<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

(Mark One)

     X      Quarterly report pursuant to Section 13 or 15(d) of the Securities
    ---     Exchange Act of 1934 for the quarterly period ended September 26,
            1999 or

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

                         Commission file number:0-15086

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

<TABLE>
<CAPTION>
                      DELAWARE                                                 94-2805249
<S>                                                                <C>
(State or other jurisdiction of incorporation or organization)     (I.R.S. Employer Identification No.)
</TABLE>

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

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

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

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

                               YES  X   NO
                                   ---     ---


                     APPLICABLE ONLY TO ISSUERS INVOLVED IN
                          BANKRUPTCY PROCEEDINGS DURING
                            THE PRECEDING FIVE YEARS:

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

                               YES      NO
                                   ---     ---


                      APPLICABLE ONLY TO CORPORATE ISSUERS:

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

<TABLE>
<CAPTION>
                  CLASS                    OUTSTANDING AT SEPTEMBER 26, 1999
<S>                                        <C>
  Common Stock -- $0.00067 par value                 781,058,867
</TABLE>

<PAGE>   2

                                      INDEX

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

INDEX                                                                           2

PART I -- FINANCIAL INFORMATION

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

     Item 2 -- Management's Discussion and Analysis of
               Results of Operations and Financial Condition                   11

     Item 3 -- Quantitative and Qualitative Disclosures about
               Market Risk                                                     24

PART II -- OTHER INFORMATION
     Item 1 -- Legal Proceedings                                               25
     Item 5 -- Other Information                                               26
     Item 6 -- Exhibits and Reports on Form 8-K                                28

SIGNATURES                                                                     29
</TABLE>

                                       2
<PAGE>   3

                         PART I -- FINANCIAL INFORMATION

ITEM 1 -- FINANCIAL STATEMENTS

                             SUN MICROSYSTEMS, INC.
                     CONDENSED CONSOLIDATED BALANCE SHEETS

                                 (in thousands)

<TABLE>
<CAPTION>
                                                September 26,        June 30,
                                                    1999               1999
                                                ------------       -----------
                                                 (unaudited)
<S>                                              <C>                <C>
ASSETS
Current assets:
       Cash and cash equivalents                 $  1,925,006       $ 1,088,972
       Short-term investments                       2,188,510         1,576,079
       Accounts receivable, net                     2,150,696         2,286,911
       Inventories                                    405,870           307,873
       Deferred tax assets                            508,791           487,150
       Other current assets                           483,470           369,365
                                                 ------------       -----------
            Total current assets                    7,662,343         6,116,350
Property, plant and equipment, at cost              3,072,845         2,871,348
Accumulated depreciation and amortization          (1,350,264)       (1,262,427)
                                                 ------------       -----------
                                                    1,722,581         1,608,921
Other assets, net                                     747,627           695,081
                                                 ------------       -----------
                                                 $ 10,132,551       $ 8,420,352
                                                 ============       ===========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:

       Short-term borrowings                     $      1,144       $     1,646
       Accounts payable                               736,658           753,838
       Accrued liabilities                          1,732,824         1,646,565
       Income taxes payable                           207,529           402,813
       Other current liabilities                      450,825           422,115
                                                 ------------       -----------
            Total current liabilities               3,128,980         3,226,977
Long-term debt and other obligations                1,880,169           381,595
Total stockholders' equity                          5,123,402         4,811,780
                                                 ------------       -----------
                                                 $ 10,132,551       $ 8,420,352
                                                 ============       ===========
</TABLE>

                             See accompanying notes.

                                       3
<PAGE>   4

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

<TABLE>
<CAPTION>
                                                     Three Months Ended
                                                ----------------------------
                                                September 26,  September 27,
                                                    1999           1998
                                                ------------    ----------
<S>                                             <C>             <C>
Net revenues:
       Products                                   $2,644,217    $2,156,118
       Services                                      477,747       335,066
                                                  ----------    ----------
Total net revenues                                 3,121,964     2,491,184
                                                  ----------    ----------
Cost and expenses:
       Cost of sales-products                      1,201,451       988,237
       Cost of sales-services                        304,646       228,100
       Research and development                      352,550       283,280
       Selling, general and administrative           881,450       711,588
       Purchased in-process research and
            development                                3,500        80,000
                                                  ----------    ----------

           Total costs and expenses                2,743,597     2,291,205
                                                  ----------    ----------
Operating income                                     378,367       199,979
Interest income, net                                  28,282        15,355
                                                  ----------    ----------
Income before income taxes                           406,649       215,334
Provision for income taxes                           135,536       101,460
                                                  ----------    ----------

Net income                                        $  271,113    $  113,874
                                                  ==========    ==========
Net income per common
       share -- basic                             $     0.35    $     0.15
                                                  ==========    ==========
Net income per common
       share -- diluted                           $     0.33    $     0.14
                                                  ==========    ==========
Shares used in the calculation
       of net income per share -- basic              776,711       754,436
                                                  ==========    ==========
Shares used in the calculation
       of net income per share -- diluted            831,378       795,204
                                                  ==========    ==========
</TABLE>

                             See accompanying notes.

                                       4
<PAGE>   5

                             SUN MICROSYSTEMS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

                                   (unaudited)
                                 (in thousands)

