              |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                   |        |       |        |      |        |      
|                                                                              |          |                                                    | Total net revenues       |                |        | 2,915              |        |                   |       | 3,108             |       |                   |        | 5,662 |        |      |        | 5,969 |       
|Cost of sales:                                                                |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                   |        |       |        |     
|                                                                              |          | Cost of sales-products                             |                          |                | 1,118  |                    |        |                   | 1,437 |                   |       |                   | 2,211  |       |        |      | 2,724  |      
|                                                                              |          | Cost of sales-services                             |                          |                | 534    |                    |        |                   | 532   |                   |       |                   | 1,056  |       |        |      | 1,050  |      
|                                                                              |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                   |        |       |        |      |        |      
|                                                                              |          |                                                    | Total cost of sales      |                |        | 1,652              |        |                   |       | 1,969             |       |                   |        | 3,267 |        |      |        | 3,774 |       
|                                                                              |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                   |        |       |        |      |        |      
|                                                                              |          |                                                    |                          | Gross margin   |        |                    | 1,263  |                   |       |                   | 1,139 |                   |        |       | 2,395  |      |        |       | 2,195  |  
|Operating expenses:                                                           |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                   |        |       |        |     
|                                                                              |          | Research and development                           |                          |                | 451    |                    |        |                   | 428   |                   |       |                   | 888    |       |        |      | 901    |      
|                                                                              |          | Selling, general and administrative                |                          |                | 830    |                    |        |                   | 966   |                   |       |                   | 1,712  |       |        |      | 1,927  |      
|                                                                              |          | Restructuring charges                              |                          |                | 357    |                    |        |                   | 511   |                   |       |                   | 381    |       |        |      | 525    |      
|                                                                              |          | Purchased in-process research and development      |                          |                | 4      |                    |        |                   |      |                   |       |                   | 4      |       |        |      | 3      |      
|                                                                              |          | Impairment of goodwill and other intangible assets |                          |                | 2,125  |                    |        |                   |      |                   |       |                   | 2,125  |       |        |      |       |      
|                                                                              |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                   |        |       |        |      |        |      
|                                                                              |          |                                                    | Total operating expenses |                |        | 3,767              |        |                   |       | 1,905             |       |                   |        | 5,110 |        |      |        | 3,356 |       
|                                                                              |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                   |        |       |        |      |        |      
|                                                                              |          |                                                    |                          | Operating loss |        |                    | (2,504 | )                 |       |                   | (766  | )                 |        |       | (2,715 | )    |        |       | (1,161 | )
|Loss on equity investments, net                                               |          |                                                    | (11                      | )              |        |                    | (39    | )                 |       |                   | (42   | )                 |        |       | (58    | )   
|Interest income, net                                                          |          |                                                    | 38                       |                |        |                    | 68     |                   |       |                   | 77    |                   |        |       | 175    |     
|                                                                              |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                   |        |       |        |      |        |      
|                                                                              |          | Loss before income taxes                           |                          |                | (2,477 | )                  |        |                   | (737  | )                 |       |                   | (2,680 | )     |        |      | (1,044 | )    
|Benefit for income taxes                                                      |          |                                                    | (194                     | )              |        |                    | (306   | )                 |       |                   | (286  | )                 |        |       | (433   | )   
|                                                                              |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                   |        |       |        |      |        |      
|                                                                              | Net loss |                                                    | $                        | (2,283         | )      |                    | $      | (431              | )     |                   | $     | (2,394            | )      |       | $      | (611 | )     
|                                                                              |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                   |        |       |        |      |        |      
|Net loss per common share-basic and diluted                                   |          | $                                                  | (0.72                    | )              |        | $                  | (0.13  | )                 |       | $                 | (0.75 | )                 |        | $     | (0.19  | )   
|                                                                              |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                   |        |       |        |      |        |      
|Shares used in the calculation of net loss per
common sharebasic and diluted |          |                                                    | 3,181                    |                |        |                    | 3,239  |                   |       |                   | 3,175 |                   |        |       | 3,240  |     
|                                                                              |          |                                                    |                          |                |        |                    |        |                   |       |                   |       |                   |        |       |        |      |        |      

See accompanying notes.

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

|                                                 |  |                                                             |                           |   |                   |       |               |   |       |       | 
|------------------------------------------------ |  | ----------------------------------------------------------- | ------------------------- | - | ----------------- | ----- | ------------- | - | ----- | ----- | 
|                                                 |  |                                                             |                           |   | December 29, 2002 |       | June 30, 2002
|                                                 |  |                                                             |                           |   |                   |       |              
|                                                 |  |                                                             |                           |   | (unaudited)       |       |               |   |      
|ASSETS                                           |  |                                                             |                           |   |                   |       |               |  
|Current assets:                                  |  |                                                             |                           |   |                   |       |               |  
|                                                 |  | Cash and cash equivalents                                   |                           | $ | 1,557             |       |               | $ | 2,024 |      
|                                                 |  | Short-term marketable debt securities                       |                           |   | 1,049             |       |               |   | 861   |      
|                                                 |  | Accounts receivable, net                                    |                           |   | 2,291             |       |               |   | 2,745 |      
|                                                 |  | Inventories                                                 |                           |   | 484               |       |               |   | 591   |      
|                                                 |  | Deferred and prepaid tax assets                             |                           |   | 718               |       |               |   | 709   |      
|                                                 |  | Prepaid expenses and other current assets                   |                           |   | 729               |       |               |   | 847   |      
|                                                 |  |                                                             |                           |   |                   |       |               |   |       |      
|                                                 |  |                                                             | Total current assets      |   |                   | 6,828 |               |   |       | 7,777 | 
|Property, plant and equipment, net               |  |                                                             | 2,321                     |   |                   |       | 2,453         |  
|Long-term marketable debt securities             |  |                                                             | 2,671                     |   |                   |       | 2,979         |  
|Goodwill                                         |  |                                                             | 326                       |   |                   |       | 2,182         |  
|Other acquisition-related intangible assets, net |  |                                                             | 121                       |   |                   |       | 104           |  
|Other non-current assets, net                    |  |                                                             | 1,202                     |   |                   |       | 1,027         |  
|                                                 |  |                                                             |                           |   |                   |       |               |   |       |      
|                                                 |  | $                                                           | 13,469                    |   |                   | $     | 16,522        |  
|                                                 |  |                                                             |                           |   |                   |       |               |   |       |      
|LIABILITIES AND STOCKHOLDERS EQUITY             |  |                                                             |                           |   |                   |       |               |  
|Current liabilities:                             |  |                                                             |                           |   |                   |       |               |  
|                                                 |  | Current portion of long-term debt and
short-term borrowings |                           | $ |                  |       |               | $ | 205   |      
|                                                 |  | Accounts payable                                            |                           |   | 809               |       |               |   | 1,044 |      
|                                                 |  | Accrued payroll-related liabilities                         |                           |   | 447               |       |               |   | 538   |      
|                                                 |  | Accrued liabilities                                         |                           |   | 1,180             |       |               |   | 1,201 |      
|                                                 |  | Deferred revenues and other                                 |                           |   | 1,589             |       |               |   | 1,785 |      
|                                                 |  | Warranty reserve                                            |                           |   | 273               |       |               |   | 284   |      
|                                                 |  |                                                             |                           |   |                   |       |               |   |       |      
|                                                 |  |                                                             | Total current liabilities |   |                   | 4,298 |               |   |       | 5,057 | 
|Long-term debt                                   |  |                                                             | 1,519                     |   |                   |       | 1,449         |  
|Other non-current obligations                    |  |                                                             | 379                       |   |                   |       | 215           |  
|Total stockholders equity                       |  |                                                             | 7,273                     |   |                   |       | 9,801         |  
|                                                 |  |                                                             |                           |   |                   |       |               |   |       |      
|                                                 |  | $                                                           | 13,469                    |   |                   | $     | 16,522        |  
|                                                 |  |                                                             |                           |   |                   |       |               |   |       |      

See accompanying notes.

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

|                                                       |                                                                                                            |                                                                                              |                          |        |                   |      |                   |      |        |      |  
|------------------------------------------------------ | ---------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------- | ------------------------ | ------ | ----------------- | ---- | ----------------- | ---- | ------ | ---- | -
|                                                       |                                                                                                            |                                                                                              |                          |        | Six Months Ended 
|                                                       |                                                                                                            |                                                                                              |                          |        |                  
|                                                       |                                                                                                            |                                                                                              |                          |        | December 29, 2002 |      | December 30, 2001
|                                                       |                                                                                                            |                                                                                              |                          |        |                   |      |                  
|Cash flows from operating activities:                  |                                                                                                            |                                                                                              |                          |        |                   |      |                   |     
|                                                       | Net loss                                                                                                   |                                                                                              | $                        | (2,394 | )                 |      | $                 | (611 | )     
|                                                       |                                                                                                            | Adjustments to reconcile net loss to net cash
provided by operating activities:              |                          |        |                   |      |                   |      |        |     
|                                                       |                                                                                                            | Depreciation and amortization                                                                |                          |        | 483               |      |                   |      | 478    |     
|                                                       |                                                                                                            | Amortization of other acquisition-related intangible
assets and unearned equity compensation |                          |        | 64                |      |                   |      | 55     |     
|                                                       |                                                                                                            | Impairment of goodwill and other intangible assets                                           |                          |        | 2,125             |      |                   |      |       |     
|                                                       |                                                                                                            | Tax benefits from employee stock plans                                                       |                          |        | 4                 |      |                   |      | 41     |     
|                                                       |                                                                                                            | Deferred taxes                                                                               |                          |        | (286              | )    |                   |      | (90    | )   
|                                                       |                                                                                                            | Loss on equity investments, net                                                              |                          |        | 42                |      |                   |      | 58     |     
|                                                       |                                                                                                            | Purchased in-process research and development                                                |                          |        | 4                 |      |                   |      | 3      |     
|                                                       |                                                                                                            | Changes in operating assets and liabilities:                                                 |                          |        |                   |      |                   |      |        |     
|                                                       |                                                                                                            |                                                                                              | Accounts receivable, net |        |                   | 454  |                   |      |        | 681  |  
|                                                       |                                                                                                            |                                                                                              | Inventories              |        |                   | 109  |                   |      |        | 425  |  
|                                                       |                                                                                                            |                                                                                              | Prepaid and other assets |        |                   | 140  |                   |      |        | 173  |  
|                                                       |                                                                                                            |                                                                                              | Accounts payable         |        |                   | (236 | )                 |      |        | (179 | )
|                                                       |                                                                                                            |                                                                                              | Other liabilities        |        |                   | (186 | )                 |      |        | (619 | )
|                                                       |                                                                                                            |                                                                                              |                          |        |                   |      |                   |      |       
|Net cash provided by operating activities              |                                                                                                            |                                                                                              | 323                      |        |                   |      | 415               |     
|                                                       |                                                                                                            |                                                                                              |                          |        |                   |      |                   |      |       
|Cash flows from investing activities:                  |                                                                                                            |                                                                                              |                          |        |                   |      |                   |     
|                                                       |                                                                                                            | Purchases of marketable debt securities                                                      |                          |        | (2,851            | )    |                   |      | (7,797 | )   
|                                                       |                                                                                                            | Proceeds from sales of marketable debt securities                                            |                          |        | 2,675             |      |                   |      | 7,556  |     
|                                                       |                                                                                                            | Proceeds from maturities of marketable debt securities                                       |                          |        | 311               |      |                   |      | 178    |     
|                                                       |                                                                                                            | Purchases of equity investments                                                              |                          |        | (4                | )    |                   |      | (25    | )   
|                                                       |                                                                                                            | Proceeds from sales of equity investments                                                    |                          |        | 2                 |      |                   |      | 5      |     
|                                                       |                                                                                                            | Acquisition of property, plant and equipment, net                                            |                          |        | (181              | )    |                   |      | (335   | )   
|                                                       |                                                                                                            | Acquisition of spare parts and other assets                                                  |                          |        | (89               | )    |                   |      | (59    | )   
|                                                       |                                                                                                            | Payments for acquisitions, net of cash acquired                                              |                          |        | (30               | )    |                   |      | (40    | )   
|                                                       |                                                                                                            |                                                                                              |                          |        |                   |      |                   |      |       
|Net cash used in investing activities                  |                                                                                                            |                                                                                              | (167                     | )      |                   |      | (517              | )   
|                                                       |                                                                                                            |                                                                                              |                          |        |                   |      |                   |      |       
|Cash flows from financing activities:                  |                                                                                                            |                                                                                              |                          |        |                   |      |                   |     
|                                                       |                                                                                                            | Acquisition of treasury stock                                                                |                          |        | (499              | )    |                   |      | (266   | )   
|                                                       |                                                                                                            | Proceeds from issuance of common stock, net                                                  |                          |        | 77                |      |                   |      | 104    |     
|                                                       |                                                                                                            | Principal payments on borrowings and other obligations                                       |                          |        | (201              | )    |                   |      | (3     | )   
|                                                       |                                                                                                            |                                                                                              |                          |        |                   |      |                   |      |       
|Net cash used in financing activities                  |                                                                                                            |                                                                                              | (623                     | )      |                   |      | (165              | )   
|                                                       |                                                                                                            |                                                                                              |                          |        |                   |      |                   |      |       
|Net decrease in cash and cash equivalents              |                                                                                                            |                                                                                              | (467                     | )      |                   |      | (267              | )   
|Cash and cash equivalents, beginning of period         |                                                                                                            |                                                                                              | 2,024                    |        |                   |      | 1,472             |     
|                                                       |                                                                                                            |                                                                                              |                          |        |                   |      |                   |      |       
|Cash and cash equivalents, end of period               |                                                                                                            | $                                                                                            | 1,557                    |        |                   | $    | 1,205             |     
|                                                       |                                                                                                            |                                                                                              |                          |        |                   |      |                   |      |       
|Supplemental disclosures of cash flow information:     |                                                                                                            |                                                                                              |                          |        |                   |      |                   |     
|                                                       | Interest paid (net of interest received from swap
agreements of $36 million and $15 million, respectively) |                                                                                              | $                        | 20     |                   |      | $                 | 57   |       
|                                                       |                                                                                                            |                                                                                              |                          |        |                   |      |                   |      |       
|                                                       | Income taxes paid (refunded) (net of refunds of $279
million and $6 million, respectively)                 |                                                                                              | $                        | (201   | )                 |      | $                 | 118  |       
|                                                       |                                                                                                            |                                                                                              |                          |        |                   |      |                   |      |       
|Supplemental schedule of noncash investing activities: |                                                                                                            |                                                                                              |                          |        |                   |      |                   |     
|                                                       | Stock and options issued in connection with acquisitions                                                   |                                                                                              | $                        | 193    |                   |      | $                 | 29   |       
|                                                       |                                                                                                            |                                                                                              |                          |        |                   |      |                   |      |       

See accompanying notes.

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

1. DESCRIPTION OF BUSINESS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Fiscal year

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

Basis of Presentation

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

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

Computation of net loss per common share

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

US GAAP requires all anti-dilutive securities, including stock options, to be
excluded from the diluted earnings
per share computation. At December 29, 2002 and December 30, 2001, due to our
net loss, all of our outstanding 602 million options and 535 million options,
respectively, were excluded from the diluted loss per share calculation because
their inclusion would have been anti-dilutive. If we had earned a profit during
the three and six months ended December 29, 2002, we would have added 24
million and 29 million common equivalent shares, respectively, to our basic
weighted-average shares outstanding to compute the diluted weighted average
shares outstanding. If we had earned a profit during the three and six months
ended December 30, 2001, we would have added 112 million and 113 million common
equivalent shares, respectively, to our basic weighted-average shares
outstanding to compute the diluted weighted average shares outstanding.

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Recent pronouncements

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

In June 2002, the FASB issued SFAS 146, Accounting for Costs Associated with
Exit or Disposal Activities, which addresses accounting for restructuring and
similar costs. SFAS 146 supersedes previous accounting guidance, principally
Emerging Issues Task Force (EITF) Issue No. 94-3 Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring). SFAS 146 requires
recognition of the liability for costs associated with an exit or disposal
activity when we exit the facility, whereas under EITF Issue No. 94-3, a
liability for an exit cost is recognized at the date a company commits to an
exit plan. In addition, SFAS 146 establishes that the liability should
initially be measured and recorded at fair value. Accordingly, SFAS 146 may
affect the timing of recognizing future restructuring costs, as well as the
amounts recognized. Application of SFAS 146 is required for restructuring
activities initiated after December 31, 2002. Because we did not early adopt
SFAS 146, our Fiscal 2003 Restructuring Plan (Note 6) announced in October 2002
is accounted for similarly to our Fiscal 2001 and 2002 Restructuring Plans
(Note 6). The most significant difference between applying EITF Issue No. 94-3
and SFAS 146 to our Fiscal 2003 Restructuring Plan relates to the timing of
recognizing losses on leases to be exited. If we had early-adopted SFAS 146, we
estimate that between $100 million and $125 million of the Fiscal 2003
Restructuring Plan would not have been recognized as a restructuring expense in
the second quarter of fiscal 2003, but instead, would have been recognized as
we exit facilities later in fiscal 2003 and fiscal 2004.