<TABLE>
<CAPTION>
                                                                       Three Months Ended
                                                                   ---------------------------
                                                                   September 26,   September 27,
                                                                       1999            1998
                                                                   ------------     ----------
<S>                                                                <C>               <C>
Cash flows from operating activities:
       Net income                                                  $   271,113       $ 113,874
       Adjustments to reconcile net income
                to operating cash flows:
                Depreciation and amortization                          186,610         161,595
                Tax benefit of options exercised                       134,002          42,083
                Purchased in-process research and development            3,500          80,000
                Net decrease in accounts receivable                    138,011          79,241
                Net increase in inventories                            (97,997)        (37,939)
                Net increase (decrease) in accounts payable            (17,741)         58,039
                Net increase in other current
                         and non-current assets                       (157,610)        (86,389)
                Net decrease in other current
                         and non-current liabilities                   (75,840)         (5,472)
                                                                   -----------       ---------
Net cash provided from operating activities                            384,048         405,032
                                                                   -----------       ---------
Cash flows from investing activities:
       Acquisition of property, plant and equipment                   (228,383)       (210,305)
       Acquisition of spare parts and other assets                     (13,308)        (34,661)
       Payments for acquisitions, net of cash acquired                 (66,091)          5,437
       Acquisition of short-term investments                        (1,693,410)       (448,929)
       Sale of short-term investments                                  518,776         118,945
       Maturities of short-term investments                            569,976         108,263
                                                                   -----------       ---------
Net cash used by investing activities                                 (912,440)       (461,250)
                                                                   -----------       ---------
Cash flows from financing activities:
       Issuance of common stock, net                                     8,409          51,364
       Acquisition of treasury stock                                  (181,974)        (72,756)
       Proceeds from employee stock purchase plans                      57,164          25,156
       Net proceeds (reduction) of short-term
            borrowings and other obligations                         1,480,827         (14,449)
                                                                   -----------       ---------
Net cash provided from (used by) financing activities                1,364,426         (10,685)
                                                                   -----------       ---------
Net increase (decrease) in cash and cash equivalents                   836,034         (66,903)
                                                                   -----------       ---------
Cash and cash equivalents, beginning of period                       1,088,972         822,267
                                                                   -----------       ---------
Cash and cash equivalents, end of period                           $ 1,925,006       $ 755,364
                                                                   ===========       =========
</TABLE>

                                       5
<PAGE>   6

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

                                   (unaudited)
                                 (in thousands)

<TABLE>
<CAPTION>
                                                                   Three Months Ended
                                                            --------------------------------
                                                            September 26,      September 27,
                                                                1999              1998
                                                              --------          --------
<S>                                                           <C>               <C>
Supplemental disclosures of cash flow information:
Cash paid during the period for:
         Interest                                             $     62          $    168
         Income taxes                                         $196,798          $ 42,745
Supplemental schedule of non-cash investing activities:
         Stock issued in conjunction with an acquisition      $    723          $140,804
         Fair value of assets acquired                        $ 77,360
         Cash paid for assets                                 $ 66,303
         Liabilities assumed                                  $ 10,334
</TABLE>

                             See accompanying notes.

                                       6
<PAGE>   7

                             SUN MICROSYSTEMS, INC.

        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

BASIS OF PRESENTATION

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

     While the quarterly financial information is unaudited, the financial
     statements included in this report reflect all adjustments (consisting of
     normal recurring accruals) that the Company considers necessary for a fair
     presentation of the results of operations for the interim periods covered
     and of the financial condition of the Company at the date of the interim
     balance sheet. The results for the interim periods are not necessarily
     indicative of the results for the entire year. The information included in
     this report should be read in conjunction with the 1999 Annual Report to
     Stockholders, which is incorporated by reference in the Company's 1999 Form
     10-K.

INVENTORIES (IN THOUSANDS)

<TABLE>
<CAPTION>
                                          September 26, 1999          June 30, 1999
                                          ------------------          -------------
<S>                                       <C>                         <C>
Raw materials                                  $109,428                 $113,070

Work in process                                  56,428                   51,183

Finished goods                                  240,014                  143,620
                                               --------                 --------

                                               $405,870                 $307,873
                                               ========                 ========
</TABLE>


INCOME TAXES

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

RECENT PRONOUNCEMENTS

In June 1998, Financial Accounting Standards No. 133 ("FAS 133"), "Accounting
for Derivative Instruments and Hedging Activities" was issued and was effective
for all fiscal years beginning after June 15, 1999. FAS 133 was subsequently
amended by Financial Accounting Standards No. 137, "Accounting for Derivative
Instruments and Hedging Activities -- Deferral of the Effective Date of FASB
Statement No. 133" and will now be effective for fiscal years beginning after
June 15, 2000, with early adoption permitted. FAS 133, as amended, requires the
Company to recognize all derivatives as either assets or liabilities and measure
those instruments at fair value. It further provides criteria for derivative
instruments to be designated as fair value, cash flow and foreign currency

                                       7
<PAGE>   8

hedges and establishes respective accounting standards for reporting changes in
the fair value of the derivative instruments. Upon adoption, the Company will be
required to adjust hedging instruments to fair value in the balance sheet and
recognize the offsetting gains or losses as adjustments to be reported in net
income or other comprehensive income, as appropriate. The Company has not
completed its assessment of the impact of FAS 133, as amended, on its
consolidated financial position or results of operations and is in the process
of determining when it will adopt FAS 133.

COMPREHENSIVE NET INCOME

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

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

<TABLE>
<CAPTION>
                                                             Three Months Ended
                                                     September 26,         September 27,
                                                         1999                  1998
                                                       ---------             ---------
<S>                                                  <C>                   <C>
Net income                                             $ 271,113             $ 113,874
Unrealized gain (loss) on securities                       7,444               (14,124)
Change in cumulative translation adjustment               (8,482)                  242
                                                       ---------             ---------
Comprehensive net income                               $ 270,075             $  99,992
                                                       =========             =========
</TABLE>


ACQUISITIONS

On August 5, 1999 Sun acquired all of the outstanding capital stock of Star
Division Corporation ("Star Division") by means of a merger transaction pursuant
to which all of the shares of Star Division were converted into the right to
receive cash for total consideration of $59.5 million. Simultaneous with the
acquisition of Star Division, Sun acquired certain assets and liabilities of
Star Division Software-Entwicklung und Vertriebs GmbH ("Star Company"), a
related party of Star Division, for total cash consideration of approximately
$14 million. These transactions were accounted for as purchases, with the excess
purchase price over the estimated fair value of net tangible assets being
allocated to various intangible assets, primarily consisting of developed
technology ($3.3 million), goodwill ($69.7 million), distribution contracts
($1.1 million) and assembled workforce ($1 million). In addition to the
intangible assets acquired, the Company recorded a $3.5 million charge,
representing the write-off of in-process research and development ("IPRD").

On August 28, 1998, the Company acquired all of the outstanding capital stock of
NetDynamics, Inc. ("NetDynamics") by means of a merger transaction pursuant to
which all the shares of NetDynamics capital stock were converted into the right
to receive shares of Sun common stock based upon an agreed-upon exchange ratio
which was calculated using an agreed-upon average market price for Sun common
stock. The Company issued 5,493,570 shares of Sun common stock (with a fair
market value of $24.13 per share) as the consideration for the acquisition.
Additionally, Sun issued 1,136,000 stock options in exchange for NetDynamics
stock options previously outstanding, including 344,000 Sun options in exchange
for vested NetDynamics stock options, with terms similar to Sun stock options.
The fair value of Sun stock options exchanged for rights to vested NetDynamics
stock options at the time of the acquisition was included as part of the
purchase price. The transaction was accounted for as a purchase and the excess
purchase price over the estimated fair value of net

                                       8
<PAGE>   9

tangible assets has been allocated to various intangible assets, primarily
consisting of developed technology ($20 million), goodwill ($36.2 million),
customer base ($10 million) and assembled workforce ($2 million). In addition to
the intangible assets acquired, the Company recorded an $80 million charge,
representing the write-off of IPRD.

The Company calculated amounts allocated to IPRD using established valuation
techniques in the high technology industry and expensed such amounts in the
quarter that each such acquisition was consummated because technological
feasibility of the in-process technology had not been achieved and no alternate
future uses had been established. The Company computed its valuations of IPRD
for the above noted acquisitions using a discounted cash flow analysis on the
anticipated income stream to be generated by the purchased technology.

The excess purchase price over the estimated value of the net tangible assets
was allocated to various intangible assets, consisting primarily of developed
technology and goodwill, as well as other goodwill-like assets, such as customer
base and assembled workforce. The value of developed technology was based upon
future discounted cash flows related to the existing product's projected income
stream. The value of the customer base was determined based upon the value of
existing relationships and the expected revenue stream. The value of the
assembled workforce was based upon the cost to replace that workforce.
Intangible assets, including goodwill, are being amortized over their estimated
useful lives, ranging from two to five years.

The results of operations of Star Division and its related party, Star Company,
from the date of acquisition through September 26, 1999 are included in the
Company's condensed consolidated statements of income and were not material to
the Company.

DEBT OFFERING

On July 14, 1999, the shelf registration statement which Sun filed with the
Securities and Exchange Commission (SEC) on June 18, 1999, relating to the
registration of senior and subordinated debt securities and common and preferred
stock with an aggregate initial offering price of up to $3 billion, became
effective. The securities registered by Sun were in addition to the $1 billion
of securities previously registered and declared effective under a different
shelf registration statement filed with the SEC. On August 4, 1999, the Company
issued $1.5 billion of unsecured senior debt securities in four tranches. Each
tranche is comprised of the following notes (the "Senior Notes"): $200 million
(due on August 15, 2002 and bearing interest at 7%), $250 million (due on August
15, 2004 and bearing interest at 7.35%), $500 million (due on August 15, 2006
and bearing interest at 7.5%), and $550 million (due on August 15, 2009 and
bearing interest at 7.65%). Interest on the Senior Notes will be payable
semi-annually. Sun may redeem all or any part of any tranche of the Senior Notes
at any time at a price equal to 100% of the principal plus accrued and unpaid
interest and an amount as determined by a quotation agent, which represents the
present value of the remaining scheduled payments. Sun anticipates that the net
proceeds from this offering will be used to fund expansion of the Company's
business, including additional working capital, capital expenditures,
acquisition of products, technologies and businesses and general corporate
matters. Sun also entered into various interest rate swap agreements to modify
the interest characteristics of the Senior Notes so that the interest associated
with these Senior Notes becomes variable.

OPERATING SEGMENTS

In fiscal 1999, the Company adopted Financial Accounting Standards No. 131 ("FAS
131"), "Disclosures About Segments of an Enterprise and Related Information."
FAS 131 establishes reporting standards for reporting information about
operating segments and related disclosures about products, geographic
information, and major customers.

                                       9
<PAGE>   10

Although the Company has various divisions, only Computer Systems and Storage
and Enterprise Services are considered reportable segments under the criteria of
FAS 131. Products in the Computer Systems and Storage segment include a broad
range of desktop systems, servers, storage, and network switches, incorporating
the UltraSPARC processors and Solaris operating environment. In the Enterprise
Services segment, the Company provides a full range of services and support to
existing and new customers, including education, professional services, and
systems integration. The Other segment consists of various software and other
miscellaneous divisions, such as corporate, which did not meet the requirements
individually for a reportable segment as defined by FAS 131.

Information on reportable segments is as follows (in thousands):

                               THREE MONTHS ENDED:
                               SEPTEMBER 26, 1999
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                   COMPUTER            ENTERPRISE
                              SYSTEMS AND STORAGE       SERVICES              OTHER                 TOTAL
                              -------------------      ----------           ---------             ----------
<S>                           <C>                      <C>                  <C>                   <C>
Revenues                          $2,484,214            $477,747            $ 160,003             $3,121,964
Interdivision revenues                    --              82,320              (82,320)                    --
Operating income                     495,595              53,065             (170,293)               378,367
</TABLE>


                               THREE MONTHS ENDED:
                               SEPTEMBER 27, 1998
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                   COMPUTER            ENTERPRISE
                              SYSTEMS AND STORAGE       SERVICES              OTHER                 TOTAL
                              -------------------      ----------           ---------             ----------
<S>                           <C>                      <C>                  <C>                   <C>
Revenues                          $2,058,033            $335,066            $  98,085             $2,491,184
Interdivision revenues                    --              76,477              (76,477)                    --
Operating income                     306,256              36,187             (142,464)               199,979
</TABLE>


SUBSEQUENT EVENTS

On October 19, 1999, the Company acquired all of the outstanding capital stock
of Forte Software, Inc. ("Forte"), a publicly-held enterprise tool software
company, by means of a stock-for-stock merger. Under terms of the merger, each
share of Forte common stock was converted to 0.3 shares of Sun common stock.
Additionally, Sun assumed the outstanding Forte stock options, which were
converted to options to purchase Sun common stock based upon the exchange ratio
utilized for the common shares exchanged. The transaction was accounted for as a
pooling of interests and all historic results will be restated. The historic
results of operations of Forte are not expected to be material to the
consolidated financial position or results of operations of the Company.

The Company announced a two-for-one stock split (in the form of a stock
dividend) on September 17, 1999 to be distributed at the close of business on
December 7, 1999 to the stockholders of record as of the close of business on
November 11, 1999. This dividend is subject to stockholder approval of an
increase in the number of authorized shares of the Company's Common Stock to 3.6
billion shares which will be sought at the Company's Annual Meeting of
Stockholders on November 10, 1999.