In November 2002, the FASB issued FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others  an Interpretation of FASB Statements
No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34. The
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also requires a guarantor to recognize, at
the inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The initial recognition and measurement
provisions of the Interpretation apply to guarantees issued or modified after
December 31, 2002. Accordingly, we are currently determining what impact these
provisions will have on our financial statements. However, we have adopted the
disclosure requirements in this quarter.

In December 2002, the FASB issued SFAS 148, Accounting for Stock-Based
Compensation  Transition and Disclosure. SFAS 148 amends SFAS 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition to the SFAS 123 fair value method of accounting for stock-based
employee compensation.
In addition, SFAS 148 requires disclosure of the effects of an entitys
accounting policy with respect to stock-based employee compensation on reported
net income and earnings per share in annual and interim financial statements.
As permitted under SFAS 148, we are adopting only the disclosure provisions of
that accounting standard beginning with our third quarter of fiscal 2003.

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3. ACQUISITION OF A DEVELOPMENT STAGE ENTERPRISE AND BUSINESS COMBINATIONS

We completed three acquisitions during the first half of fiscal 2003. The
acquisitions of Afara Websystems, Inc. (Afara), Pirus Networks, Inc. (Pirus)
and Terraspring, Inc. (Terraspring) are described below. Our 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 aggregate basis.

Afara

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

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

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

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

Pirus

In November 2002, we acquired Pirus, a corporation based in Acton,
Massachusetts. Pirus developed intelligent storage networking systems that
enable the delivery of advanced storage services within multi-protocol
environments from a single, centrally-managed platform. We acquired Pirus to
enhance our intellectual property and storage product offerings. Pirus was
acquired by means of a merger pursuant to which all of the outstanding shares
of capital stock of Pirus were exchanged for shares of Suns common stock. In
addition, all outstanding options to purchase Pirus common stock were converted
into options to purchase shares of our stock. In accordance with SFAS 141,
Business Combinations, this transaction was accounted for as a purchase
business combination.

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The total purchase price was approximately $167 million and consisted of
approximately 50 million shares of Suns common stock (issued in the merger or
issuable upon exercise of options) valued in the aggregate at approximately
$166 million together, with transaction costs of approximately $1 million. The
total purchase price was allocated as follows (in millions):

|                                                     |  |   |     |  
|---------------------------------------------------- |  | - | --- | -
|Goodwill                                             |  | $ | 143 |  
|Developed technology                                 |  |   | 36  |  
|Unearned stock-based compensation                    |  |   | 7   |  
|Purchased in-process research and development        |  |   | 3   |  
|Tangible assets acquired and net liabilities assumed |  |   | (7  | )
|Deferred tax liabilities                             |  |   | (15 | )
|                                                     |  |   |     |  
|Total                                                |  | $ | 167 |  
|                                                     |  |   |     |  

The developed technology will be amortized on a straight-line basis over a
three-year period and will be charged to costs of sales.

Terraspring

In November 2002, we acquired Terraspring, a corporation based in San Jose,
California. Terraspring developed automated networking solutions in
heterogeneous networks. We acquired Terraspring to enhance our N1 product line
offering.

We purchased Terrapring for approximately $30 million in cash, including
approximately $1 million in transaction costs. In accordance with SFAS 141,
Business Combinations, this transaction was accounted for as a purchase
business combination. The total purchase price was allocated as follows (in
millions):

|                                                     |  |   |    |  
|---------------------------------------------------- |  | - | -- | -
|Goodwill                                             |  | $ | 27 |  
|Developed technology                                 |  |   | 3  |  
|Purchased in-process research and development        |  |   |   |  
|Tangible assets acquired and net liabilities assumed |  |   | 1  |  
|Deferred tax liabilities                             |  |   | (1 | )
|                                                     |  |   |    |  
|Total                                                |  | $ | 30 |  
|                                                     |  |   |    |  

The developed technology will be amortized on a straight-line basis over a
three-year period and will be charged to costs of sales.

4. BALANCE SHEET DETAILS

Inventory

Inventory consisted of the following (in millions):

|                |  |                   |     |               |  |   |     | 
|--------------- |  | ----------------- | --- | ------------- |  | - | --- | 
|                |  | December 29, 2002 |     | June 30, 2002
|                |  |                   |     |              
|Raw Materials   |  | $                 | 119 |               |  | $ | 168 | 
|Work in Process |  |                   | 130 |               |  |   | 125 | 
|Finished Goods  |  |                   | 235 |               |  |   | 298 | 
|                |  |                   |     |               |  |   |     | 
|                |  | $                 | 484 |               |  | $ | 591 | 
|                |  |                   |     |               |  |   |     | 

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Income taxes

Our effective income tax benefit rate was 7.8% for the second quarter of fiscal
2003 and 10.7% for the first half of fiscal 2003, as compared with an effective
income tax benefit rate of 41.5% for both corresponding periods of fiscal 2002.
The difference in our tax benefit rate for the second quarter and the first
half of fiscal 2003, as compared with the corresponding periods of fiscal 2002
is primarily due to non-deductibility of the goodwill impairment recognized in
the second quarter of fiscal 2003.

Warranty reserve

We accrue for our products warranty costs at the time of shipment. The
products warranty costs are estimated based upon our historical experience and
specific identification of the products requirements. At December 29, 2002,
the warranty reserve balance was $273 million.

The following table sets forth an analysis of the warranty reserve activity (in
millions):

|                              |  |                  |      |  
|----------------------------- |  | ---------------- | ---- | -
|                              |  | Warranty Reserve
|                              |  |                 
|Balance at June 30, 2002      |  | $                | 284  |  
|Charged to costs and expenses |  |                  | 183  |  
|Utilization                   |  |                  | (194 | )
|Balance at December 29, 2002  |  | $                | 273  |  
|                              |  |                  |      |  

5. IMPAIRMENT OF GOODWILL AND OTHER INTANGIBLE ASSETS

During the three months ended December 29, 2002, we recognized an impairment
expense of $2,125 million. As discussed further below, this impairment related
to three different types of intangible assets: (1) goodwill ($2,027 million),
(2) other acquisition-related intangible assets ($42 million), and (3) a
revenue generating technology license ($56 million).

Goodwill Impairment

SFAS 142, Goodwill and Other Intangible Assets, is the authoritative standard
on the accounting for the impairment of goodwill. SFAS 142 requires that we
evaluate on an annual basis (or whenever events occur which may indicate
possible impairment) whether any portion of our recorded goodwill is impaired.
We performed this analysis at one level below the operating segment level (Note
8) as defined in SFAS 142. As discussed in our Annual Report on Form 10-K for
the fiscal year ended June 30, 2002, this analysis requires management to make
a series of critical assumptions to: (1) evaluate whether any impairment
exists, and (2) measure the amount of impairment.

In October 2002, based on a combination of factors, particularly: (1) our
current and projected operating results; (2) our decision to reduce our
workforce and eliminate excess facility space; and (3) our then current market
capitalization, we concluded there were sufficient indicators to require us to
perform an analysis to assess whether any portion of our recorded goodwill
balance was impaired.

As part of this analysis, SFAS 142 requires that we estimate the fair value of
our reporting units as compared with their estimated book value. If the
estimated fair value of a reporting unit is less than the estimated book value,
then an impairment is deemed to have occurred. In estimating the fair value of
our reporting units, we primarily used the income approach (which utilizes
forecasted discounted cash flows to estimate the fair value of the reporting
unit) and the market approach (which estimates fair value based on market
prices for comparable companies). We also considered Suns total market
capitalization as of October 17, 2002 (the date we concluded an analysis was
required), and our average market capitalization for the 30 days prior to and
subsequent to October 17, 2002 in order to assess volatility of our market
capitalization on that day.

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Our last analysis was in the fourth quarter of fiscal 2002. We concluded at
that time that we did not have any impairment of goodwill based on our then
forecasted discounted cash flows as well as our market capitalization. However,
in October 2002, the estimated fair value of our reporting units
decreased because our current forecasted
discounted cash flows and market capitalization were lower than at the time of our previous
analysis. Based on this new analysis, we concluded that the goodwill in our
Network Storage and Volume Server reporting units was impaired. As required by
SFAS 142, in measuring the amount of goodwill impairment, we made a
hypothetical allocation of the estimated fair value of these reporting units to
the tangible and intangible assets (other than goodwill) within these reporting
units. Based on this allocation, we concluded that all of the recorded goodwill
in the Network Storage reporting unit ($461 million) and the Volume Server
reporting unit ($1,566 million) was impaired and needed to be expensed as a
noncash charge to continuing operations during the second quarter of fiscal
2003. Approximately $1,560 million and $360 million of the impairment related
to goodwill acquired in our acquisitions of Cobalt Networks, Inc. and
HighGround Systems, Inc., respectively.

Information regarding our goodwill intangible assets is as follows (in
millions):

|         |  |               |       |              |  |           |       |          |  |          |     |          |  |           |     |          |  |          |    |          |  |          |   |  |  |   |   |  |  |   |    |  |  |   |     | 
|-------- |  | ------------- | ----- | ------------ |  | --------- | ----- | -------- |  | -------- | --- | -------- |  | --------- | --- | -------- |  | -------- | -- | -------- |  | -------- | - |  |  | - | - |  |  | - | -- |  |  | - | --- | 
|         |  | Product Group |       | Sun Services |  | Total    
|         |  |               |       |              |  |          
|         |  | June 30,      |       | Impair-      |  |           |       |          |  | December |     | June 30, |  | Impair-   |     |          |  |          |    | December |  | December
|         |  | 2002          |       | ments        |  | Additions |       | 29, 2002 |  | 2002     |     | ments    |  | Additions |     | 29, 2002 |  | 29, 2002
|         |  |               |       |              |  |           |       |          |  |          |     |          |  |           |     |          |  |         
|Goodwill |  | $             | 2,116 |              |  | $         | 2,027 |          |  | $        | 171 |          |  | $         | 260 |          |  | $        | 66 |          |  | $        |  |  |  | $ |  |  |  | $ | 66 |  |  | $ | 326 | 
|         |  |               |       |              |  |           |       |          |  |          |     |          |  |           |     |          |  |          |    |          |  |          |   |  |  |   |   |  |  |   |    |  |  |   |     | 

Other Acquisition-Related Intangible Assets Impairment

Based on the considerations outlined in the previous discussion on goodwill, in
October 2002, we also concluded that sufficient indicators existed to require
us to perform an analysis to assess whether a portion of our other
acquisition-related intangible assets was impaired. SFAS 144, Accounting for
the Impairment or Disposal of Long-Lived Assets, is the authoritative standard
on the accounting for the impairment of other intangible assets. This analysis differs
from our goodwill analysis in that an impairment is only deemed to have
occurred if the sum of the forecasted undiscounted future cash flows related to
the asset are less than the carrying value of the intangible asset we
are testing for impairment. If the forecasted cash flows are less than
the carrying value, then we must write down the carrying value to its estimated
fair value. As a result of our analysis, we recognized an impairment charge of
$42 million in our Product Group reporting segment to reduce our other
acquisition-related intangible assets balance to its estimated fair value
during the second quarter of fiscal 2003. The estimated fair value of the other
acquisition-related intangibles was determined using the income approach
(discounted cash flows). Approximately
$31 million and $11 million of the impairment related to intangible assets
acquired in our acquisitions of Cobalt Networks, Inc. and HighGround Systems,
Inc., respectively.

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

|                              |  |                       |     |                          |  |       |     |          |  |          |     |           |  |       |     |          |  |          |      |          |  |          |     |   |  |   |    |  |  |   |      |   |  |   |     | 
|----------------------------- |  | --------------------- | --- | ------------------------ |  | ----- | --- | -------- |  | -------- | --- | --------- |  | ----- | --- | -------- |  | -------- | ---- | -------- |  | -------- | --- | - |  | - | -- |  |  | - | ---- | - |  | - | --- | 
|                              |  | Gross Carrying Amount |     | Accumulated Amortization |  | Net  
|                              |  |                       |     |                          |  |      
|                              |  | June 30,              |     |                          |  |       |     | Impair-  |  | December |     | June 30,  |  |       |     |          |  | Impair-  |      | December |  | December
|                              |  | 2002                  |     | Additions                |  | ments |     | 29, 2002 |  | 2002     |     | Additions |  | ments |     | 29, 2002 |  | 29, 2002
|                              |  |                       |     |                          |  |       |     |          |  |          |     |           |  |       |     |          |  |         
|Developed Technology          |  | $                     | 308 |                          |  | $     | 39  |          |  | $        | (47 | )         |  | $     | 300 |          |  | $        | (224 | )        |  | $        | (29 | ) |  | $ | 14 |  |  | $ | (239 | ) |  | $ | 61  | 
|Customer Base                 |  |                       | 51  |                          |  |       |    |          |  |          | (8  | )         |  |       | 43  |          |  |          | (34  | )        |  |          | (6  | ) |  |   |   |  |  |   | (40  | ) |  |   | 3   | 
|Assembled Workforce
and Other |  |                       | 7   |                          |  |       | 68  |          |  |          | (1  | )         |  |       | 74  |          |  |          | (4   | )        |  |          | (13 | ) |  |   |   |  |  |   | (17  | ) |  |   | 57  | 
|                              |  |                       |     |                          |  |       |     |          |  |          |     |           |  |       |     |          |  |          |      |          |  |          |     |   |  |   |    |  |  |   |      |   |  |   |     | 
|                              |  | $                     | 366 |                          |  | $     | 107 |          |  | $        | (56 | )         |  | $     | 417 |          |  | $        | (262 | )        |  | $        | (48 | ) |  | $ | 14 |  |  | $ | (296 | ) |  | $ | 121 | 
|                              |  |                       |     |                          |  |       |     |          |  |          |     |           |  |       |     |          |  |          |      |          |  |          |     |   |  |   |    |  |  |   |      |   |  |   |     | 

Amortization expense of other acquisition-related intangible assets was $24
million and $48 million for the three and six months ended December 29, 2002,
respectively, and $18 million and $36 million for the three and six months
ended December 30, 2001, respectively.

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

|                                                                                       |  |   |     | 
|-------------------------------------------------------------------------------------- |  | - | --- | 
|2003 (including $48 million of amortization expense for the first
half of fiscal 2003) |  | $ | 78  | 
|2004                                                                                   |  |   | 48  | 
|2005                                                                                   |  |   | 38  | 
|2006                                                                                   |  |   | 5   | 
|                                                                                       |  |   |     | 
|                                                                                       |  | $ | 169 | 
|                                                                                       |  |   |     | 

The above amounts reflect amortization of intangible assets on our December 29,
2002 balance sheet and exclude any intangible assets (and the related
amortization) that may have been acquired subsequent to that date.

Revenue Generating Technology License Impairment

Based on the considerations outlined in the previous discussion on goodwill, in
October 2002, we concluded that sufficient indicators existed to require us to
perform an analysis to assess whether a portion of the technology license we
acquired from America Online in fiscal 1999 was impaired. Please refer to our
Annual Report on Form 10-K for the year ended June 30, 2002 which describes
this arrangement in more detail. SFAS 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, is the authoritative standard on the accounting
for the impairment of other intangible assets. An impairment is deemed to have occurred if
the sum of the forecasted undiscounted future cash flows related to the asset
are less than the carrying value of the intangible asset we are testing
for impairment. If the forecasted cash flows are less than the carrying
value, then we must write down the carrying value to its estimated fair value.
The estimated fair value of the technology license was determined using the
income approach (discounted cash flows) to estimate the fair value of the
asset. Based on this impairment analysis, we concluded that the carrying value
of the asset was impaired. Accordingly, we recognized a noncash impairment
expense of $56 million related to this technology license during the second
quarter of fiscal 2003.

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6. RESTRUCTURING CHARGES

Fiscal 2003 Restructuring Plan

In October 2002, we committed to and began implementing a workforce reduction
and facility exit plan (Fiscal
2003 Restructuring Plan). The goal of this plan is to reduce costs and improve
operating efficiencies in order to adjust to the current business environment.
Specifically, it is our intent to reduce headcount to approximately 35,000
employees and to eliminate excess facility capacity in light of revised
facility requirements. In accordance with EITF Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an Activity (including Certain Costs Incurred in a Restructuring), during the
three and six months ended December 29, 2002, we recognized $308 million in
restructuring charges associated with the Fiscal 2003 Restructuring Plan
(consisting of a $176 million workforce reduction charge and a $132 million
excess facility charge as discussed below).

During the second quarter of fiscal 2003, we recognized a workforce reduction
charge of $176 million relating to severance and related fringe benefits for
approximately 3,200 employees. The workforce reduction will result in the
termination of employees across all employee levels, business functions,
operating units, and geographic regions. As of December 29, 2002, approximately
2,700 employees had been terminated as a result of the restructuring. We expect
the remaining employees to be terminated during the third and fourth quarters
of fiscal 2003, depending on the local employment laws that govern such
employees. We may incur additional workforce-related charges should
we identify additional individual employees to be terminated in
certain countries and, again, depending on the local employment laws that
govern such employees.

In addition, during the second quarter of fiscal 2003, we recorded a charge of
$132 million relating to the consolidation of excess facilities. The facility
exit charges include:



| |  |  | $114 million of estimated future obligations for
noncancelable lease payments (net of estimated sublease
income of $44 million) or termination fees generated by
exiting excess rental facilities. We estimated the cost of
exiting and terminating the facility leases by referring to
the contractual terms of the agreements and by evaluating
the current real estate market conditions. In addition, we
intend to sublease certain leased facilities and estimated
the sublease income by evaluating the current real estate
market conditions or, where applicable, by referring to
amounts being negotiated;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | $18 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 their carrying value as of December 29, 2002.                                                                                                                                                                                                                                                                      

We expect to exit the facilities relating to the amounts accrued under the
Fiscal 2003 Restructuring Plan by December 29, 2003. At December 29, 2002, we
had an aggregate accrued liability of $236 million with respect to the Fiscal
2003 Restructuring Plan.

Fiscal 2002 Restructuring Plan and Fiscal 2001 Facility Exit Plan

We committed to a restructuring plan in fiscal 2002 (Fiscal 2002 Restructuring
Plan) and a facility exit plan in fiscal 2001 (Fiscal 2001 Facility Exit Plan).
We recorded initial restructuring charges in fiscal years 2002 and 2001 based
on assumptions and related estimates that were deemed appropriate for the
economic environment that existed at the time these estimates were made.
However, due to the continued deterioration of the commercial real estate
market, primarily in the U.S., we revised certain estimates and made the
appropriate adjustments to the initial restructuring charges recorded during
fiscal years 2002 and 2001. Additionally, during the three and six months ended
December 29, 2002, we recognized net charges of $27 million and $41 million,
respectively, related to our Fiscal 2002 Restructuring Plan, and charges of $23
million and $34 million, respectively, for the Fiscal 2001 Facility Exit Plan,
primarily due to continued deterioration of the commercial
real estate market, which resulted in a reduction of our estimated sublease
income on exited facilities. At December 29, 2002, we had an aggregate accrued
liability of $272 million with respect to these two plans.

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Our accrued liability for all plans at December 29, 2002, was net of
approximately $163 million of estimated sublease income to be generated from
sublease contracts not yet negotiated. Our ability to generate this amount of
sublease income, as well as our ability to terminate lease obligations at the
amounts we have estimated, is highly dependent upon economic conditions,
particularly local real estate market conditions, at the time we negotiate the
lease termination and sublease arrangements with third parties. While the
amount we have accrued represents our best estimate of the total unpaid loss we
expect to incur in connection with these plans, estimates are subject to change
and may require routine adjustment as conditions and facts change through the
implementation period. If adverse macroeconomic conditions continue,
particularly as they pertain to the commercial real estate market, we may be
required to reduce our estimated future sublease income and, accordingly,
increase our estimated cost to exit certain facilities.

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

|                                           |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    |     |             |    |     |      |   |     | 
|------------------------------------------ | --------------------------------- | - | ------------------------------------------ | --- | ------------------ | --- | ------------------ | --- | ------------- | --- | ----------- | ---- | ----------- | --- | ----- | --- | - | --- | -- | --- | ----------- | -- | --- | ---- | - | --- | 
|                                           |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    |     | Fiscal 2001 |    |     |      |  
|                                           |                                   |   |                                            |     | Fiscal 2003        |     | Fiscal 2002        |     | Facility Exit |     |             |      |            
|                                           |                                   |   |                                            |     | Restructuring Plan |     | Restructuring Plan |     | Plan          |     |             |      |            
|                                           |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |            
|                                           |                                   |   |                                            |     | Severance          |     |                    |     |               |     | Severance   |      |             |     |       |     |   |     |    |     |             |    |    
|                                           |                                   |   |                                            |     | and                |     | Facilities-        |     | and           |     | Facilities- |      | Facilities- |     |       |     |  
|                                           |                                   |   |                                            |     | Benefits           |     | Related            |     | Benefits      |     | Related     |      | Related     |     | Total
|                                           |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |      
|Restructuring provision in fiscal 2001:    |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    |     |             |    |     |     
|                                           | Accrued lease costs               |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     | $  | 46  |             |    | $   | 46   |  
|                                           | Property and equipment impairment |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    | 29  |             |    |     | 29   |  
|                                           |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    |     |             |    |     |     
|                                           |                                   |   | Total restructuring charges in
fiscal 2001 |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    |     |             | 75 |     |      |   | 75  | 
|                                           | Non-cash charges                  |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    | (29 | )           |    |     | (29  | )
|                                           |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    |     |             |    |     |     
|Balance of accrual as of June 30, 2001     |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     | 46 |     |             |    | 46  |     
|Restructuring provision in fiscal 2002:    |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    |     |             |    |     |     
|                                           | Severance and benefits            |   |                                            |     |                    |     |                    |     |               |     | $           | 146  |             |     | $     |    |   |     |    |    |             |    |     | 146  |  
|                                           | Accrued lease costs               |   |                                            |     |                    |     |                    |     |               |     |             |     |             |     |       | 282 |   |     |    |    |             |    |     | 282  |  
|                                           | Property and equipment impairment |   |                                            |     |                    |     |                    |     |               |     |             |     |             |     |       | 83  |   |     |    |    |             |    |     | 83   |  
|                                           | Provision adjustments             |   |                                            |     |                    |     |                    |     |               |     |             |     |             |     |       | (20 | ) |     |    | 26  |             |    |     | 6    |  
|                                           |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    |     |             |    |     |     
|                                           |                                   |   | Total restructuring charges in
fiscal 2002 |     |                    |     |                    |     |               |     |             |      |             | 146 |       |     |   | 345 |    |     |             | 26 |     |      |   | 517 | 
|                                           | Cash paid                         |   |                                            |     |                    |     |                    |     |               |     |             | (127 | )           |     |       | (93 | ) |     |    | (19 | )           |    |     | (239 | )
|                                           | Non-cash charges                  |   |                                            |     |                    |     |                    |     |               |     |             |     |             |     |       | (83 | ) |     |    |    |             |    |     | (83  | )
|                                           |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    |     |             |    |     |     
|Balance of accrual as of June 30, 2002     |                                   |   |                                            |     |                    |     |                    |     |               |     | 19          |      |             |     | 169   |     |   |     | 53 |     |             |    | 241 |     
|Restructuring provision in fiscal 2003:    |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    |     |             |    |     |     
|                                           | Severance and benefits            |   | $                                          | 176 |                    |     | $                  |    |               |     |             |     |             |     |       |    |   |     |    |    |             |    |     | 176  |  
|                                           | Accrued lease costs               |   |                                            |    |                    |     |                    | 114 |               |     |             |     |             |     |       |    |   |     |    |    |             |    |     | 114  |  
|                                           | Property and equipment impairment |   |                                            |    |                    |     |                    | 18  |               |     |             |     |             |     |       |    |   |     |    |    |             |    |     | 18   |  
|                                           | Provision adjustments             |   |                                            |    |                    |     |                    |    |               |     |             | (2   | )           |     |       | 41  |   |     |    | 34  |             |    |     | 73   |  
|                                           |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    |     |             |    |     |     
|                                           |                                   |   | Total restructuring charges in
fiscal 2003 |     |                    | 176 |                    |     |               | 132 |             |      |             | (2  | )     |     |   | 41  |    |     |             | 34 |     |      |   | 381 | 
|                                           | Cash paid                         |   |                                            | (54 | )                  |     |                    |    |               |     |             | (16  | )           |     |       | (14 | ) |     |    | (12 | )           |    |     | (96  | )
|                                           | Non-cash charges                  |   |                                            |    |                    |     |                    | (18 | )             |     |             |     |             |     |       |    |   |     |    |    |             |    |     | (18  | )
|                                           |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    |     |             |    |     |     
|Balance of accrual as of December 29,
2002 |                                   | $ | 122                                        |     |                    | $   | 114                |     |               | $   | 1           |      |             | $   | 196   |     |   | $   | 75 |     |             | $  | 508 |     
|                                           |                                   |   |                                            |     |                    |     |                    |     |               |     |             |      |             |     |       |     |   |     |    |     |             |    |     |     

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The remaining cash expenditures relating to workforce reductions are expected
to be substantially paid by the fourth quarter of fiscal 2003. The current
estimates accrued for abandoned leases (net of anticipated sublease proceeds)
will be paid over their respective lease terms through fiscal 2018. As of
December 29, 2002, $222 million of the $508 million accrual was classified as
current and the remaining $286 million was classified as non-current. In
addition, the estimates for leases to be terminated prior to lease expiration
are classified as current as we anticipate making these payments within the
next twelve months.

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

7. COMPREHENSIVE LOSS

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

|                                                          |  |                    |        |                  |  |              |      |              |  |   |        |   |  |   |      |  
|--------------------------------------------------------- |  | ------------------ | ------ | ---------------- |  | ------------ | ---- | ------------ |  | - | ------ | - |  | - | ---- | -
|                                                          |  | Three Months Ended |        | Six Months Ended
|                                                          |  |                    |        |                 
|                                                          |  | December 29,       |        | December 30,     |  | December 29, |      | December 30,
|                                                          |  | 2002               |        | 2001             |  | 2002         |      | 2001        
|                                                          |  |                    |        |                  |  |              |      |             
|Net loss                                                  |  | $                  | (2,283 | )                |  | $            | (431 | )            |  | $ | (2,394 | ) |  | $ | (611 | )
|Change in unrealized value
on investments, net            |  |                    | 2      |                  |  |              | (29  | )            |  |   | 23     |   |  |   | (6   | )
|Change in unrealized fair
value of derivative
instruments |  |                    | (3     | )                |  |              | 11   |              |  |   | 6      |   |  |   | (17  | )
|Translation adjustments, net                              |  |                    | 3      |                  |  |              | (17  | )            |  |   | 52     |   |  |   | 36   |  
|                                                          |  |                    |        |                  |  |              |      |              |  |   |        |   |  |   |      |  
|                                                          |  | $                  | (2,281 | )                |  | $            | (466 | )            |  | $ | (2,313 | ) |  | $ | (598 | )
|                                                          |  |                    |        |                  |  |              |      |              |  |   |        |   |  |   |      |  

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

|                                            |  |                   |     |               |  |   |     |  
|------------------------------------------- |  | ----------------- | --- | ------------- |  | - | --- | -
|                                            |  | December 29, 2002 |     | June 30, 2002
|                                            |  |                   |     |              
|Unrealized gains on investments, net        |  | $                 | 48  |               |  | $ | 25  |  
|Unrealized losses on derivative instruments |  |                   | (25 | )             |  |   | (31 | )
|Cumulative translation adjustments          |  |                   | 27  |               |  |   | (25 | )
|                                            |  |                   |     |               |  |   |     |  
|                                            |  | $                 | 50  |               |  | $ | (31 | )
|                                            |  |                   |     |               |  |   |     |  

8. INDUSTRY SEGMENTS

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

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

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

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

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

|                    |  |         |       |          |  |       |     |  |  |   |       | 
|------------------- |  | ------- | ----- | -------- |  | ----- | --- |  |  | - | ----- | 
|                    |  | Product |       | Sun      |  |       |     | 
|Three Months Ended: |  | Group   |       | Services |  | Total
|                    |  |         |       |          |  |      
|December 29, 2002   |  |         |       |          |  |       |     |  |  |   |       | 
|Net Revenues        |  | $       | 2,013 |          |  | $     | 902 |  |  | $ | 2,915 | 
|Gross margin        |  |         | 895   |          |  |       | 368 |  |  |   | 1,263 | 
|December 30, 2001   |  |         |       |          |  |       |     |  |  |   |       | 
|Net Revenues        |  |         | 2,260 |          |  |       | 848 |  |  |   | 3,108 | 
|Gross margin        |  |         | 823   |          |  |       | 316 |  |  |   | 1,139 | 

|                  |  |         |       |          |  |       |       |  |  |   |       | 
|----------------- |  | ------- | ----- | -------- |  | ----- | ----- |  |  | - | ----- | 
|                  |  | Product |       | Sun      |  |       |       | 
|Six Months Ended: |  | Group   |       | Services |  | Total
|                  |  |         |       |          |  |      
|December 29, 2002 |  |         |       |          |  |       |       |  |  |   |       | 
|Net Revenues      |  | $       | 3,893 |          |  | $     | 1,769 |  |  | $ | 5,662 | 
|Gross margin      |  |         | 1,682 |          |  |       | 713   |  |  |   | 2,395 | 
|December 30, 2001 |  |         |       |          |  |       |       |  |  |   |       | 
|Net Revenues      |  |         | 4,317 |          |  |       | 1,652 |  |  |   | 5,969 | 
|Gross margin      |  |         | 1,593 |          |  |       | 602   |  |  |   | 2,195 | 

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9. LEGAL PROCEEDINGS

On February 11, 2002, Eastman Kodak Company (Kodak) filed a civil lawsuit
against us, Eastman Kodak Company v. Sun Microsystems, Inc., Civil Action No.
02-CV-6074, in the United States District Court for the Western District of New
York. Kodak filed a First Amended Complaint on March 22, 2002. In the First
Amended Complaint Kodak asserts that some of our products, including those
relating to our JavaTM
technology, infringe one or more claims of U.S. Patent No. 5,206,951, U.S.
Patent No. 5,421,012, and U.S. Patent No. 5,226,161 (collectively, the Kodak
Patents). Kodak further alleges that we have contributed to and induced
infringement of one or more claims of the Kodak Patents. Kodak seeks
injunctive relief against future infringement, unspecified damages for past
infringement, and attorneys fees and costs. On May 24, 2002, we filed an
Answer to First Amended Complaint and Counterclaims, denying infringement of
any valid and enforceable claim of any of the Kodak Patents. In the Answer and
Counterclaims, we are also seeking declaratory judgment of noninfringement,
invalidity and/or unenforceability of the Kodak Patents. We further allege that
Kodaks claims are barred in whole or in part by the doctrines of estoppel,
laches and patent exhaustion, and that we have license and/or sublicense rights
to the Kodak Patents. This case is at a very preliminary stage. Discovery has
only recently commenced, and a trial has not been scheduled. Based on
discussions over many months with Kodak, we believe that this suit is without
merit and, accordingly, we will defend ourselves and pursue our counterclaims
vigorously. At this time, we cannot forecast with reasonable certainty the
potential costs associated with an adverse outcome of this matter.

On March 8, 2002, we filed suit against Microsoft Corporation (Microsoft) in
the United States District Court for the Northern District of California,
pursuant to United States and State of California antitrust laws, alleging
numerous illegal acts on the part of Microsoft, including efforts to acquire,
maintain and expand a number of illegal monopolies; illegal tying arrangements;
illegal exclusive dealings; copyright infringement; unreasonable restraints of
trade; and unfair competition. Our requested remedies include: (1) preliminary
injunctions requiring Microsoft to distribute our binary implementation of the
Java Run-time Environment as part of Windows XP and Internet Explorer (must
carry remedy) and to stop the unlicensed distribution of Microsofts Virtual
Machine for Java; (2) a permanent injunction to restore competition to the
markets in which Microsoft is unlawfully attempting to acquire, maintain and
expand a number of monopolies; and (3) compensation for losses we suffered as a
result of Microsofts unlawful actions. On August 9, 2002, the Judicial Panel
on Multidistrict Litigation issued an order transferring our lawsuit to the
District of Maryland, for pretrial proceedings, in the case entitled Microsoft
Corp. Windows Operating System Antitrust Litigation, MDL-1332. We filed an
amended complaint on August 26, 2002, alleging additional illegal tying
arrangements and acts of illegal monopoly maintenance. On December 23, 2002,
the Honorable J. Frederick Motz issued an opinion stating he would grant our
motions seeking a preliminary injunction regarding the must carry remedy and
a preliminary injunction prohibiting distribution of Microsofts Virtual
Machine for Java, subject to the parties conferring on the form of a final
order. On January 15, 2003, a final order was entered by Judge Motz requiring
Microsoft to implement our requested must carry remedy within 120 days for
shipments of Windows XP. We have posted a $25 million bond in relation to the
preliminary injunction. At the January 15, 2003 hearing, Judge Motz also
reversed an earlier order dismissing two of our claims, subject to our filing
of a minor amendment to one of those claims, and denied Microsofts remaining
motions to dismiss. At the conclusion of the pretrial proceedings in MDL-1332,
the lawsuit will return for trial to the Northern District of California. On
January 22, 2003, Microsoft filed an appeal seeking review of Judge Motzs
must carry preliminary injunction and requesting that the injunction be
stayed while such appeal is pending. On February 3, 2003, a panel of the Court
of Appeals for the Fourth Circuit granted Microsofts stay request and granted
a request by both parties for expedited consideration. A hearing has not been
set, but we anticipate the Court of Appeals will hear the matter at or around
the last week of March 2003.

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In early February 2002, Sun and two of its subsidiaries received several
charging letters from the United States Department of Commerce, Bureau of
Industry and Security, Office of Export Enforcement (BIS) claiming that we had
violated export control regulations. The letters relate to sales in 1998 in
Egypt and in 1997 to a reseller in Hong Kong for subsequent resale in the
Peoples Republic of China. The relevant export statutes provide for monetary
penalties, and in some instances, denial of export privileges and exclusion
from practice before the BIS if a violation is found. We are involved in
ongoing settlement discussions with BIS authorities regarding penalties and
remedies. In order to facilitate these discussions, the BIS granted us an
extension until November
1, 2002 to respond to the charging letters. A subsequent extension was granted
until January 31, 2003, and at the governments request, a further extension
was granted until April 30, 2003. As previously reported, the BIS had informed
us verbally that additional charges probably would be added and would be
addressed in the context of the ongoing investigation and negotiations. On
January 16, 2003, the BIS provided us with a proposed charging letter
documenting nineteen (19) proposed additional charges. To our knowledge, the
new charges relate to transactions occurring more than three years ago, and do
not involve any recent transactions. We have submitted a written response
acknowledging the additional proposed charges, without admitting or denying the
alleged conduct, pending further investigation and discussion with the BIS.
Based on settlement discussions with the BIS, we believe we are reasonably
likely to reach a negotiated resolution encompassing all of these charging
letters and that such resolution will not have a material adverse effect on our
operations. Absent a negotiated resolution, an administrative hearing would be
set and, in such case, we would assert a vigorous defense. We believe that any
monetary penalties imposed would not have a material adverse effect on our
financial condition or operating results. Although we do not believe the
evidence would support the extreme sanction of a denial of export privileges or
exclusion from practice before the BIS, any such penalties would have a
material adverse effect on our business.