                                       10
<PAGE>   11

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

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

<TABLE>
<CAPTION>
                                                           Three Months Ended,
                                                     --------------------------------
                                                     September 26,      September 27,
                                                         1999               1998
                                                        ------             ------
<S>                                                  <C>                <C>
Net revenues:
         Products                                        84.7%               86.5%
         Services                                        15.3                13.5
                                                        -----               -----
Total net revenues                                      100.0               100.0
                                                        -----               -----

Cost of sales:
         Products                                        38.4                39.7
         Services                                         9.8                 9.1
                                                        -----               -----
Total cost of sales                                      48.2                48.8
                                                        -----               -----
         Gross margin                                    51.8                51.2
Research and development                                 11.3                11.4
Selling, general and administrative                      28.3                28.6
Purchased in-process research and
         development                                      0.1                 3.2
                                                        -----               -----
Operating income                                         12.1                 8.0
Interest income, net                                      0.9                 0.6
                                                        -----               -----
Income before income taxes                               13.0                 8.6
Provision for income taxes                                4.3                 4.1
                                                        -----               -----
         Net income                                       8.7%                4.5%
                                                        =====               =====
</TABLE>


The following section contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995, particularly statements
regarding Japanese macroeconomic trends, the impact on our gross margin from
shifts in customer purchasing patterns, our expectations to invest in our
services business, services gross margin expectations for fiscal year 2000, our
expectations relating to future research and development and selling, general
and administrative expenses in fiscal year 2000, our expectations to continue
hiring personnel in certain areas, our intention to mitigate interest rate risks
with interest rate swap transactions, expected effective income tax rate for
fiscal 2000 and our beliefs as to our liquidity and capital resources. These
forward-looking statements involve risks and uncertainties, and the cautionary
statements set forth below and those contained in "Future Operating Results,"
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, adverse changes in general economic conditions,
including adverse changes in the specific markets for our products, adverse
business conditions, decreased or lack of growth in the computing industry,
adverse changes in customer order patterns, increased competition, lack of
acceptance of new products, pricing pressures, lack of success in technological
advancements, risks associated with foreign operations (including the downturn
of economic trends and unfavorable currency movements in the Asia Pacific
marketplace), and risks associated with our efforts to comply with Year 2000
requirements. Other factors that may affect such results and financial condition
are set forth in our 1999 Annual Report to Stockholders which is incorporated by
reference in our Form 10-K.

                                       11
<PAGE>   12

RESULTS OF OPERATIONS

NET REVENUES

Net revenues were $3,122 million for the first quarter of fiscal 2000,
representing an increase of 25.3% over the corresponding period of fiscal 1999.

Our products net revenues increased by $488.1 million or 22.6% to $2,644.2
million over the corresponding period of fiscal 1999. More than 50% of the
increase in products revenues in the first quarter of fiscal 2000 is due to
continued strong demand for our enterprise and workgroup servers and increased
revenues generated by our storage products. The growth in products revenue was
partially offset by a decline in high-end desktop system volumes as the result
of a shift in customer purchasing patterns towards workgroup servers. Our
services net revenues increased by $142.7 million or 42.6% to $477.7 million.
The increases in services net revenues in the first quarter of fiscal 2000 in
comparison to the first quarter of fiscal 1999 are primarily the result of a
shift in product mix toward premium priced service and support contracts and a
larger installed product base due to increased product unit sales, as well as
increased revenues associated with our professional and educational services.

Our domestic net revenues increased by 24.6% while our international net
revenues grew 26.2% in the first quarter of fiscal 2000 compared with the
corresponding period of fiscal 1999. In US dollars, European net revenues
increased 23.4%, Rest of World (ROW) net revenues increased 23.6%, and Japanese
net revenues increased 38.9%, in the first quarter of fiscal 2000 when compared
with the corresponding period of fiscal 1999. The increase in Europe is due
primarily to continued market acceptance of our network computing products and
services in Germany and southern European countries, and to a lesser extent from
growth in northern European countries, the United Kingdom and France. Although
we have experienced U.S. dollar revenue growth in the European marketplace on a
year over year basis, there can be no assurance that such trends will continue.
In particular, if capital spending declines in certain countries or industries,
our results of operations and cash flow could suffer. The increases in ROW and
Japan net revenues are attributable to increased demand across the Asia Pacific
region for our products and services. We remain cautious with regard to the
Japanese market and do not expect the current Japanese macroeconomic trends to
change significantly in the near term. In addition, if the economic trends in
Japan significantly worsen in a quarter or decline over an extended period of
time, our results of operations and cash flows could suffer.

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

To mitigate the short-term effect of changes in currency exchange rates on our
non-U.S. dollar-based sales, product procurement, and operating expenses, we
regularly hedge our net non-U.S. dollar-based exposures by

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entering into foreign exchange forward and option contracts to hedge anticipated
transactions. Currently, hedges of transactions do not extend beyond three
months. Given the short term nature of our foreign exchange forward and option
contracts, our exposure to risk associated with currency market movement on the
instruments is not material.

GROSS MARGIN

Total gross margin was 51.8% for the first quarter of fiscal 2000, compared with
51.2% for the corresponding period of fiscal 1999.

Products gross margin was 54.6% in the first quarter of fiscal 2000 compared
with 54.2% for the corresponding period of fiscal 1999. The modest increase in
the products gross margin reflects the effects of increased volumes of higher
margin servers, partially offset by lower margin low-end workstations. There
could be a possible downward impact on our products gross margins as the result
of continued shifts in customer purchasing patterns from high-end desktop
systems toward low-end desktop systems and workgroup servers. Services gross
margin was 36.2% in the first quarter of fiscal 2000, compared with 31.9% for
the corresponding period of fiscal 1999. The increase in services gross margin
reflects the impact of increased market penetration in enterprise data center
accounts, an overall shift toward premium priced service and support contracts
resulting from a larger installed base of high-end server products, continued
growth in professional services, and increased economies of scale in certain
geographic markets. We expect to continue to invest in our services business
through increased headcount, increased spares inventory and other infrastructure
related initiatives. We currently expect our services gross margin to be in the
mid to high thirty percent range for the remainder of fiscal 2000. Additionally,
there can be no assurance that services gross margins will grow at rates
consistent with those previously realized.