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INDEPENDENT ACCOUNTANTS REVIEW REPORT

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

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

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

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

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

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

San Jose, California
January 15, 2003

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

This quarterly report, including the following sections, contains
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995, particularly statements regarding the goal of
our Fiscal 2003 Restructuring Plan to reduce costs and improve operating
efficiencies, our intent to reduce our headcount to approximately 35,000
employees and to eliminate excess facility capacity, our expectations that the
remaining employees to be terminated under our Fiscal 2003 Restructuring Plan
will be terminated during the third and fourth quarters of fiscal 2003, our
expectations related to estimated sublease income and our intent to sublease
certain of our leased facilities, our expectations to exit the facilities
related to amounts accrued under our Fiscal 2003 Restructuring Plan by December
29, 2003, our expectations that the volatility of our portfolio of marketable
securities will decrease as its duration decreases, our intent to focus on
inventory management, our expectations to make significant cash outlays during
the second half of fiscal 2003 including capital expenditures for investment in
our product development and initiatives and funding of liabilities associated
with the reduction in force and the consolidation of facilities in connection
with our restructuring plans, our long-term strategy for cash and cash
equivalents, our belief that there is no need to repatriate funds to the U.S.,
our belief that we have sufficient capital to meet our requirements for at
least the next twelve months, our belief that the level of our financial
resources is a competitive factor, our belief that the Kodak litigation is
without merit, our belief that a hearing relating to the Microsoft litigation
will occur around the last week of March 2003, and our belief that we will be
able to reach a negotiated settlement with the BIS, and as set forth in the
section entitled Purchased in-process research and development expenses:
statements regarding our belief about the realization of expected economic
return and projected income stream from acquired in-process technology and
resulting or related products, our expected growth factors and anticipated
nature and timing of new product introductions, that we do not expect 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, the significant assumptions underlying
the valuation related to the IPRD and that we continue to make substantial
progress related to the development and commercialization of acquired
technologies.

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

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

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RESULTS OF OPERATIONS

Net Revenues
(dollars in millions)

|                     |                                  |   |                    |      |                   |   |        |      |                   |  |                   |    |        |   |       |      |   |   |       |      |   |  |      |    | 
|-------------------- | -------------------------------- | - | ------------------ | ---- | ----------------- | - | ------ | ---- | ----------------- |  | ----------------- | -- | ------ | - | ----- | ---- | - | - | ----- | ---- | - |  | ---- | -- | 
|                     |                                  |   | Three Months Ended |      | Six Months Ended 
|                     |                                  |   |                    |      |                  
|                     |                                  |   | December 29, 2002  |      | December 30, 2001 |   | Change |      | December 29, 2002 |  | December 30, 2001 |    | Change
|                     |                                  |   |                    |      |                   |   |        |      |                   |  |                   |    |       
|Products net revenue |                                  | $ | 2,013              |      |                   | $ | 2,260  |      |                   |  | (10.9             | )% |        | $ | 3,893 |      |   | $ | 4,317 |      |   |  | (9.8 | )%
|                     | Percentage of total net revenues |   |                    | 69.1 | %                 |   |        | 72.7 | %                 |  |                   |    |        |   |       | 68.8 | % |   |       | 72.3 | % |  |      |    | 
|Services net revenue |                                  | $ | 902                |      |                   | $ | 848    |      |                   |  | 6.4               | %  |        | $ | 1,769 |      |   | $ | 1,652 |      |   |  | 7.1  | % 
|                     | Percentage of total net revenues |   |                    | 30.9 | %                 |   |        | 27.3 | %                 |  |                   |    |        |   |       | 31.2 | % |   |       | 27.7 | % |  |      |    | 
|Total net revenues   |                                  | $ | 2,915              |      |                   | $ | 3,108  |      |                   |  | (6.2              | )% |        | $ | 5,662 |      |   | $ | 5,969 |      |   |  | (5.1 | )%

Products Net Revenue

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

During the three and six months ended December 29, 2002, our products net
revenue decreased 10.9% and 9.8%, respectively, as compared with the
corresponding periods of fiscal 2002, primarily as a result of the continuing
adverse macroeconomic conditions that began at the end of the second quarter of
fiscal 2001. These conditions have led to significant reductions and deferrals
in IT spending, particularly by customers in the telecommunications and
financial services industries who are also being significantly affected by the
adverse economic conditions. As a result, during the three and six months ended
December 29, 2002, we experienced continued lower sales volumes and increased
competitive pricing pressure on most of our product lines. Specifically, we
experienced decreases in net revenues in our desktop and enterprise server
products during the second quarter and the first half of fiscal 2003, as
compared with the corresponding periods of fiscal 2002. These decreases in net
revenues were partially offset by increases in net revenues in our mid-range
server and our data center server products.

Services Net Revenue

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

During the three and six months ended December 29, 2002, the 6.4% and 7.1%
growth in services net revenue, respectively, as compared with the
corresponding periods of fiscal 2002, was due to an increase in revenue from
Support Services, partially offset by decreases in revenue from Professional
Services and Educational Services. Support Services revenue, which represents
over 70% of services net revenue for all periods presented, consists primarily
of maintenance contract revenue, which is recognized ratably over the
contractual period. Support Services revenue growth was primarily a result of
an increase in our installed base of systems. Sun Professional Services revenue
is generated from technical consulting and systems integration services to help
customers plan, implement, and manage distributed network computing
environments. Sun Educational Services revenue is generated by developing and
delivering integrated learning solutions for enterprises, IT organizations, and
individual IT professionals. The Professional Services and the Educational
Services revenue decreases during the second quarter and the first half of
fiscal 2003 were due to a combination of: (1) a reduction in customers
discretionary spending, and (2) the continuing decline in new product sales,
both resulting primarily from the adverse economic conditions discussed above.

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

Net Revenues by Geographic
Area
(dollars in millions)

|                                          |                            |   |                    |      |                   |   |        |      |                   |  |                   |    |        |   |       |      |   |   |       |      |   |  |      |    | 
|----------------------------------------- | -------------------------- | - | ------------------ | ---- | ----------------- | - | ------ | ---- | ----------------- |  | ----------------- | -- | ------ | - | ----- | ---- | - | - | ----- | ---- | - |  | ---- | -- | 
|                                          |                            |   | Three Months Ended |      |                   |   |        |      | Six Months Ended  |  |                   |    |       
|                                          |                            |   |                    |      |                   |   |        |      |                   |  |                   |    |       
|                                          |                            |   | December 29, 2002  |      | December 30, 2001 |   | Change |      | December 29, 2002 |  | December 30, 2001 |    | Change
|                                          |                            |   |                    |      |                   |   |        |      |                   |  |                   |    |       
|U.S.                                      |                            | $ | 1,267              |      |                   | $ | 1,436  |      |                   |  | (11.8             | )% |        | $ | 2,509 |      |   | $ | 2,783 |      |   |  | (9.8 | )%
|Americas-Other (Canada and
Latin America) |                            |   | 146                |      |                   |   | 149    |      |                   |  | (2.0              | )% |        |   | 268   |      |   |   | 259   |      |   |  | 3.5  | % 
|                                          |                            |   |                    |      |                   |   |        |      |                   |  |                   |    |        |   |       |      |   |   |       |      |   |  |      |   
|Americas-Total                            |                            |   | 1,413              |      |                   |   | 1,585  |      |                   |  | (10.8             | )% |        |   | 2,777 |      |   |   | 3,042 |      |   |  | (8.7 | )%
|                                          | Percentage of net revenues |   |                    | 48.5 | %                 |   |        | 51.0 | %                 |  |                   |    |        |   |       | 49.1 | % |   |       | 51.0 | % |  |      |    | 
|EMEA (Europe, Middle East and
Africa)     |                            |   | 987                |      |                   |   | 958    |      |                   |  | 3.0               | %  |        |   | 1,839 |      |   |   | 1,819 |      |   |  | 1.1  | % 
|                                          | Percentage of net revenues |   |                    | 33.8 | %                 |   |        | 30.8 | %                 |  |                   |    |        |   |       | 32.5 | % |   |       | 30.5 | % |  |      |    | 
|APAC (Asia, Australia and New
Zealand)    |                            |   | 515                |      |                   |   | 565    |      |                   |  | (8.8              | )% |        |   | 1,046 |      |   |   | 1,108 |      |   |  | (5.6 | )%
|                                          | Percentage of net revenues |   |                    | 17.7 | %                 |   |        | 18.2 | %                 |  |                   |    |        |   |       | 18.4 | % |   |       | 18.5 | % |  |      |    | 
|Total net revenues                        |                            | $ | 2,915              |      |                   | $ | 3,108  |      |                   |  | (6.2              | )% |        | $ | 5,662 |      |   | $ | 5,969 |      |   |  | (5.1 | )%

|                   |                            |   |                    |      |                   |   |        |      |                   |  |                   |    |        |   |       |      |   |   |       |      |   |  |      |    | 
|------------------ | -------------------------- | - | ------------------ | ---- | ----------------- | - | ------ | ---- | ----------------- |  | ----------------- | -- | ------ | - | ----- | ---- | - | - | ----- | ---- | - |  | ---- | -- | 
|                   |                            |   | Three Months Ended |      |                   |   |        |      | Six Months Ended  |  |                   |    |       
|                   |                            |   |                    |      |                   |   |        |      |                   |  |                   |    |       
|                   |                            |   | December 29, 2002  |      | December 30, 2001 |   | Change |      | December 29, 2002 |  | December 30, 2001 |    | Change
|                   |                            |   |                    |      |                   |   |        |      |                   |  |                   |    |       
|U.S.               |                            | $ | 1,267              |      |                   | $ | 1,436  |      |                   |  | (11.8             | )% |        | $ | 2,509 |      |   | $ | 2,783 |      |   |  | (9.8 | )%
|                   | Percentage of net revenues |   |                    | 43.5 | %                 |   |        | 46.2 | %                 |  |                   |    |        |   |       | 44.3 | % |   |       | 46.6 | % |  |      |    | 
|International      |                            | $ | 1,648              |      |                   | $ | 1,672  |      |                   |  | (1.4              | )% |        | $ | 3,153 |      |   | $ | 3,186 |      |   |  | (1.0 | )%
|                   | Percentage of net revenues |   |                    | 56.5 | %                 |   |        | 53.8 | %                 |  |                   |    |        |   |       | 55.7 | % |   |       | 53.4 | % |  |      |    | 
|Total net revenues |                            | $ | 2,915              |      |                   | $ | 3,108  |      |                   |  | (6.2              | )% |        | $ | 5,662 |      |   | $ | 5,969 |      |   |  | (5.1 | )%

In the second quarter and the first half of fiscal 2003, our total net revenues
decreased by 6.2% and 5.1%, respectively, as compared with the corresponding
periods of fiscal 2002. Within the U.S., our total net revenues decreased by
11.8% and 9.8% during the second quarter and the first half of fiscal 2003,
respectively, as compared with the corresponding periods of fiscal 2002.
Internationally, our total net revenues decreased by 1.4% and 1.0% during the
second quarter and the first half of fiscal 2003, respectively, as compared
with the corresponding periods of fiscal 2002. The decrease in total net
revenues in the U.S. and internationally is primarily the result of continued
adverse economic conditions.

In the second quarter of fiscal 2003, as compared with the corresponding period
of fiscal 2002, the marginal decrease of 1.4% in international net revenues was
primarily the result of decreases in net revenues in Japan, the United Kingdom
and Greater China, partially offset by increases in Germany, Northern Europe,
and Southern Europe, Africa and Middle East (SEAME). Greater China consists of
the Peoples Republic of China, Taiwan and Hong Kong. Southern Europe consists
primarily of Italy, Spain, Switzerland and other Mediterranean countries.
Northern Europe consists primarily of the Scandinavian countries, the
Netherlands, Belgium/Luxembourg, Eastern European countries and Russia.

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In the first half of fiscal 2003, as compared with the corresponding period of
fiscal 2002, the marginal decrease of 1.0% in international net revenues was
primarily the result of decreases in net revenues in Japan, the United Kingdom,
SEAME and Greater China, partially offset by increases in Germany, Korea,
France and Thailand.

In the second quarter of fiscal 2003, within the Americas-Other region, net
revenues decreased by 2.0% as compared with the corresponding period of fiscal
2002, primarily because of decreases in net revenues in Venezuela and Brazil,
partially offset by increases in Chile and Canada.

In the first half of fiscal 2003, within the Americas-Other region, net
revenues increased by 3.5% as compared with the corresponding period of fiscal
2002, primarily because of increases in net revenues in Mexico and Canada,
partially offset by decreases in Venezuela and Brazil.

In the second quarter of fiscal 2003, within the EMEA region, net revenues
increased by 3.0%, as compared with the corresponding period of fiscal 2002,
primarily because of increases in net revenues in Germany, Northern Europe and
the SEAME region, partially offset by decreases in the United Kingdom. During
the second quarter of fiscal 2003, EMEA revenues benefited from a favorable
foreign exchange impact as compared with the corresponding period of fiscal
2002. While the benefit from a change in currency rates cannot be precisely
calculated because we regularly adjust our prices to current market conditions,
we note that the average exchange rate for the euro for the three months ended
December 29, 2002 increased approximately 9% as compared with the corresponding
period of fiscal 2002.

In the first half of fiscal 2003, within the EMEA region, net revenues
increased by 1.1%, as compared with the corresponding period of fiscal 2002,
primarily because of increases in net revenues in Germany and France, partially
offset by decreases in the United Kingdom and the SEAME region. During the
first half of fiscal 2003, EMEA revenues benefited from a favorable foreign
exchange impact as compared with the corresponding period of fiscal 2002. For
example, the average exchange rate for the euro for the six months ended
December 29, 2002 increased approximately 11% as compared with the
corresponding period of fiscal 2002.

In the second quarter of fiscal 2003, within the APAC region, net revenues
decreased by 8.8% as compared with the corresponding period of fiscal 2002,
primarily because of decreases in net revenues in Japan and Greater China.

In the first half of fiscal 2003, within the APAC region, net revenues
decreased by 5.6% as compared with the corresponding period of fiscal 2002,
primarily because of decreases in net revenues in Japan and Greater China.
These decreases were partially offset by increases in Korea and Thailand.
Economic conditions in Japan have declined substantially in recent years and
have adversely impacted our sales in this region. If the economic trend in
Japan continues or economic conditions significantly worsen in a quarter or
decline over an extended period of time, our results of operations and cash
flows could be further adversely affected.

Gross Margin
(dollars in millions)

|                      |                                    |   |                    |      |                   |   |        |      |                   |  |                   |   |        |      |       |  |  |      |       |  |         |  |      |   | 
|--------------------- | ---------------------------------- | - | ------------------ | ---- | ----------------- | - | ------ | ---- | ----------------- |  | ----------------- | - | ------ | ---- | ----- |  |  | ---- | ----- |  | ------- |  | ---- | - | 
|                      |                                    |   | Three Months Ended |      |                   |   |        |      | Six Months Ended  |  |                   |   |       
|                      |                                    |   |                    |      |                   |   |        |      |                   |  |                   |   |       
|                      |                                    |   | December 29, 2002  |      | December 30, 2001 |   | Change |      | December 29, 2002 |  | December 30, 2001 |   | Change
|                      |                                    |   |                    |      |                   |   |        |      |                   |  |                   |   |       
|Products gross margin |                                    | $ | 895                |      |                   | $ | 823    |      |                   |  | 8.7               | % |        | $    | 1,682 |  |  | $    | 1,593 |  |         |  | 5.6  | %
|                      | Percentage of products net revenue |   |                    | 44.5 | %                 |   |        | 36.4 | %                 |  | 8.1 pts           |   |        | 43.2 | %     |  |  | 36.9 | %     |  | 6.3 pts
|Services gross margin |                                    | $ | 368                |      |                   | $ | 316    |      |                   |  | 16.5              | % |        | $    | 713   |  |  | $    | 602   |  |         |  | 18.4 | %
|                      | Percentage of services net revenue |   |                    | 40.8 | %                 |   |        | 37.3 | %                 |  | 3.5 pts           |   |        | 40.3 | %     |  |  | 36.4 | %     |  | 3.9 pts
|Total gross margin    |                                    | $ | 1,263              |      |                   | $ | 1,139  |      |                   |  | 10.9              | % |        | $    | 2,395 |  |  | $    | 2,195 |  |         |  | 9.1  | %
|                      | Percentage of net revenues         |   |                    | 43.3 | %                 |   |        | 36.6 | %                 |  | 6.7 pts           |   |        | 42.3 | %     |  |  | 36.8 | %     |  | 5.5 pts

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Products Gross Margin

In the second quarter and first half of fiscal 2003, products gross margin
increased by 8.1 and 6.3 percentage points, respectively, as compared with the
corresponding periods of fiscal 2002. The 8.1 and 6.3 percentage point
increases in products gross margin were primarily a result of: (1) lower
purchased component costs; (2) lower platform transition costs associated with
the conversion of a majority of our product lines to the UltraSPARC III
microprocessor that were incurred in the first half of fiscal 2002; and (3)
lower fixed manufacturing costs. These favorable elements were partially offset
by: (1) reductions in product pricing (normal price list reductions and
competitive transaction pricing); and (2) changes in the sales products mix.
The fiscal 2002 transition costs primarily consisted of write-offs for excess
and obsolete inventory and costs associated with rework.