We continuously evaluate the competitiveness of our product and service
offerings. These evaluations could 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 and by achieving component cost reductions, operating efficiencies and
increasing volumes.

RESEARCH AND DEVELOPMENT

Our research and development (R&D) expenses increased to $352.5 million in the
first quarter of fiscal 2000, compared with $283.3 million for the corresponding
period of fiscal 1999. As a percentage of net revenues, R&D expenses remained
relatively flat at 11.3% for the first quarter of fiscal 2000 compared with
11.4% in the corresponding period of fiscal 1999. The dollar increase in R&D
expenses in the first quarter of fiscal 2000 over the corresponding period in
fiscal 1999 primarily reflects our continued development of a broad line of
scaleable hardware products, including servers, workstations and storage
technologies, software products which utilize the Java(TM) platform, Solaris(TM)
operating environment software and SPARC(TM) microprocessors. The remaining
increase in R&D expenses is due to further development of products acquired
through acquisitions and increased compensation and compensation-related costs
due primarily to higher levels of R&D staffing. The increase in R&D spending
reflects our belief that to maintain our competitive position in a market
characterized by rapid rates of technological advancement, we must continue to
invest significant resources in new systems, software, and microprocessor
development, as well as in enhancements to existing products. We expect research
and development expenses to increase in dollar amount in fiscal 2000 while
remaining in the range of 11% of revenue in fiscal 2000.

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SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative (SG&A) expenses increased to $881.5 million
in the first quarter of fiscal 2000 compared with $711.6 million for the same
period of fiscal 1999. As a percentage of net revenues, SG&A expenses decreased
to 28.3% in the first quarter of fiscal 2000 from 28.6% in the corresponding
period of fiscal 1999. Overall SG&A spending increased by approximately $169.9
million or 23.9% in the first quarter of fiscal 2000 in comparison with the same
period of fiscal 1999. The dollar increase in fiscal 1999 is primarily
attributable to increased compensation resulting from higher levels of
headcount, principally in the sales organization, annual salary adjustments and
marketing costs related to promotional programs. We also made additional
investments aimed at improving our own business processes. In fiscal 2000, we
expect SG&A expense to increase in dollar amount, as we continue to invest in
efforts to achieve additional operating efficiencies through the continual
review and improvement of business processes. In addition, we expect to continue
to hire personnel to drive demand-creation programs and service and support
organizations.

PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT

The following paragraphs contain forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995, particularly statements
regarding our expectations, including percentage of completion, expected product
release dates, dates for which we expect to begin generating benefits from
projects, expected product capabilities and product life cycles, costs and
efforts to complete projects, growth rates, royalty rates, projected revenues,
cost of revenue and operating expense information used by us to calculate
discounted cash flows and discount rates and our expectations to continue and
successfully complete product development as well as realize our expected
economic return. These forward-looking statements involve risks and
uncertainties, and the cautionary statements including those set forth below and
in "Future Operating Results" identify important factors that could cause actual
results to differ materially from those predicted in any such forward-looking
statement. Such factors include but are not limited to, delays in the
development of in-process technologies or the release of 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 market or general economic conditions. In addition,
there can be no assurance that any of the new products discussed below will be
completed, 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, the complexity of the
technology, changes in customer needs, or for other reasons, including those
described above.

Purchased in-process research and development ("IPRD") of $3.5 million and $80
million, in the first quarter of fiscal 2000 and 1999, respectively, represents
the write-off of in-process technologies associated with our acquisitions of
Star Division Corporation ("Star Division") and certain assets and liabilities
of Star Division Software-Entwicklung und Vertriebs GmbH ("Star Company"), a
related party of Star Division, and NetDynamics, Inc. ("NetDynamics"),
respectively (collectively the "Acquired Companies"). At the date of each
acquisition noted above, the projects associated with the IPRD efforts had not
yet reached technological feasibility and the R&D in process had no alternative
future uses. Accordingly, these amounts were expensed on the respective
acquisition dates of each of the Acquired Companies. Also see Notes to Condensed
Consolidated Financial Statements (Unaudited) -- Acquisitions.

Star Division Corporation and Star Division Software-Entwicklung und Vertriebs
GmbH

On August 5, 1999, we acquired all of the outstanding capital stock of Star
Division by means of a merger transaction pursuant to which all of the shares of
Star Division were converted into the right to receive cash for total
consideration of $59.5 million. Simultaneous with the acquisition of Star
Division, we acquired certain

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<PAGE>   15

assets and liabilities of Star Division Software-Entwicklung und Vertriebs GmbH,
a related party of Star Division, for total cash consideration of approximately
$14 million. (Collectively, these companies are referred to as the "Star
Companies"). These transactions were accounted for as purchases, with the
purchase price being allocated to tangible and intangible assets and IPRD.

IPRD Overview -- Star Companies

At the acquisition date (August 5, 1999), the Star Companies were conducting
development, coding and testing activities associated with the completion of a
new technology which would enable their most recent version of StarOffice to be
utilized in a portal environment (the "Star Product Offering"). The Star Product
Offering is an updated office productivity suite which will provide word
processing, spreadsheet, graphics design, presentation and data base
applications. The Star Product Offering was initially schedule to be released at
the end of calendar 1999. Key product features under development include:

     o    Portal technology that will allow individuals to access office
          applications and data via the Internet from different types of devices
          including cell phones and personal data assistants.

     o    Greater interoperability with other office applications. The Star
          Product Offering will allow corporate intranets and extranets, as well
          as service providers, to host an entire workplace, including
          applications, from a single location which would also be accessible
          via the Internet.

     o    Improved functionality and performance across each office application.

At the acquisition date, the Star Companies had made substantial progress in the
areas of product definition, architecture design, and coding. Remaining efforts
necessary to complete the Star Product Offering relate primarily to additional
coding, testing, and implementation. We anticipate that an early access/beta
version of the Star Product Offering will be available in the second quarter of
fiscal 2000, with a general availability version scheduled for release in the
second half of fiscal 2000 at which time we expect to realize economic benefits
associated with the Star Product Offering.