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

Services Gross Margin

In the second quarter and the first half of fiscal 2003, the 3.5 and 3.9
percentage point increases in services gross margin, respectively, as compared
with the corresponding periods of fiscal 2002, reflected the impact of: (1)
overall cost reductions, primarily from decreases in discretionary spending,
and improved operating efficiencies across all lines of our services business,
helped, in part, by lower overall headcount; and (2) support services revenue
increasing as a percentage of total services net revenue (support services
generates a higher gross margin than professional services or educational
services). The impact of these favorable items on services gross margin in the
second quarter and the first half of fiscal 2003, as compared with the
corresponding periods of fiscal 2002, was partially offset by competitive
pricing pressures.

Operating Expenses
(dollars in millions)

|                                                   |                            |   |                    |      |                   |   |        |      |                   |  |                   |    |        |   |       |      |   |   |       |      |   |  |       |    | 
|-------------------------------------------------- | -------------------------- | - | ------------------ | ---- | ----------------- | - | ------ | ---- | ----------------- |  | ----------------- | -- | ------ | - | ----- | ---- | - | - | ----- | ---- | - |  | ----- | -- | 
|                                                   |                            |   | Three Months Ended |      |                   |   |        |      | Six Months Ended  |  |                   |    |       
|                                                   |                            |   |                    |      |                   |   |        |      |                   |  |                   |    |       
|                                                   |                            |   | December 29, 2002  |      | December 30, 2001 |   | Change |      | December 29, 2002 |  | December 30, 2001 |    | Change
|                                                   |                            |   |                    |      |                   |   |        |      |                   |  |                   |    |       
|Research and development                           |                            | $ | 451                |      |                   | $ | 428    |      |                   |  | 5.4               | %  |        | $ | 888   |      |   | $ | 901   |      |   |  | (1.4  | )%
|                                                   | Percentage of net revenues |   |                    | 15.5 | %                 |   |        | 13.8 | %                 |  |                   |    |        |   |       | 15.7 | % |   |       | 15.1 | % |  |       |    | 
|Selling, general and administrative                |                            | $ | 830                |      |                   | $ | 966    |      |                   |  | (14.1             | )% |        | $ | 1,712 |      |   | $ | 1,927 |      |   |  | (11.2 | )%
|                                                   | Percentage of net revenues |   |                    | 28.5 | %                 |   |        | 31.1 | %                 |  |                   |    |        |   |       | 30.2 | % |   |       | 32.3 | % |  |       |    | 
|Restructuring charges                              |                            | $ | 357                |      |                   | $ | 511    |      |                   |  | (30.1             | )% |        | $ | 381   |      |   | $ | 525   |      |   |  | (27.4 | )%
|                                                   | Percentage of net revenues |   |                    | 12.2 | %                 |   |        | 16.4 | %                 |  |                   |    |        |   |       | 6.7  | % |   |       | 8.8  | % |  |       |    | 
|Purchased in-process research and
development      |                            | $ | 4                  |      |                   | $ |       |      |                   |  | N/M               |    |        | $ | 4     |      |   | $ | 3     |      |   |  | 33.3  | % 
|                                                   | Percentage of net revenues |   |                    | 0.1  | %                 |   |        |     | %                 |  |                   |    |        |   |       | 0.1  | % |   |       | 0.1  | % |  |       |    | 
|Impairment of goodwill and other
intangible assets |                            | $ | 2,125              |      |                   | $ |       |      |                   |  | N/M               |    |        | $ | 2,125 |      |   | $ |      |      |   |  | N/M   |   
|                                                   | Percentage of net revenues |   |                    | 72.9 | %                 |   |        |     | %                 |  |                   |    |        |   |       | 37.5 | % |   |       |     | % |  |       |    | 

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Research and Development (R&D) Expenses

In the second quarter of fiscal 2003, R&D expenses, as a percentage of total
net revenues, increased to 15.5% from 13.8% in the corresponding period of
fiscal 2002. The increase in the percentage of R&D expenses to total net
revenues is the result of: (1) an increase in the dollar amount of expenses
incurred during the second quarter of fiscal 2003, as compared with the dollar
amount of expenses incurred during the second quarter of fiscal 2002; and (2) a
decrease in total net revenues in the second quarter of fiscal 2003, as
compared with total net revenues in the second quarter of fiscal 2002. In
dollars, R&D expenses increased by 5.4% to $451 million in the second quarter
of fiscal 2003, as compared with $428 million in the second quarter of fiscal
2002. The dollar increase in R&D expenses for the second quarter of fiscal
2003, as compared with the corresponding period of fiscal 2002, was primarily a
result of: (1) higher variable compensation costs in the second
quarter of fiscal 2002 due to the cancellation of
certain bonuses previously
accrued for, and which action did not recur in the
second quarter of fiscal 2003; and (2) higher costs due to our fiscal 2003
acquisitions. In general, fluctuations in R&D expenses will occur depending on
the timing of product introductions, among other factors.

In the first half of fiscal 2003, R&D expenses, as a percentage of total net
revenues, increased to 15.7% from 15.1% in the corresponding period of fiscal
2002. The increase in the percentage of R&D expenses to total net revenues is
the result of a decrease in revenues in the first half of fiscal 2003, as
compared with the corresponding period of fiscal 2002. In dollars, R&D expenses
decreased by 1.4% to $888 million in the first half of fiscal 2003, as compared
with $901 million in the first half of fiscal 2002. The dollar decrease in R&D
expenses for the first half of fiscal 2003, as compared with the corresponding
period of fiscal 2002, was a result of: (1) lower costs incurred for prototype
development; (2) lower infrastructure costs due to our restructuring plans; and
(3) lower depreciation costs. The impact of these favorable items was partially
offset by increases in variable compensation costs due to: (1) a decreased
benefit from our mandatory July 2002 shutdown, as compared with our mandatory
July 2001 shutdown, resulting from fewer required vacation days in July 2002 as
compared with July 2001; and (2) the cancellation of certain bonuses in the
second quarter of fiscal 2002 (previously accrued for), which action did not recur in the second quarter of
fiscal 2003.

Selling, General and Administrative (SG&A) Expenses

In the second quarter of fiscal 2003, SG&A expenses, as a percentage of total
net revenues, decreased to 28.5% from 31.1% in the corresponding period of
fiscal 2002. The decrease in the percentage of SG&A expenses to total net
revenues is the result of a decrease in SG&A expenses incurred during the
second quarter of fiscal 2003, as compared with the level of SG&A expenses
incurred during the second quarter of fiscal 2002. In dollars, SG&A expenses
decreased $136 million to $830 million in the second quarter of fiscal 2003, as
compared with $966 million in the second quarter of fiscal 2002. The dollar
decrease is primarily the result of: (1) lower discretionary spending in areas
such as advertising and consulting; and (2) lower headcount-related costs and
occupancy spending due to our previous years restructuring plans. These
reductions were partially offset by higher incentive compensation
costs, primarily in the form of sales commissions, in the second
quarter of fiscal 2003.

In the first half of fiscal 2003, SG&A expenses, as a percentage of total net
revenues, decreased to 30.2% from 32.3% in the corresponding period of fiscal
2002. The decrease in the percentage of SG&A expenses to total net revenues is
the result of a decrease in SG&A expenses incurred during the first half of
fiscal 2003, as compared with the level of SG&A expenses incurred during the
first half of fiscal 2002. In dollars, SG&A expenses decreased $215 million to
$1,712 million in the first half of fiscal 2003, as compared with $1,927
million in the first half of fiscal 2002. The dollar decrease is the result of:
(1) lower headcount-related costs and occupancy spending due to our previous
years restructuring plans; and (2) lower discretionary spending in areas such
as advertising and consulting. These reductions were partially offset by (1) a
decreased benefit from our mandatory July 2002 shutdown, as compared with our
mandatory July 2001 shutdown, resulting from fewer required vacation days in
July 2002 as compared with July 2001; and (2) higher incentive compensation
costs, primarily in the form of sales commissions, in the second
quarter of fiscal 2003.

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Restructuring Charges

Fiscal 2003 Restructuring Plan

In October 2002, we committed to and began implementing a workforce reduction
and facility exit plan (Fiscal 2003 Restructuring Plan). The goal of this plan
is to reduce costs and improve operating efficiencies in order to adjust to the
current business environment. Specifically, it is our intent to reduce
headcount to approximately 35,000 employees and to eliminate excess facility
capacity in light of revised facility requirements. In accordance with EITF
Issue No. 94-3, Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring), during the three and six months ended December 29, 2002,
we recognized $308 million in restructuring charges associated with the Fiscal
2003 Restructuring Plan (consisting of a $176 million workforce reduction
charge and a $132 million excess facility charge as discussed below).

During the second quarter of fiscal 2003, we recognized a workforce reduction
charge of $176 million relating to severance and related fringe benefits for
approximately 3,200 employees. The workforce reduction will result in the
termination of employees across all employee levels, business functions,
operating units, and geographic regions. As of December 29, 2002, approximately
2,700 employees had been terminated as a result of the restructuring. We expect
the remaining employees to be terminated during the third and fourth quarters
of fiscal 2003, depending on the local employment laws that govern such
employees. We may incur additional workforce-related charges should
we identify additional individual employees to be terminated in
certain countries and, again, depending on the local employment laws
that govern such employees.

In addition, during the second quarter of fiscal 2003, we recorded a charge of
$132 million relating to the consolidation of excess facilities. The facility
exit charges include:



| |  |  | $114 million of estimated future obligations for
noncancelable lease payments (net of estimated sublease
income of $44 million) or termination fees generated by
exiting excess rental facilities. We estimated the cost of
exiting and terminating the facility leases by referring to
the contractual terms of the agreements and by evaluating
the current real estate market conditions. In addition, we
intend to sublease certain leased facilities and estimated
the sublease income by evaluating the current real estate
market conditions or, where applicable, by referring to
amounts being negotiated;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | $18 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 their carrying value as of December 29, 2002.                                                                                                                                                                                                                                                                      

We expect to exit the facilities relating to the amounts accrued under the
Fiscal 2003 Restructuring Plan by December 29, 2003. At December 29, 2002, we
had an aggregate accrued liability of $236 million with respect to the Fiscal
2003 Restructuring Plan.

Fiscal 2002 Restructuring Plan and Fiscal 2001 Facility Exit Plan

We committed to a restructuring plan in fiscal 2002 (Fiscal 2002 Restructuring
Plan) and a facility exit plan in
fiscal 2001 (Fiscal 2001 Facility Exit Plan). We recorded initial restructuring
charges in fiscal years 2002 and 2001 based on assumptions and related
estimates that were deemed appropriate for the economic environment that
existed at the time these estimates were made. However, due to the continued
deterioration of the commercial real estate market, primarily in the U.S., we
revised certain estimates and made the appropriate adjustments to the initial
restructuring charges recorded during fiscal years 2002 and 2001. Additionally,
during the three and six months ended December 29, 2002, we recognized net
charges of $27 million and $41 million, respectively, related to our Fiscal
2002 Restructuring Plan, and charges of $23 million and $34 million,
respectively, for the Fiscal 2001 Facility Exit Plan, primarily due to
continued deterioration of the commercial real estate market, which resulted in
a reduction of our estimated sublease income on exited facilities. At December
29, 2002, we had an aggregate accrued liability of $272 million with respect to
these two plans.

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Purchased In-Process Research and Development (IPRD)

Overview

We incurred purchased in-process research and development (IPRD) expenses
of $3.5 million in the second quarter and the first half of fiscal 2003 which
represented the write-off of in-process technologies associated with our
acquisitions of: (1) Pirus ($3.3 million); and (2) Terraspring ($0.2 million),
both of which occurred in the second quarter of fiscal 2003. There was $3.2
million of IPRD expenses in the first half of fiscal 2002, associated with the
acquisition of Isopia, Inc, which occurred during the first quarter of fiscal
2002. At the date of each of these acquisitions, the projects associated with
the IPRD efforts had not yet reached technological feasibility and the IPRD had
no alternative future uses. Accordingly, these amounts were expensed on the
respective acquisition dates of each acquired company. See also Note 3 to the
Condensed Consolidated Financial Statements.

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

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Valuation assumptions

The following table summarizes the significant assumptions underlying the
valuation related to the IPRD for the six months ended December 29, 2002
(dollars in millions):



|            |  |      |     |             |  |                |     |              |  |             |    |              |  |             |    |                    |  |                       |    |   |  |  |    |   |  |  |   |   |  |  |    |  
|----------- |  | ---- | --- | ----------- |  | -------------- | --- | ------------ |  | ----------- | -- | ------------ |  | ----------- | -- | ------------------ |  | --------------------- | -- | - |  |  | -- | - |  |  | - | - |  |  | -- | -
|            |  |      |     |             |  |                |     |              |  |             |    |              |  |             |    |                    |  | Percentage of Revenue
|            |  |      |     |             |  | Estimated Cost |     |              |  |             |    |              |  |             |    |                   
|            |  |      |     |             |  | to Complete    |     | Percentage   |  |             |    |              |  |             |    |                    |  |                       |    |   |  |  |    |   |  |  |   |  
|            |  |      |     |             |  | Technology     |     | Completed at |  | Average     |    |              |  |             |    |                    |  |                       |    |   |  |  |    |   |  | 
|Acquired    |  |      |     |             |  | at Time of     |     | Time of      |  | Revenue     |    |              |  |             |    |                    |  |                       |    |   |  |  |    |   |  | 
|Company     |  | IPRD |     | Acquisition |  | Acquisition    |     | Growth Rate  |  | Average COS |    | Average SG&A |  | Average R&D |    | Discount Rate Used
|            |  |      |     |             |  |                |     |              |  |             |    |              |  |             |    |                   
|Pirus       |  | $    | 3.3 |             |  |                | 3.8 |              |  |             | 30 | %            |  |             | 15 | %                  |  |                       | 51 | % |  |  | 31 | % |  |  | 4 | % |  |  | 22 | %
|Terraspring |  | $    | 0.2 |             |  |                | 1.0 |              |  |             | 25 | %            |  |             | 23 | %                  |  |                       | 12 | % |  |  | 22 | % |  |  | 2 | % |  |  | 31 | %

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
achieve 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.

Specifically, at the respective acquisition dates, Pirus was engaged in
development activity associated with certain storage utility switch upgrades
and Terraspring was engaged in development activity associated with certain
upgraded infrastructure software solutions.

Overall status of business
combinations prior to fiscal 2003

Except for the acquisitions discussed
under Note 5 to the Condensed Consolidated Financial Statements, 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, from our estimates
at the time of the acquisitions. 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 as of the quarter ended December 29, 2002, or
results of operations for the two quarters then ended.

Impairment of Goodwill and Other Intangible Assets

Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and
Other Intangible Assets, is the authoritative standard on the accounting for
the impairment of goodwill. SFAS 142 requires that we evaluate on an annual
basis (or whenever events occur which may indicate possible impairment) whether
any portion of our recorded goodwill is impaired. We performed this analysis at
one level below the operating segment level (Note 8) as defined in SFAS 142.
As discussed in our Annual Report on Form 10-K for the fiscal year ended June
30, 2002, this analysis requires management to make a series of critical
assumptions to: (1) evaluate whether any impairment exists; and (2) measure the
amount of impairment.

In October 2002, based on a combination of factors, particularly: (1) our
current and projected operating results; (2) our decision to reduce our
workforce and eliminate excess facility space; and (3) our then current market
capitalization, we concluded there were sufficient indicators to require us to
perform an analysis to assess whether any portion of our recorded goodwill
balance was impaired.

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As part of this analysis, SFAS 142 requires that we estimate the fair value of
our reporting units as compared with their estimated book value. If the
estimated fair value of a reporting unit is less than the estimated book value,
then an impairment is deemed to have occurred. In estimating the fair value of
our reporting units, we primarily used the income approach (which utilizes
forecasted discounted cash flows to estimate the fair value of the reporting
unit) and the market approach (which estimates fair value based on market
prices for comparable companies). We also considered Suns total market
capitalization as of October 17, 2002 (the date we concluded an analysis was
required), and our average market capitalization for the 30 days prior to and
subsequent to October 17, 2002 in order to assess volatility in market
capitalization on that day.

Our last analysis was in the fourth quarter of fiscal 2002. We concluded at
that time, that we did not have any impairment of goodwill based on our then
forecasted discounted cash flows as well as our market capitalization. However,
in October 2002, the estimated fair value of our reporting units decreased because our current forecasted
discounted cash flows and market capitalization were lower than at the time of our previous
analysis. Based on this analysis, we concluded that the goodwill in our Network
Storage and Volume Server reporting units was impaired. As required by SFAS
142, in measuring the amount of goodwill impairment, we made a hypothetical
allocation of the estimated fair value of the reporting units to the tangible
and intangible assets (other than goodwill) within these reporting units. Based
on this allocation, we concluded that all of the recorded goodwill in the
Network Storage reporting unit ($461 million) and the Volume Server reporting
unit ($1,566 million) was impaired and needed to be expensed as a noncash
charge to continuing operations during the second quarter of fiscal 2003.

Based on the considerations outlined in the above discussion on goodwill, in
October 2002, we concluded there were sufficient indicators to require us to
perform an analysis to assess whether a portion of our other intangible assets
was impaired. SFAS 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, is the authoritative standard on the accounting for the
impairment of other intangible assets. As a result of our analysis we recognized an
impairment expense of $98 million in our Product Group reporting segment to
reduce our other intangible assets balance to its fair value during the second
quarter of fiscal 2003. The fair value of the other acquisition-related
intangibles and a revenue generating technology license was determined based
primarily on the income approach, which utilizes discounted cash flows to
estimate the fair value of the asset.

Loss on Equity Investments

(dollars in millions)

|                                       |                            |   |                    |      |                   |   |        |      |                   |  |                   |   |        |   |     |      |    |   |     |      |    |  |      |   | 
|-------------------------------------- | -------------------------- | - | ------------------ | ---- | ----------------- | - | ------ | ---- | ----------------- |  | ----------------- | - | ------ | - | --- | ---- | -- | - | --- | ---- | -- |  | ---- | - | 
|                                       |                            |   | Three Months Ended |      |                   |   |        |      | Six Months Ended  |  |                   |   |       
|                                       |                            |   |                    |      |                   |   |        |      |                   |  |                   |   |       
|                                       |                            |   | December 29, 2002  |      | December 30, 2001 |   | Change |      | December 29, 2002 |  | December 30, 2001 |   | Change
|                                       |                            |   |                    |      |                   |   |        |      |                   |  |                   |   |       
|Gain (loss) on equity investments,
net |                            | $ | (11                | )    |                   | $ | (39    | )    |                   |  | 71.8              | % |        | $ | (42 | )    |    | $ | (58 | )    |    |  | 27.6 | %
|                                       | Percentage of net revenues |   |                    | (0.4 | )%                |   |        | (1.3 | )%                |  |                   |   |        |   |     | (0.7 | )% |   |     | (1.0 | )% |  |      |   | 

Our equity investments portfolio, which primarily consists of investments in
publicly traded and privately-held technology companies contained within our
internally-managed venture capital fund, has continued to be negatively
impacted by the adverse global economic condition of and decreased equity
valuations in the
technology sector during the second quarter of fiscal 2003. The loss on equity
investments in the second quarter and first half of fiscal 2003 of $11 million
and $42 million, respectively, as compared with the $39 million and $58 million
loss in the corresponding periods of fiscal 2002, respectively, was primarily
related to a continuing decline in value of the portfolio that was considered other than
temporary.

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

Interest Income, net
(dollars in millions)

|                     |                            |   |                    |     |                   |   |        |     |                   |  |                   |    |        |   |    |     |   |   |     |     |   |  |       |    | 
|-------------------- | -------------------------- | - | ------------------ | --- | ----------------- | - | ------ | --- | ----------------- |  | ----------------- | -- | ------ | - | -- | --- | - | - | --- | --- | - |  | ----- | -- | 
|                     |                            |   | Three Months Ended |     |                   |   |        |     | Six Months Ended  |  |                   |    |       
|                     |                            |   |                    |     |                   |   |        |     |                   |  |                   |    |       
|                     |                            |   | December 29, 2002  |     | December 30, 2001 |   | Change |     | December 29, 2002 |  | December 30, 2001 |    | Change
|                     |                            |   |                    |     |                   |   |        |     |                   |  |                   |    |       
|Interest income, net |                            | $ | 38                 |     |                   | $ | 68     |     |                   |  | (44.1             | )% |        | $ | 77 |     |   | $ | 175 |     |   |  | (56.0 | )%
|                     | Percentage of net revenues |   |                    | 1.3 | %                 |   |        | 2.2 | %                 |  |                   |    |        |   |    | 1.4 | % |   |     | 2.9 | % |  |       |    | 

In the second quarter and the first half of fiscal 2003, interest income, net,
decreased 44.1% and 56.0%, respectively, as compared with the corresponding
periods of fiscal 2002. The decrease in the second quarter of fiscal 2003, as compared with
the corresponding period of fiscal 2002, is primarily due to a
combination of lower interest rates and lower cash and marketable debt
securities balances. In addition, fewer realized gains on the sale of certain
marketable debt securities were recorded in the first half of fiscal 2003, as
compared with the corresponding period of fiscal 2002.

The average duration of our portfolio of marketable securities decreased to
0.84 years as of December 29, 2002 from 1.36 years as of December 30, 2001. In
general, we would expect the volatility of this portfolio to decrease as its
duration decreases.

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

Income Taxes
(dollars in millions)

|                   |                                 |   |                    |     |                   |   |        |      |                   |  |                   |    |        |   |      |      |   |   |      |      |   |  |       |    | 
|------------------ | ------------------------------- | - | ------------------ | --- | ----------------- | - | ------ | ---- | ----------------- |  | ----------------- | -- | ------ | - | ---- | ---- | - | - | ---- | ---- | - |  | ----- | -- | 
|                   |                                 |   | Three Months Ended |     |                   |   |        |      | Six Months Ended  |  |                   |    |       
|                   |                                 |   |                    |     |                   |   |        |      |                   |  |                   |    |       
|                   |                                 |   | December 29, 2002  |     | December 30, 2001 |   | Change |      | December 29, 2002 |  | December 30, 2001 |    | Change
|                   |                                 |   |                    |     |                   |   |        |      |                   |  |                   |    |       
|Income tax benefit |                                 | $ | (194               | )   |                   | $ | (306   | )    |                   |  | (36.6             | )% |        | $ | (286 | )    |   | $ | (433 | )    |   |  | (33.9 | )%
|                   | Percentage of loss before taxes |   |                    | 7.8 | %                 |   |        | 41.5 | %                 |  |                   |    |        |   |      | 10.7 | % |   |      | 41.5 | % |  |       |    | 

Our effective income tax benefit rate was 7.8% for the second quarter of fiscal
2003 and 10.7% for the first half of fiscal 2003, as compared with an effective
income tax benefit rate of 41.5% for both corresponding periods of fiscal 2002.
The difference in our tax benefit rate for the second quarter and the first
half of fiscal 2003, as compared with the corresponding periods of fiscal 2002
is primarily due to the non-deductibility of goodwill
impairment recognized in the second quarter of fiscal 2003.

Our quarterly tax rate for the third and fourth quarters as well as the full
year of fiscal 2003 will be largely dependent on our profit or loss during such
quarters and could fluctuate significantly.

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Critical Accounting Policies

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

Goodwill

In October 2002, based on a combination of factors, particularly: (1) our
current and projected operating results; (2) our decision to reduce our
workforce and eliminate excess facility space; and (3) our current market
capitalization, we concluded that there were sufficient indicators to require
us to perform an analysis to assess whether any portion of our recorded
goodwill balance was impaired. SFAS 142, Goodwill and Other Intangible
Assets, is the authoritative standard on the accounting for the impairment of
goodwill. After engaging independent valuation experts to assist us in
determining the amount of goodwill impairment, we recognized an impairment
charge of $2,027 million to reduce our goodwill balance to its fair value. This
impairment charge was recognized in the second quarter of fiscal 2003. As of
December 29, 2002, we have a remaining goodwill balance of $326 million which
we will be required to periodically evaluate for further impairments. Any
additional impairments could have a significant impact on our future earnings.

Other Intangible Assets

Pursuant to the considerations outlined in the preceding discussion on
goodwill, in October 2002, we concluded there were sufficient indicators to
require us to perform an analysis to assess whether a portion of our other
intangible assets balance was impaired. SFAS 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, is the authoritative standard on
the accounting for the impairment of other intangible assets. As a result of our analysis
we recognized an impairment charge of $98 million to reduce our other
intangible assets balance to its fair value. As of December 29, 2002, we have a
remaining other intangible assets balance of $148 million, which consists of
$121 million related to intangible assets acquired through business
combinations and $27 million related to a revenue generating technology
license. We will be required to periodically evaluate our other intangible
assets balance for further impairments. Any additional impairments could have
a significant impact on our future earnings.

Stock Options and Incentive Plans

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

|                             |  |           |     |        |  |                     |     |   |  |   |       | 
|---------------------------- |  | --------- | --- | ------ |  | ------------------- | --- | - |  | - | ----- | 
|                             |  |           |     |        |  | Outstanding Options
|                             |  | Shares    |     |       
|                             |  | Available |     | Number |  | Weighted           
|                             |  | for       |     | of     |  | Average            
|                             |  | Grant     |     | Shares |  | Exercise Price     
|                             |  |           |     |        |  |                    
|Balance at June 30, 2002     |  |           | 244 |        |  |                     | 556 |   |  | $ | 15.86 | 
|Additional shares reserved   |  |           | 135 |        |  |                     |    |   |  |   |      | 
|Grants and assumptions       |  |           | (71 | )      |  |                     | 73  |   |  |   | 3.49  | 
|Exercises                    |  |           |    |        |  |                     | (7  | ) |  |   | 1.40  | 
|Cancellations                |  |           | 19  |        |  |                     | (20 | ) |  |   | 16.83 | 
|Plan expiration              |  |           | (17 | )      |  |                     |    |   |  |   |      | 
|                             |  |           |     |        |  |                     |     |   |  |   |       | 
|Balance at December 29, 2002 |  |           | 310 |        |  |                     | 602 |   |  | $ | 14.48 | 
|                             |  |           |     |        |  |                     |     |   |  |   |       | 

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

|                         |  |                     |     |                     |  |           |     |          |  |           |       |           |  |       |    |       |  |          |      |           |  |           |     |  |  |   |       |  |  |   |    |  |  |  |     |  
|------------------------ |  | ------------------- | --- | ------------------- |  | --------- | --- | -------- |  | --------- | ----- | --------- |  | ----- | -- | ----- |  | -------- | ---- | --------- |  | --------- | --- |  |  | - | ----- |  |  | - | -- |  |  |  | --- | -
|                         |  | Outstanding Options |     | Options Exercisable
|                         |  |                     |     |                    
|                         |  |                     |     |                     |  | Weighted  |     |          |  |           |       |           |  |       |    |       |  |          |      |           |  |           |     |  |  |   |       |  |  |   |    |  |  | 
|                         |  |                     |     |                     |  | Average   |     | Weighted |  |           |       |           |  |       |    |       |  |          |      |           |  | Weighted  |     |  |  |   |       |  |  |  
|                         |  |                     |     |                     |  | Remaining |     | Average  |  | Aggregate |       |           |  |       |    |       |  |          |      | Average   |  | Aggregate |     |  |  |  
|                         |  |                     |     |                     |  | Life      |     | Exercise |  | Intrinsic |       | Potential |  |       |    |       |  | Exercise |      | Intrinsic |  | Potential
|Range of Exercise Prices |  | Shares              |     | in Years            |  | Price     |     | Value    |  | Dilution  |       | Shares    |  | Price |    | Value |  | Dilution
|                         |  |                     |     |                     |  |           |     |          |  |           |       |           |  |       |    |       |  |         
|$0.01 - $3.25            |  |                     | 61  |                     |  |           | 2.3 |          |  | $         | 1.84  |           |  | $     | 86 |       |  |          | 1.9  | %         |  |           | 55  |  |  | $ | 1.87  |  |  | $ | 76 |  |  |  | 1.7 | %
|$3.26 - $5.01            |  |                     | 119 |                     |  |           | 5.4 |          |  |           | 3.71  |           |  |       |   |       |  |          | 3.7  | %         |  |           | 53  |  |  |   | 3.68  |  |  |   |   |  |  |  | 1.7 | %
|$5.02 - $10.00           |  |                     | 170 |                     |  |           | 5.5 |          |  |           | 7.33  |           |  |       |   |       |  |          | 5.3  | %         |  |           | 66  |  |  |   | 6.12  |  |  |   |   |  |  |  | 2.1 | %
|$10.01 - $15.00          |  |                     | 53  |                     |  |           | 5.4 |          |  |           | 12.63 |           |  |       |   |       |  |          | 1.7  | %         |  |           | 24  |  |  |   | 12.67 |  |  |   |   |  |  |  | 0.7 | %
|$15.01 - $20.00          |  |                     | 93  |                     |  |           | 5.8 |          |  |           | 17.95 |           |  |       |   |       |  |          | 2.9  | %         |  |           | 28  |  |  |   | 17.62 |  |  |   |   |  |  |  | 0.9 | %
|$20.01 - $40.00          |  |                     | 56  |                     |  |           | 5.3 |          |  |           | 37.64 |           |  |       |   |       |  |          | 1.7  | %         |  |           | 24  |  |  |   | 36.83 |  |  |   |   |  |  |  | 0.7 | %
|$40.00 - $108.30         |  |                     | 50  |                     |  |           | 5.4 |          |  |           | 49.90 |           |  |       |   |       |  |          | 1.6  | %         |  |           | 21  |  |  |   | 49.86 |  |  |   |   |  |  |  | 0.7 | %
|                         |  |                     |     |                     |  |           |     |          |  |           |       |           |  |       |    |       |  |          |      |           |  |           |     |  |  |   |       |  |  |   |    |  |  |  |     |  
|                         |  |                     | 602 |                     |  |           | 5.2 |          |  | $         | 14.48 |           |  | $     | 86 |       |  |          | 18.8 | %         |  |           | 271 |  |  | $ | 12.62 |  |  | $ | 76 |  |  |  | 8.5 | %
|                         |  |                     |     |                     |  |           |     |          |  |           |       |           |  |       |    |       |  |          |      |           |  |           |     |  |  |   |       |  |  |   |    |  |  |  |     |  

The aggregate intrinsic value in the table above represents the total pretax
intrinsic value (i.e., the difference between our closing stock price of $3.25
at December 29, 2002, and the exercise price, times the number of shares) that
would have been received by the option holder had all option holders exercised
their options on December 29, 2002. This amount changes based on the market
value of Suns stock.

Potential dilution is computed by dividing the options in the related range of
exercise prices by the shares of common stock issued, adjusted for treasury
stock, as of December 29, 2002 (3,194 million shares).

The 602 million options outstanding at December 29, 2002 will vest as follows
(in millions):

|                  |  |                 |     |      |  |      |    |      |  |      |    |      |  |      |    |       |  |  |    |  |  |  |    |  |  |  |    |  |  |  |     | 
|----------------- |  | --------------- | --- | ---- |  | ---- | -- | ---- |  | ---- | -- | ---- |  | ---- | -- | ----- |  |  | -- |  |  |  | -- |  |  |  | -- |  |  |  | --- | 
|                  |  | Q2'03 and prior |     | 2003 |  | 2004 |    | 2005 |  | 2006 |    | 2007 |  | 2008 |    | Total
|                  |  |                 |     |      |  |      |    |      |  |      |    |      |  |      |    |      
|Number of Options |  |                 | 271 |      |  |      | 64 |      |  |      | 88 |      |  |      | 76 |       |  |  | 54 |  |  |  | 35 |  |  |  | 14 |  |  |  | 602 | 

Options Granted to the Five Most Highly Compensated Executive Officers

|                  |  |                           |           |                |  |   |      | 
|----------------- |  | ------------------------- | --------- | -------------- |  | - | ---- | 
|Name              |  | Number of Options Granted |           | Exercise Price
|                  |  |                           |           |               
|Scott G. McNealy  |  |                           | 1,000,000 |                |  | $ | 3.70 | 
|Michael E. Lehman |  |                           | 20,000    |                |  | $ | 3.40 | 

At December 29, 2002, only two executive officers named in the Summary
Compensation Table as reported in our Proxy Statement dated
September 30, 2002 were executive officers and/or Board members of Sun.