Valuation Analysis -- Star Companies

We calculated the value of the IPRD technology using a discounted cash flow
analysis on the anticipated income stream of the related product sales. The
discounted cash flow analysis was based upon our forecast of future revenues,
cost of revenues, and operating expenses related to the product and technology
acquired from the Star Companies which are intended to be used in our future
software application products. We projected total company revenue to increase at
a compound growth rate of approximately 31% from fiscal 2000 through 2009. We
also expected revenues for the IPRD to peak in fiscal 2002 (as a percentage of
revenue) and decline thereafter, as we expect to introduce new product
technologies. These projections are based on our estimates of market size and
growth, expected trends in technology, and the expected timing of new product
introductions.

Our assumptions with respect to operating expenses used in the valuation
analysis included: (i) cost of goods sold, (ii) SG&A expenses, and (iii) R&D
expenses. Selected operating expense assumptions we used were based on an
evaluation of the Star Companies' overall business model, including both
historical and expected direct expense levels (as appropriate), and an
assessment of general industry metrics. We project that cost of revenues
(expressed as a percentage of revenue) for the IPRD averages 20% over the
projection period. We estimated SG&A (expressed as a percentage of revenue) for
the IPRD averages 40% over the projection period. Maintenance R&D related to the
IPRD was estimated to be approximately 2% of revenue over the projection period.

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<PAGE>   16

The discount rate we selected for the IPRD was 23%. In the selection of the
appropriate discount rate, we gave consideration to our weighted average cost of
capital (WACC), as well as other factors, including the useful life of the
technology, profitability levels of the technology, the uncertainty of
technology advances that are known at the valuation date, and the stage of
completion of the technology. The discount rate we used for the IPRD was
determined to be greater than our WACC due to the fact that the technology had
not yet reached technological feasibility as of the date of the valuation.

The value of the IPRD reflects the relative value and contribution of the
acquired research and development. We gave consideration to the R&D's stage of
completion, the complexity of the work completed to date, the difficulty
completing the remaining development, costs already incurred, and the projected
cost to complete the project in determining the value assigned to IPRD.

Comparison to Actual Results -- Star Companies

At September 26, 1999, significant progress had been made on the development
related to the Star Product Offering that was underway as of the acquisition
date. We are continuing to invest in the development of new technologies that
were underway at the consummation of the Star Companies acquisition. At
September 26, 1999, we had incurred approximately $1.1 million of the planned
total cost to complete of $7.5 million and no significant adjustments have been
made in the economic assumptions or expectations which underlie our acquisition
decision and related purchase accounting. We are continuing our development
efforts related to the IPRD technology acquired. These development efforts are
advancing at a rate consistent with our expectations.

Given the uncertainties of the development and commercialization process, no
assurance can be given that deviations from these estimates will not occur. We
expect to continue the development of the Star Product Offering and believe that
there is a reasonable chance of successfully completing such development.
However, as there is risk associated with the completion of the in-process
project due to the remaining efforts to achieve technological feasibility,
rapidly changing customer needs, complexity of technology and growing
competitive pressures, there can be no assurance that any project will meet with
either technological or commercial success. Failure to successfully develop and
commercialize this 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.

Overall status of IPRD acquired prior to fiscal 2000

With respect to acquisitions completed prior to fiscal 2000, we believe that the
projections we used in performing our valuations with respect to each
acquisition are still valid in all material respects, however, there can be no
assurance that the projected results will be achieved. We continue to make
substantial progress related to the development of acquired technologies.
Although we have experienced minor delays in the completion of certain of our
development efforts and their related commercialization, the total costs to
complete such technologies have not increased, individually or in aggregate. We
periodically evaluate our product development timeline and modify our overall
business plan in response to various factors. Modifications to our business plan
include the reallocation of resources among various alternative development
projects. The impact of delays in the realization of economic benefits related
to acquire technologies, individually or in aggregate, has not been material to
our overall consolidated financial position or results of operations as of and
for the three months ended September 26, 1999.

We expect to continue the development of each project and believe that there is
a reasonable chance of successfully completing such development efforts.
However, as there is risk associated with the completion of the in-process
projects, there can be no assurance that any project will meet with either
technological or

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<PAGE>   17

commercial success. Failure to successfully develop and commercialize these
in-process projects would result in the loss of the expected economic return
inherent in the fair value allocation. Additionally, the value of other
intangible assets acquired may become impaired.

INTEREST INCOME, NET

Net interest income was $28.3 million for the first quarter of fiscal 2000,
compared with $15.4 million in net interest income for the corresponding period
in fiscal 1999. This increase is primarily the result of higher interest
earnings due to a larger average portfolio of cash and short-term investments.
Our cash and investment portfolio increased in August 1999 due to our issuance
of $1.5 billion of unsecured senior debt securities.

Our interest income and expense are sensitive to changes in the general level of
U.S. interest rates. In this regard, changes in the U.S. interest rates affect
the interest earned on our cash equivalents and short-term investments, as well
as interest paid on our short-term borrowings. To mitigate the impact of
fluctuations in U.S. interest rates, we entered into an interest rate swap
transaction. This swap is intended to better match our floating-rate interest
income on cash equivalents and short-term investments with the interest expense
on our notes payable.

INCOME TAXES

Our effective income tax rate for the first quarter of fiscal 2000 was 33%
before a $3.5 million tax charge resulting from the write-off of IPRD associated
with the acquisition of the Star Companies. Our effective tax rate including
IPRD was 33.3% for the first quarter of fiscal 2000. The effective income tax
rate for the first quarter of fiscal 1999 was 33% before a $30.4 million tax
charge resulting from the write-off of IPRD associated with NetDynamics. We
currently expect an effective tax rate of 33% for fiscal 2000. The expected rate
excludes the impact of potential mergers and acquisitions. The tax effects of
merger and acquisition transactions would be accounted for in the interim
quarter in which the transactions occur. The expected rate is based on current
tax law and current estimates of earnings, and is subject to change.

LIQUIDITY AND CAPITAL RESOURCES

Our financial condition strengthened as of September 26, 1999 when compared with
June 30, 1999. During the first quarter of fiscal 2000, operating activities
generated $384 million in cash and cash equivalents. Non-cash expenses affecting
cash provided by operating activities included depreciation and amortization
expense of $186.6 million, tax benefit of options exercised of $134 million, and
a charge for IPRD of $3.5 million in connection with the acquisition of Star
Companies. Accounts receivable decreased $138 million, due primarily to
increased collection of outstanding balances. Deferred tax assets, other current
and noncurrent assets increased $157.6 million due primarily to the timing of
payments for income and other taxes and the recording of goodwill and other
intangible assets related to our acquisitions. Other current and noncurrent
liabilities increased $75.8 million due primarily to increased compensation and
compensation-related costs, and increases in sales and marketing costs. Accounts
payable increased $17.7 million, due to additional operating expenses associated
with the expansion of our business.