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Equity Compensation Plan
Information

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

|                                                                            |  |                      |     |                      |  |                           |       |  |  |  |     | 
|--------------------------------------------------------------------------- |  | -------------------- | --- | -------------------- |  | ------------------------- | ----- |  |  |  | --- | 
|                                                                            |  | Number of Securities |     | Weighted Average     |  |                           |       | 
|                                                                            |  | to be Issued upon    |     | Exercise Price of    |  | Number of Securities     
|                                                                            |  | Exercise of          |     | Outstanding Options, |  | Remaining Available      
|                                                                            |  | Outstanding Options, |     | Warrants and Rights  |  | for Future Issuance Under
|Plan Category                                                               |  | Warrants and Rights  |     | (in dollars)         |  | Equity Compensation Plans
|                                                                            |  |                      |     |                      |  |                          
|Equity compensation
plans approved by
security holders
(excluding ESPP)     |  |                      | 582 |                      |  | $                         | 14.64 |  |  |  | 280 | 
|Equity compensation
plans not approved by
security holders
(excluding ESPP) |  |                      | 20  |                      |  | $                         | 9.96  |  |  |  | 30  | 
|                                                                            |  |                      |     |                      |  |                           |       |  |  |  |     | 
|Total (excluding ESPP)                                                      |  |                      | 602 |                      |  | $                         | 14.48 |  |  |  | 310 | 
|                                                                            |  |                      |     |                      |  |                           |       |  |  |  |     | 
|Equity compensation
plans approved by
security holders
(ESPP only)          |  |                      | N/A |                      |  |                           | N/A   |  |  |  | 68  | 
|Equity compensation
plans not approved by
security holders
(ESPP only)      |  |                      | N/A |                      |  |                           | N/A   |  |  |  |    | 
|                                                                            |  |                      |     |                      |  |                           |       |  |  |  |     | 
|Total (ESPP only)                                                           |  |                      | N/A |                      |  |                           | N/A   |  |  |  | 68  | 
|                                                                            |  |                      |     |                      |  |                           |       |  |  |  |     | 
|All Plans                                                                   |  |                      | 602 |                      |  | $                         | 14.56 |  |  |  | 378 | 
|                                                                            |  |                      |     |                      |  |                           |       |  |  |  |     | 

LIQUIDITY, CAPITAL RESOURCES AND
FINANCIAL CONDITION
(dollars in millions)

|                                                            |                            |   |                   |      |               |   |        |      |   |   |      |        | 
|----------------------------------------------------------- | -------------------------- | - | ----------------- | ---- | ------------- | - | ------ | ---- | - | - | ---- | ------ | 
|                                                            |                            |   | December 29, 2002 |      | June 30, 2002 |   | Change
|                                                            |                            |   |                   |      |               |   |       
|Cash and cash equivalents                                   |                            | $ | 1,557             |      |               | $ | 2,024  |      |   | $ | (467 | )     
|Marketable debt securities                                  |                            |   | 3,720             |      |               |   | 3,840  |      |   |   | (120 | )     
|                                                            |                            |   |                   |      |               |   |        |      |   |   |      |       
|Total cash, cash equivalents and
marketable debt securities |                            | $ | 5,277             |      |               | $ | 5,864  |      |   | $ | (587 | )     
|                                                            |                            |   |                   |      |               |   |        |      |   |   |      |       
|                                                            | Percentage of total assets |   |                   | 39.2 | %             |   |        | 35.5 | % |   |      | 3.7pts | 
|Days sales outstanding (DSO)                                |                            |   | 71                |      |               |   | 72     |      |   |   | (1   | )     
|Inventory turns  product only                              |                            |   | 9.0               |      |               |   | 6.7    |      |   |   | 2.3  |       

|                                          |  |                   |      |                   |  |        |      |   |  |   |      |  
|----------------------------------------- |  | ----------------- | ---- | ----------------- |  | ------ | ---- | - |  | - | ---- | -
|                                          |  | Six Months Ended  |      |                   |  |       
|                                          |  |                   |      |                   |  |       
|                                          |  | December 29, 2002 |      | December 30, 2001 |  | Change
|                                          |  |                   |      |                   |  |       
|Cash provided by operating activities     |  | $                 | 323  |                   |  | $      | 415  |   |  | $ | (92  | )
|Cash used in investing activities         |  | $                 | (167 | )                 |  | $      | (517 | ) |  | $ | 350  |  
|Cash used in financing activities         |  | $                 | (623 | )                 |  | $      | (165 | ) |  | $ | (458 | )
|Net decrease in cash and cash equivalents |  | $                 | (467 | )                 |  | $      | (267 | ) |  | $ | (200 | )

Changes in Cash Flow

During the six months ended December 29, 2002, our operating activities
generated cash flows of $323 million. However, during this same period our
cash, cash equivalents and marketable debt securities decreased by $587
million. This decrease was primarily attributable to the $499 million purchase
of our common stock in the open market, the $200 million principal payment on
our issued fixed-rate unsecured senior debt securities (Senior Notes) and the
$270 million capital spending on equipment additions to support product
development and spare parts investments and investments in other assets.

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The decrease in cash flows provided by operating activities during the six
months ended December 29,
2002, resulted from decreases in accounts payable and other liabilities and were
partially offset by decreases in net accounts receivable, and inventory.

Net accounts receivable decreased to $2,291 million at December 29, 2002 from
$2,745 million at June 30, 2002. The decrease in net accounts receivable was
primarily due to the lower volume of sales and a decrease in days of sales
outstanding (DSO). DSO measures the average age (in terms of days) of our
accounts receivable, or in other words, the average time it takes to turn the
receivable into cash. DSO is also an indicator of a companys linearity of
sales for a quarter. There are a number of factors affecting DSO, including our
invoicing, payment terms and collection ability. The decrease in DSO from 72 to
71 days was primarily attributable to the timing of customer payments.

Inventory decreased to $484 million at December 29, 2002 from $591 million at
June 30, 2002 and our inventory turns rate has increased to 9.0 times at
December 29, 2002 from 6.7 at June 30, 2002. Inventory turns is annualized and
represents the number of times it is replenished during the year. The increase
in the inventory turns rate is a function of the lower balance in inventory and
our ability to efficiently manage our inventory to meet customer demands.
Inventory management will continue to be an area of focus as we balance the
need to maintain strategic inventory levels to help ensure competitive lead
times with the risk of inventory obsolescence because of rapidly changing
technology and customer requirements.

Prepaid expenses and other current assets decreased to $729 million at December
29, 2002 from $847 million at June 30, 2002 due to the receipt of an income tax
refund during the second quarter of fiscal 2003, partially offset by increases
in value added tax receivable.

Accounts payable decreased to $809 million at December 29, 2002 from $1,044
million at June 30, 2002. This decrease was primarily due to lower inventory
levels and decreases in related operating activities, partially offset by an
increase in value added tax payable. Our accrued payroll-related liabilities
decreased to $447 million at December 29, 2002 from $538 million at June 30,
2002, as a result of a reduction in accrued incentive compensation costs.
Accrued liabilities decreased to $1,180 million at December 29, 2002 from
$1,201 million at June 30, 2002, as a result of the overall decrease in our
sales and related operational costs. Other non-current obligations increased to
$1,898 million at December 29, 2002 from $1,664 million at June 30, 2002
primarily due to increases in the long-term liability related to our
restructuring plans and increases in the interest rate swap valuation of our
Senior Notes.

Liquidity

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

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Capital Resources and Financial Condition

Our long-term strategy is to maintain a minimum amount of cash and cash
equivalents in subsidiaries for operational purposes and to invest the
remaining amount of our cash in interest bearing and highly liquid cash
equivalents and marketable debt securities. Accordingly, in addition to the
$1,557 million in cash and cash equivalents, we currently have for shorter-term
requirements approximately $3,720 million in marketable debt securities that
are available for future operating, financing and investing activities, for a
total cash and investments position of $5,277 million. However, part of this
balance (approximately $1,463 million at June 30, 2002) represents cash
generated from operations domiciled in foreign tax jurisdictions that are
designated as permanently invested in the respective tax jurisdictions. While
we do not currently believe there is a need to repatriate these funds to the
U.S. in the short-term, if these funds are required for our operations in the
U.S., we would be required to accrue and pay additional taxes to repatriate
these funds.

In addition, we have uncommitted lines of credit aggregating approximately $549
million. No amounts were drawn from these lines of credit as of December 29,
2002. Interest rates and other terms of borrowing under these lines of credit
vary from country to country depending on local market conditions at the time
of borrowing. There is no guarantee that the banks would approve our request
for funds under these uncommitted lines of credit.

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

NON-AUDIT SERVICES OF INDEPENDENT AUDITORS

Our auditors, Ernst & Young LLP, perform the following non-audit services that
have been approved by our Audit Committee of the Board of Directors: expatriate
tax services; international and U.S. tax planning and compliance services; and
tax due diligence for acquisitions. In addition, certain of our
officers, including Scott McNealy our Chairman of the Board of
Directors, President and Chief Executive Officer, retain Ernst & Young LLP to advise them on their personal income taxes.

RISK FACTORS

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

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

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

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

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

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

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

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

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

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

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

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 to
minimize the impact of customer-delayed purchases of existing products in
anticipation of new product releases. We must also try to reduce the levels of
older product and component inventories to minimize inventory write-offs. If we
have excess inventory, it may be necessary to reduce our prices and write down
inventory, which could result in lower gross margins. Additionally, our
customers may delay orders for existing products in anticipation of new product
introductions. As a result, we may decide to adjust prices of our existing
products during this process to try to increase customer demand for these
products. If we are introducing new products at the same time or shortly after
the price adjustment, this will complicate our ability to anticipate customer
demand for our new products. We continuously evaluate the competitiveness of
our product and service offerings. These evaluations could also result in
repricing actions in the near term. Our future operating results would be
adversely affected if such repricing actions were to occur and we were unable
to mitigate the resulting margin pressure by maintaining a favorable mix of
systems, software, service and other products, or if we were unsuccessful in
achieving component cost reductions, operating efficiencies and increasing
sales volumes.

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

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

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

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

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

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

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

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

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

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Our products may have quality issues that could adversely affect our sales and
reputation.

In the course of conducting our business, we experience and address quality
issues. Some of our software and hardware products contain defects, including
defects in our engineering, design and manufacturing processes, as well as
defects in third party components included in our products, which may be
beyond our control. Often defects are identified during our design,
development and manufacturing processes and we are able to correct many of
these. Sometimes defects are identified after introduction and shipment of new
products or enhancements to existing products.

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

Finding solutions to quality issues for our customers can be expensive and may
result in additional warranty and other costs to Sun, reducing our operating
results. Delays in product shipments to our customers will delay revenue
recognition and could adversely affect our revenues and reported results. If
we are unable to fix identified errors or adequately address quality issues,
our relationships with customers can be impaired, our reputation can suffer
and we can lose customers or sales which could have a material adverse effect
on our revenues, operating results, cash flows from operations and financial
condition.

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

Currently more than half of our revenues come from international sales. In
addition, a portion of our operations consists of manufacturing and sales
activities outside of the U.S. Our ability to sell our products and conduct our
operations internationally is subject to a number of risks. Local economic,
political and labor conditions in each country could adversely affect demand
for our products and services or disrupt our operations in these markets.
Currency fluctuations could also adversely affect our business in a number of
ways. Although we take steps to reduce or eliminate certain foreign currency
exposures that can be identified or quantified, we may incur currency
translation losses as a result of our international operations. Further, in the
event that currency fluctuations cause our products to become more expensive in
overseas markets in local currencies, there could be a reduction in demand for
our products or we could lower our pricing in some or all of these markets
resulting in reduced revenue and margins. Alternatively, a weakening dollar
could result in greater costs to us for our overseas operations. Changes to and
compliance with a variety of foreign laws and regulations may increase our cost
of doing business in these jurisdictions. Trade protection measures and import
and export licensing requirements subject us to additional regulation and may
prevent us from shipping products to a particular market, and increase our
operating costs. In addition, we could be subject to regulations, fines and
penalties for violations of import and export regulations such as, our products
being shipped directly or through a third party to certain countries. Such
violations could result in penalties, including prohibiting us from exporting
our products to one or more countries, and could adversely affect our business.
See Part II, Item 1. Legal Proceedings for further discussion.

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

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

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

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

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

Goodwill and Other Intangible Assets. Statement of Financial Accounting
Standards No. 142 (SFAS 142) Goodwill and Other Intangible Assets requires
that we perform an analysis on our goodwill balances to test for impairment on
an annual basis or whenever events occur that may indicate impairment possibly
exists. Under SFAS 142, goodwill is deemed to be impaired if the net book value
of the reporting unit exceeds the estimated fair value. We recognized a
significant impairment charge related to our goodwill and other intangible
asset balances during the second quarter of fiscal 2003. Going forward, we will
continue to review our goodwill and other intangible assets for possible
impairment. Any additional impairment charges could adversely affect our
reported results.

We are dependent on significant customers and specific industries.

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

Adverse Business Conditions in Specific Industries. We also depend on the
telecommunications, financial services and manufacturing industries for a
significant portion of our revenues. Significant reduction in technology
capital spending in these industries, such as we have experienced since the
last half of fiscal 2001, may continue to result in decreased revenues and
earnings. Our revenues are dependent on the level of technology capital
spending in the U.S. and international economies. If the current adverse
economic conditions continue, we would expect that the significant reduction
and deferrals of capital spending would continue. If capital spending continues
to decline in these industries over an extended period of time, our business
will continue to be adversely affected. We continue to execute on our strategy
to reduce our dependence on these industries by expanding our product reach
into new industries, but no assurance can be given that this strategy will be
successful.

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

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

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

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

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

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

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

Business interruptions could adversely affect our business.

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

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

In response to the continuing global economic slowdown, we implemented a new
facility exit plan during the second quarter of fiscal year 2003 as part of our
ongoing efforts to consolidate excess facilities. The continuing general
adverse economic conditions in the United States and in many of the countries
in which we have significant leased properties have resulted in a surplus of
business facilities making it difficult to sublease properties. If the adverse
economic conditions continue, we may be unable to sublease our excess
properties, or
we may not meet our expected estimated levels of subleasing income, and our
results of operations could be negatively affected.

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

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

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

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

Our stock price can be volatile.

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

Our credit rating is subject to downgrade.

In October 2002, Standards & Poors, a credit agency that follows Sun,
downgraded us from triple-B-plus to triple-B rating. In addition,
Standards & Poors and Moodys Investor Services, another credit agency,
continued to place the Company on negative outlook. This reflects those credit
agencies expectations that continued economic weakness and reduced IT spending
will continue over at least the near-term to challenge Suns sales and
profitability. The downgrade by Standards & Poors could increase our costs of
obtaining, or make it more difficult to obtain new debt financing or issue new
debt, either of which could adversely affect our business and financial
condition.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Interest Rate Sensitivity

Our investment portfolio consists primarily of fixed income instruments with an
average duration of 0.84 years as of December 29, 2002. The primary objective
of our investments in debt securities is to preserve principal while maximizing
yields, without significantly increasing risk. These available-for-sale
securities are subject to interest rate risk. The fair market value of these
securities may fluctuate with changes in interest rates. A sensitivity analysis
was performed on this investment portfolio based on a modeling technique that
measures the hypothetical fair market value changes (using a three month
horizon) that would result from a parallel shift in the yield curve of plus 150
basis points (BPS). Based on this analysis, for example, a hypothetical 150 BPS
increase in interest rates would result in an approximate $43 million decrease
in the fair value of our investments in debt securities as of December 29,
2002.

We also entered into various interest-rate swap agreements to modify the
interest characteristics of the Senior Notes so that the interest payable on
the Senior Notes effectively becomes variable and thus matches the variable
interest rate received from our cash and marketable securities. Accordingly,
interest rate fluctuations impact the fair value of our Senior Notes
outstanding, which will be offset by corresponding changes in the fair value of
the swap agreements. However, by entering into these swap agreements, we have a
cash flow exposure related to the risk that interest rates may increase. For
example, a hypothetical 150 BPS increase in interest rates would result in an
approximate $22 million decrease in cash over a year.

Foreign Currency Exchange Risk

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

Based on our foreign currency exchange instruments outstanding at December 29,
2002, we estimate a maximum potential one-day loss in fair value of
approximately $9 million, as compared with $8 million as of September 29, 2002,
using a Value-at-Risk (VAR) model. The VAR model estimates were made assuming
normal market conditions and a 95% confidence level. We used a Monte Carlo
simulation type model that valued foreign currency instruments against three
thousand randomly generated market price paths. Anticipated transactions, firm
commitments, receivables, and accounts payable denominated in foreign
currencies were excluded from the model. The VAR model is a risk estimation
tool, and as such is not intended to represent actual losses in fair value that
will be incurred by us. Additionally, as we utilize foreign currency
instruments for hedging anticipated and firmly committed transactions, a loss
in fair value for those instruments is generally offset by increases in the
value of the underlying exposure. Foreign currency fluctuations did not have a
material impact on our results of operations and financial position during the
three or six month period ended December 29, 2002.

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Equity Security Price Risk

We are exposed to price fluctuations on the marketable portion of equity
securities included in our portfolio of equity investments. These investments
are generally in companies in the high-technology industry sector, many of
which are small capitalization stocks. We typically do not attempt to reduce or
eliminate the market exposure on these securities. A 20% adverse change in
equity prices would result in an approximate $2 million decrease in the fair
value of our available-for-sale equity investments as of December 29, 2002. At
December 29, 2002, these equity securities represented approximately $12
million of the $15 million total fair value of the marketable equity
securities.




ITEM 4. CONTROLS AND PROCEDURES

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

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PART II  OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS

On February 11, 2002, Eastman Kodak Company (Kodak) filed a civil lawsuit
against us, Eastman Kodak Company v. Sun Microsystems, Inc., Civil Action No.
02-CV-6074, in the United States District Court for the Western District of New
York. Kodak filed a First Amended Complaint on March 22, 2002. In the First
Amended Complaint Kodak asserts that some of our products, including those
relating to our JavaTM technology, infringe one or more claims of U.S. Patent
No. 5,206,951, U.S. Patent No. 5,421,012, and U.S. Patent No. 5,226,161
(collectively, the Kodak Patents). Kodak further alleges that we have
contributed to and induced infringement of one or more claims of the Kodak
Patents. Kodak seeks injunctive relief against future infringement,
unspecified damages for past infringement, and attorneys fees and costs. On
May 24, 2002, we filed an Answer to First Amended Complaint and Counterclaims,
denying infringement of any valid and enforceable claim of any of the Kodak
Patents. In the Answer and Counterclaims, we are also seeking declaratory
judgment of noninfringement, invalidity and/or unenforceability of the Kodak
Patents. We further allege that Kodaks claims are barred in whole or in part
by the doctrines of estoppel, laches and patent exhaustion, and that we have
license and/or sublicense rights to the Kodak Patents. This case is at a very
preliminary stage. Discovery has only recently commenced, and a trial has not
been scheduled. Based on discussions over many months with Kodak, we believe
that this suit is without merit and, accordingly, we will defend ourselves and
pursue our counterclaims vigorously. At this time, we cannot forecast with
reasonable certainty the potential costs associated with an adverse outcome of
this matter.