Our investing activities used $912.4 million of cash during the first quarter of
fiscal 2000, an increase of $451.1 million from the $461.3 million used during
the corresponding period in fiscal 1999. The increase is primarily due to
additional short-term investments made as the result of additional cash
available from our $1.5 billion debt offering. Additions to short-term
investments totaled $1,693.4 million, up $1,244.5 million, or 277%, from
additions made during the first quarter of fiscal 1999. Also included in
investing activities is capital spending for real estate development, as well as
capital additions to support increased headcount, primarily in our engineering,
services and marketing organizations.

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Approximately $1,364.4 million of cash was provided from financing activities
during the first quarter of fiscal 2000, compared with $10.7 million used during
the corresponding period in fiscal 1999. The increase in cash provided by
financing activities is primarily due to our issuance of $1.5 billion of
unsecured senior debt securities.

Our exposure to interest rate risk on the international short-term borrowings of
$1.1 million is not material, given the short-term maturity of these instruments
and our evaluation of the potential for rate changes associated with such
instruments.

At September 26, 1999, our primary sources of liquidity consisted of cash, cash
equivalents and short-term investments of $4,113.5 million and a revolving
credit facility with banks aggregating $500 million, which was available subject
to compliance with certain covenants. On October 16, 1997, we filed a shelf
registration statement with the Securities and Exchange Commission relating to
the registration for public offering of senior and subordinated debt securities
and common stock with an aggregate initial public offering price of up to $1
billion. On October 24, 1997, this shelf registration statement became
effective. On June 18, 1999, we filed an additional shelf registration statement
with the Securities and Exchange Commission relating to the registration for
public offering of senior and subordinated debt securities and common and
preferred stock with an aggregate initial public offering price of up to $3
billion. On July 14, 1999, this shelf registration statement became effective.
As a result, we may choose to offer up to $4 billion, from time to time, of debt
securities and common and preferred stock pursuant to Rule 415 in one or more
separate series, in amounts, at prices and on terms to be set forth in the
prospectus contained in these registration statements and in one or more
supplements to the prospectus. On August 4, 1999, we issued $1.5 billion in
unsecured debt securities in four tranches. Each tranche is comprised of the
following notes (the "Senior Notes"): $200 million (due on August 15, 2002 and
bearing interest at 7%), $250 million (due on August 15, 2004 and bearing
interest at 7.35%), $500 million (due on August 15, 2006 and bearing interest at
7.5%), $550 million (due on August 15, 2009 and bearing interest at 7.65%). Sun
also entered into various interest rate swap agreements to modify the interest
characteristics of the Senior Notes so that the interest associated with these
Senior Notes becomes variable.

We believe that the liquidity provided by existing cash and short-term
investments and the borrowing arrangements described above will provide
sufficient capital to meet our requirements through fiscal 2001. We believe the
level of financial resources is a significant competitive factor in our industry
and may choose at any time to raise additional capital through debt or equity
financings to strengthen our financial position, facilitate growth and provide
us with additional flexibility to take advantage of business opportunities that
may arise.

FUTURE OPERATING RESULTS

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

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

Our competitors are some of the largest, most successful companies in the world.
They include Hewlett Packard Company (HP), International Business Machines
Corporation (IBM), Compaq Computer Corporation (Compaq), and EMC Corporation
(EMC). Our future competitive performance depends on a number of factors,
including our ability to: continually develop and introduce new products and
services with better prices and performance than offered by our competitors;
offer a wide range of products and solutions from small

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single-processor systems to large complex enterprise-level systems; offer
solutions to customers that operate effectively within a computing environment
that includes hardware and software from multiple vendors; offer products that
are reliable and that ensure the security of data and information; create
products for which third party software vendors will develop a wide range of
applications; and offer high quality products and services.

We also compete with systems manufacturers and resellers of systems based on
microprocessors from Intel Corporation (Intel) and Windows NT operating system
software from Microsoft Corporation (Microsoft). These competitors include Dell
Computer Corporation (Dell), HP, and Compaq, in addition to Intel and Microsoft.
This competition creates increased pressure, including pricing pressure, on our
workstation and lower-end server product lines. We expect this competitive
pressure to intensify considerably during our fiscal year 2000 with the
anticipated releases of new software products from Microsoft and new
microprocessors from Intel.

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

Over the last two years, we have invested significantly in our storage products
business with a view to increasing the sales of these products both on a
stand-alone basis to customers using the systems of our competitors, and as part
of the systems that we sell. The intelligent storage products business is
intensely competitive. EMC is currently the leader in this market. To the extent
we are unable to penetrate this market and compete effectively, our business and
operating results could be seriously harmed. In addition, we will be making
significant investments over the next few years to develop, market, and sell
software products under our recent alliance with America Online, Inc. (AOL) and
have agreed to significant minimum revenue commitments. These alliance products
are targeted at the e-commerce market and are strategic to our ability to
successfully compete in this market. If we are unable to successfully compete in
this market, our business and operating results could be seriously harmed.

The products we make are very complex and if we are unable to rapidly and
successfully develop and introduce new products, 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 would be seriously harmed. We must quickly develop,
introduce, and deliver in quantity new, complex systems, software, and hardware
products and components including our Ultra SPARC microprocessors, the Solaris
operating environment, our intelligent storage products, and other software
products, such as those products under development or to be developed under our
recent alliance with AOL. The development process for these complicated products
is very uncertain. It requires high levels of innovation from both our product
designers and our 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. In addition,
the successful development of software products under our alliance with AOL
depends on many factors, including our ability to work effectively within the
alliance on complex product development and any encumbrances that may arise from
time to time that may prevent us from developing, marketing, or selling these
alliance software products. If we are unable to successfully develop,

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<PAGE>   20

market, or sell the alliance software products or other software products, our
business and operating results could be seriously harmed.

Software and hardware products such as ours may contain known as well as
undetected errors, and these defects may be found following introduction and
shipment of new products or enhancements to existing products. Although we
attempt to fix errors that we believe would be considered critical by our
customers prior to shipment, we may not be able to detect or fix all such
errors, and this could result in lost revenues and delays in customer
acceptance, and could be detrimental to our business and reputation.