On March 8, 2002, we filed suit against Microsoft Corporation (Microsoft) in
the United States District Court for the Northern District of California,
pursuant to United States and State of California antitrust laws, alleging
numerous illegal acts on the part of Microsoft, including efforts to acquire,
maintain and expand a number of illegal monopolies; illegal tying arrangements;
illegal exclusive dealings; copyright infringement; unreasonable restraints of
trade; and unfair competition. Our requested remedies include: (1) preliminary
injunctions requiring Microsoft to distribute our binary implementation of the
Java Run-time Environment as part of Windows XP and Internet Explorer (must
carry remedy) and to stop the unlicensed distribution of Microsofts Virtual
Machine for Java; (2) a permanent injunction to restore competition to the
markets in which Microsoft is unlawfully attempting to acquire, maintain and
expand a number of monopolies; and (3) compensation for losses we suffered as a
result of Microsofts unlawful actions. On August 9, 2002, the Judicial Panel
on Multidistrict Litigation issued an order transferring our lawsuit to the
District of Maryland, for pretrial proceedings, in the case entitled Microsoft
Corp. Windows Operating System Antitrust Litigation, MDL-1332. We filed an
amended complaint on August 26, 2002, alleging additional illegal tying
arrangements and acts of illegal monopoly maintenance. On December 23, 2002,
the Honorable J. Frederick Motz issued an opinion stating he would grant our
motions seeking a preliminary injunction regarding the must carry remedy and
a preliminary injunction prohibiting distribution of Microsofts Virtual
Machine for Java, subject to the parties conferring on the form of a final
order. On January 15, 2003, a final order was entered by Judge Motz requiring
Microsoft to implement our requested must carry remedy within 120 days for
shipments of Windows XP. We have posted a $25 million bond in relation to the
preliminary injunction. At the January 15, 2003 hearing, Judge Motz also
reversed an earlier order dismissing two of our claims, subject to our filing
of a minor amendment to one of those claims, and denied Microsofts remaining
motions to dismiss. At the conclusion of the pretrial proceedings in MDL-1332,
the lawsuit will return for trial to the Northern District of California. On
January 22, 2003, Microsoft filed an appeal seeking review of Judge Motzs
must carry preliminary injunction and requesting that the injunction be
stayed while such appeal is pending. On February 3, 2003, a panel of the Court
of Appeals for the Fourth Circuit granted Microsofts stay request and granted
a request by both parties for expedited consideration. A hearing has not been
set, but we anticipate the Court of Appeals will hear the matter
at or around the last week of March 2003.

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In early February 2002, Sun and two of its subsidiaries received several
charging letters from the United States Department of Commerce, Bureau of
Industry and Security, Office of Export Enforcement (BIS) claiming that we had
violated export control regulations. The letters relate to sales in 1998 in
Egypt and in 1997 to a reseller in Hong Kong for subsequent resale in the
Peoples Republic of China. The relevant export statutes provide for monetary
penalties, and in some instances, denial of export privileges and exclusion
from practice before the BIS if a violation is found. We are involved in
ongoing settlement discussions with BIS authorities regarding penalties and
remedies. In order to facilitate these discussions, the BIS granted us an
extension until November 1, 2002 to respond to the charging letters. A
subsequent extension was granted until January 31, 2003, and at the
governments request, a further extension was granted until April 30, 2003. As
previously reported, the BIS had informed us verbally that additional charges
probably would be added and would be addressed in the context of the ongoing
investigation and negotiations. On January 16, 2003, the BIS provided us with a
proposed charging letter documenting nineteen (19) proposed additional charges.
To our knowledge, the new charges relate to transactions occurring more than
three years ago, and do not involve any recent transactions. We have submitted
a written response acknowledging the additional proposed charges, without
admitting or denying the alleged conduct, pending further investigation and
discussion with the BIS. Based on settlement discussions with the BIS, we
believe we are reasonably likely to reach a negotiated resolution encompassing
all of these charging letters and that such resolution will not have a material
adverse effect on our operations. Absent a negotiated resolution, an
administrative hearing would be set and, in such case, we would assert a
vigorous defense. We believe that any monetary penalties imposed would not have
a material adverse effect on our financial condition or operating results.
Although we do not believe the evidence would support the extreme sanction of a
denial of export privileges or exclusion from practice before the BIS, any such
penalties would have a material adverse effect on our business.




ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

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

|                         |  |                     |  |                     |            |                     |  |                 
|------------------------ |  | ------------------- |  | ------------------- | ---------- | ------------------- |  | ----------------
|                         |  |                     |  | Number of Shares of |            |                    
|                         |  |                     |  | Sun Common Stock    |            |                    
|                         |  |                     |  | Issued (rounded to  |            | Basis for Exemption
|Name of Company Acquired |  | Date of Acquisition |  | nearest thousand)   |            | from Registration  
|                         |  |                     |  |                     |            |                    
|Pirus Networks, Inc.     |  | November 14, 2002   |  |                     | 50,259,000 |                     |  | Section 3(a)(10)

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

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

We held our Annual Meeting of Stockholders on November 7, 2002. At such
meeting, the following actions were voted upon:



|(a) |  | Election of Directors:
|--- |  | ----------------------

|                   |  |     |               |          |  |  |             | 
|------------------ |  | --- | ------------- | -------- |  |  | ----------- | 
|                   |  | FOR |               | WITHHELD
|                   |  |     |               |         
|Scott G. McNealy   |  |     | 2,583,609,933 |          |  |  | 113,689,137 | 
|James L. Barksdale |  |     | 2,213,551,635 |          |  |  | 483,747,435 | 
|L. John Doerr      |  |     | 2,509,518,223 |          |  |  | 187,780,847 | 
|Judith L. Estrin   |  |     | 2,589,838,963 |          |  |  | 107,460,107 | 
|Robert J. Fisher   |  |     | 2,594,178,957 |          |  |  | 103,120,113 | 
|Michael E. Lehman  |  |     | 2,589,662,417 |          |  |  | 107,636,653 | 
|Robert L. Long     |  |     | 2,587,639,571 |          |  |  | 109,659,499 | 
|M. Kenneth Oshman  |  |     | 2,540,644,384 |          |  |  | 156,654,686 | 
|Naomi O. Seligman  |  |     | 2,593,684,412 |          |  |  | 103,614,658 | 
|Lynn E. Turner     |  |     | 2,596,565,259 |          |  |  | 100,733,811 | 

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



|(b) |  | Amendment of our 1990 Long-Term Equity Incentive Plan to increase the
number of shares of common stock authorized for issuance thereunder by
120,000,000 shares of common stock to an aggregate of 1,287,475,000
shares:
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|              |  |         |             |         |  |           |            |  |  |  |   | 
|------------- |  | ------- | ----------- | ------- |  | --------- | ---------- |  |  |  | - | 
|FOR           |  | AGAINST |             | ABSTAIN |  | NON-VOTES
|              |  |         |             |         |  |          
|1,793,295,743 |  |         | 882,453,159 |         |  |           | 21,550,168 |  |  |  | 0 | 

The amendment was approved.



|(c) |  | Stockholder proposal regarding China business principles
for rights of workers in China:
|--- |  | ----------------------------------------------------------------------------------------

|            |  |         |               |         |  |           |             |  |  |  |               | 
|----------- |  | ------- | ------------- | ------- |  | --------- | ----------- |  |  |  | ------------- | 
|FOR         |  | AGAINST |               | ABSTAIN |  | NON-VOTES
|            |  |         |               |         |  |          
|135,478,699 |  |         | 1,179,837,783 |         |  |           | 112,833,749 |  |  |  | 1,269,148,839 | 

The proposal was not approved.

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



|(a) |  | Exhibits                                                                                                                                                                                                                                                                                                                                                               
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | See Index to Exhibits on pages 53 to 54 hereof.                                                                                                                                                                                                                                                                                                                        
|   
|(b) |  | Reports on Form 8-K                                                                                                                                                                                                                                                                                                                                                    
|   
|    |  | On September 30, 2002, we filed a report on Form 8-K with the Securities
and Exchange Commission containing the Statements under Oath of the
Principal Executive Officer, Scott G. McNealy, and of the Principal
Financial Officer, Stephen T. McGowan, certifying our Annual
Report on Form 10-K for the fiscal year ended June 30, 2002 and our 2002
Proxy Statement.

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SIGNATURES

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

| |  |                                                                                                                           
| |  | --------------------------------------------------------------------------------------------------------------------------
| |  | SUN MICROSYSTEMS, INC.                                                                                                    
| |  |                                                                                                                           
| |  | BY                                                                                                                        
| |  |                                                                                                                           
| |  | /s/ Stephen T. McGowan                                                                                                    
| |  |                                                                                                                           
| |  | Stephen T. McGowanChief Financial Officer and Executive Vice President, 
Corporate Resources
(Principal Financial Officer)
| |  |                                                                                                                           
| |  | /s/ Kenneth A. Barker                                                                                                     
| |  |                                                                                                                           
| |  | Kenneth A. BarkerVice President and Corporate Controller
(Principal Accounting Officer)                                   

Date: February 12, 2003

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CERTIFICATION

I, Scott G. McNealy, certify that:



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



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



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



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



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

Date: February 12, 2003

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

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CERTIFICATION

I, Stephen T. McGowan, certify that:



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



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



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



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

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

Date: February 12, 2003

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

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##### Table of Contents






INDEX TO EXHIBITS

|           |  |                                                                                                                                                                                                                                                                                          
|---------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit    |  |                                                                                                                                                                                                                                                                                          
|Number     |  | Description                                                                                                                                                                                                                                                                              
|           |  |                                                                                                                                                                                                                                                                                          
|3.1 (1)    |  | Registrants Restated Certificate of Incorporation.                                                                                                                                                                                                                                      
|3.2 (2)    |  | Certificate of Amendment of the Restated Certificate of Incorporation of Registrant dated November 8, 2000.                                                                                                                                                                              
|3.3 (3)    |  | Amended and Restated Certificate of Designations dated December 13, 2000.                                                                                                                                                                                                                
|3.4 (14)   |  | Bylaws of the Registrant, as amended September 17, 2002.                                                                                                                                                                                                                                 
|4.8 (4)    |  | Third Amended and Restated Shares Rights Agreement dated July 25, 2002.                                                                                                                                                                                                                  
|4.10 (5)   |  | Indenture, dated August 1, 1999 (the Indenture) between Registrant and The Bank of New York, as Trustee.                                                                                                                                                                               
|4.11 (5)   |  | Form of Subordinated Indenture.                                                                                                                                                                                                                                                          
|4.12 (5)   |  | Officers Certificate Pursuant to Section 301 of the Indenture, without exhibits, establishing the terms
of Registrants Senior Notes.                                                                                                                                                   
|4.13 (5)   |  | Form of Senior Note.                                                                                                                                                                                                                                                                     
|10.64 (6)  |  | Registrants 1988 Directors Stock Option Plan, as amended on August 11, 1999.                                                                                                                                                                                                           
|10.65 (7)  |  | Registrants 1990 Employee Stock Purchase Plan, as amended on August 13, 1997.                                                                                                                                                                                                           
|10.66 (8)  |  | Registrants 1990 Long-Term Equity Incentive Plan, as amended on September 17, 2002.                                                                                                                                                                                                     
|10.66A(9)  |  | Representative form of agreement to Registrants 1990 Long-Term Equity Incentive Plan (LTEIP).                                                                                                                                                                                           
|10.66B(9)  |  | French Sub-Plan to 1990 Long Term Equity Incentive Plan.                                                                                                                                                                                                                                 
|10.84 (10) |  | Registrants Non-Qualified Deferred Compensation Plan, as amended June 30, 2002.                                                                                                                                                                                                         
|10.85 (11) |  | Registrants Section 162(m) Executive Officer Performance-Based Bonus Plan, as amended and restated July
1, 2001.                                                                                                                                                                        
|10.87 (14) |  | Registrants Equity Compensation Acquisition Plan, as amended on July 25, 2002.                                                                                                                                                                                                          
|10.89 (12) |  | Form of Change of Control Agreement executed by each executive officer of Registrant.                                                                                                                                                                                                    
|10.90 (12) |  | Form of Change of Control Agreement executed by Chief Executive Officer of Registrant.                                                                                                                                                                                                   
|10.94 (10) |  | Promissory Notes issued by Robert L. Long on November 12, 2001 and January 10, 2002 and related documents.                                                                                                                                                                               
|10.95 (10) |  | Promissory Notes issued by Masood A. Jabbar on November 7, 2001 and related documents.                                                                                                                                                                                                   
|10.96 (13) |  | Promissory Notes issued by Jonathan I. Schwartz dated October 29, 2001 (Note 1), Promissory Note issued
by Jonathan I. Schwartz dated June 28, 2002 (Note 2), cancellation of Notes 1 and 2 dated July 18, 2002,
and Promissory Note issued by Jonathan I. Schwartz on July 19, 2002.
|10.97 (14) |  | Retirement Transition Agreement dated April 30, 2002, and Resignation dated September 17, 2002, between
the Registrant and Michael Lehman.                                                                                                                                               
|10.98 (14) |  | Retirement Transition Agreement dated April 30, 2002 between the Registrant and Edward Zander.                                                                                                                                                                                           
|10.99 (14) |  | Retirement Transition Agreement dated July 18, 2002 between the Registrant and Masood Jabbar.                                                                                                                                                                                            
|10.100(14) |  | Retirement Transition Agreement dated July 25, 2002 between the Registrant and John Shoemaker.                                                                                                                                                                                           
|10.101(14) |  | Employment Agreement dated January 3, 2001 between the Registrant and David Yen, as amended May 17, 2001.                                                                                                                                                                                
|10.102(14) |  | Retention Bonus Agreement dated September 5, 2002 between the Registrant and Patricia Sueltz.                                                                                                                                                                                            
|10.103(14) |  | Retention Bonus Agreement dated September 5, 2002 between the Registrant and Eva Sage-Gavin.                                                                                                                                                                                             
|10.104(14) |  | Form of Indemnification Agreement executed by each Board member of Registrant.                                                                                                                                                                                                           
|10.105(15) |  | Registrants 1989 French Stock Option Plan, as amended December 23, 2002.                                                                                                                                                                                                                
|15.1       |  | Letter Regarding Unaudited Interim Financial Information.                                                                                                                                                                                                                                
|99.1       |  | Certification of Chief Executive Officer, Scott G. McNealy.                                                                                                                                                                                                                              
|99.2       |  | Certification of Chief Financial Officer, Stephen T. McGowan.                                                                                                                                                                                                                            

53



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##### Table of Contents





|     |  |                                                                                                                                   
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------
|(1)  |  | Incorporated by reference to Registrants Quarterly Report on Form 10-Q for fiscal quarter ended March 29, 1998.                  
|    
|(2)  |  | Incorporated by reference as Exhibit 3.5 to Registrants Quarterly Report on Form 10-Q for fiscal quarter ended December 31, 2000.
|    
|(3)  |  | Incorporated by reference as Exhibit 2.2 to Registrants Form 8-A/ A filed December 20, 2000.                                     
|    
|(4)  |  | Incorporated by reference to the Registrants Form 8-A/ A filed September 26, 2002.                                               
|    
|(5)  |  | Incorporated by reference to Registrants Current Report on Form 8-K filed August 6, 1999.                                        
|    
|(6)  |  | Incorporated by reference to Registrants Annual Report on Form 10-K for the fiscal year ended June 30, 1999.                     
|    
|(7)  |  | Incorporated by reference to Registrants Registration Statement on Form S-8 filed on November 20, 1997.                          
|    
|(8)  |  | Incorporated by reference to Registrants Registration Statement on Form S-8 filed November 20, 2002.                             
|    
|(9)  |  | Incorporated by reference to Registrants Annual Report on Form 10-K for the fiscal year ended June 30, 2001.                     
|    
|(10) |  | Incorporated by reference to Registrants Quarterly Report on Form 10-Q for fiscal quarter ended March 31, 2002.                  
|    
|(11) |  | Incorporated by reference to Registrants Quarterly Report on Form 10-Q for fiscal quarter ended September 30, 2001.              
|    
|(12) |  | Incorporated by reference to Registrants Quarterly Report on Form 10-Q for fiscal quarter ended December 29, 1996.               
|    
|(13) |  | Incorporated by reference to Registrants Current Report on Form 8-K filed on August 9, 2002.                                     
|    
|(14) |  | Incorporated by reference to Registrants Annual Report on Form 10-K for the fiscal year ended June 30, 2002.                     
|    
|(15) |  | Incorporated by reference to Registrants Registration Statement on Form S-8 filed on February 3, 2003.                           

54