The manufacture and introduction of our new hardware and software products is
also a complicated process. Once we have developed a new product we face the
following 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 so
that we can minimize the impact of customers delaying purchases of existing
products in anticipation of the new product release. We must also try to reduce
the levels of older product and component inventories to minimize inventory
write-offs. We may also decide to adjust prices of our existing products during
this process in order 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.

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

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 Sony for various monitors, and on Texas Instruments for
our SPARC microprocessors. If we were unable to purchase the necessary parts and
components from a particular vendor and we had to find a new supplier for such
parts and components, our new and existing product shipments could be delayed,
severely affecting our business and operating results.

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

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

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

As part of our component inventory planning, we frequently pay certain suppliers
well in advance of receipt of customer orders. For example, we often enter into
noncancelable purchase commitments with vendors early in the manufacturing
process of our microprocessors to make sure we have enough of these components
for our new products to meet customer demand. Because the design and
manufacturing process for these components is very complicated it is possible
that we could experience a design or manufacturing flaw that could delay or even
prevent the production of the components for which we have previously committed
to pay. We also face the risk of ordering too many components, or conversely,
not enough components, since the orders are based on the forecasts of customer
orders rather than actual orders. If we cannot change or be released from the
noncancelable purchase commitments, we could incur significant costs from the
purchase of unusable components, due to a delay in the production of the
components or as a result of inaccurately predicting component orders in advance
of customer orders. Our business and operating results could be seriously harmed
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.

Delays in product development and customer acceptance and implementation of new
products could seriously harm our business. Delays in the development and
introduction of our products may occur for various reasons. For example, delays
in software development could delay shipments of related new hardware products.
Generally, the computer systems we sell to customers incorporate hardware and
software products that we sell, such as the UltraSPARC microprocessor, the
Solaris operating environment and intelligent storage products. Any delay in the
development of the software and hardware included in our systems could delay our
shipment of these systems.

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. Also, customers may wait to implement new systems until after
January 1, 2000 so that there is less likelihood of Year 2000 computer problems.

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

Currently, approximately half of our revenues come from international sales. Our
ability to sell our products internationally is subject to the following risks:
general economic and political conditions in each country could adversely affect
demand for our products and services in these markets; currency exchange rate
fluctuations could result in lower demand for our products, as well as currency
translation losses; changes to and compliance with a variety of foreign laws and
regulations may increase our cost of doing business in these jurisdictions;
trade protection measures and import and export licensing requirements subject
us to additional regulation and may prevent us from shipping products to a
particular market, and increase our operating costs.

                                       21
<PAGE>   22

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 operating results usually fluctuate downward in the first
and third quarters of each fiscal year due to customer buying patterns for
hardware and software products and services.

     Increases in Operating Expenses. Our operating expenses will continue to
increase as we continue to expand our operations. Our operating results could
suffer if our revenues do not increase at least as fast as our expenses.

     Acquisitions/Alliances. If, in the future, we acquire technologies,
products, or businesses, or we form alliances with companies requiring
technology investments or revenue commitments (such as our recent alliance with
AOL), we will face a number of risks to our business. The risks we may encounter
include those associated with integrating or co-managing operations, personnel,
and technologies acquired or licensed, and the potential for unknown liabilities
of the acquired or combined business. Also, we will include amortization expense
of acquired intangible assets in our financial statements for several years
following these acquisitions. Our business and operating results on a quarterly
basis could be harmed if our acquisition or alliance activities are not
successful.

     Significant Customers. Only one of our customers accounted for more than
10% of our revenues in fiscal 1999 and fiscal 1998. Sales to this customer
accounted for approximately 14% of our fiscal 1999 and 1998 revenues. Our
business could suffer if this customer or another significant customer
terminated its business relationship with us or significantly reduced the amount
of business it did with us.

Our failure or the failure of our business partners and customers to be Year
2000 compliant could harm our business.

Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. As the Year 2000
approaches, these code fields will need to be able to distinguish years
beginning with "19" from those beginning with "20." As a result, computer
systems and/or software products used by many companies may need to be upgraded
to comply with such Year 2000 requirements. We are currently expending resources
to review our products and services, as well as our internal use software and
systems, in order to identify and modify those products, services and systems
that are not Year 2000 compliant. We believe that the vast majority of these
costs are not incremental to us but represent a reallocation of existing
resources and include regularly scheduled systems upgrades and maintenance. In
this regard, we have made custom coding enhancements and other necessary
modifications to our mission-critical internal business systems, as well as a
majority of our other internal business systems. We believe that such internal
systems are now Year 2000 compliant. We expect our review and evaluation, and
any remediation necessary of the small number of our remaining internal systems,
which we believe are immaterial to Sun's business and operations will be
complete by December 31, 1999.

Although we believe that the costs associated with the aforementioned Year 2000
efforts are not material, we currently estimate that such costs will be between
$40 to $45 million, of which approximately $31 million has been spent through
September 26, 1999. The aforementioned costs are estimates due in large part to
the fact that we do not separately track the internal labor costs associated
with Year 2000 compliance, unless such costs are incurred by individuals devoted
primarily to Year 2000 compliance efforts. These cost estimates do not include
any potential costs related to any customer or other claim. In addition, these
cost estimates are based on the current assessment of the ongoing activities
described herein, and are subject to change as we continuously

                                       22
<PAGE>   23

monitor these activities. We believe any modifications deemed necessary will be
made on a timely basis and we do not believe that the cost of such modifications
will seriously harm our business. Our expectations as to the costs related to
achieve Year 2000 compliance are forward- looking statements subject to risks
and uncertainties. Actual results may vary materially as a result of a number of
factors, including, among others, those described in this section.

We established a program to assess whether certain of our products are Year 2000
compliant. Under this program, we have performed tests on Sun products listed on
our price lists. To monitor this program and to help customers evaluate their
Year 2000 issues, we have created a web site at http://sun.com/y2000/cpl.html,
which identifies the following categories: products that were released Year 2000
compliant; products that require modifications to be Year 2000 compliant;
products under review; products that are not Year 2000 compliant and need to be
replaced with a Year 2000 compliant product; source code products that could be
modified and implemented without our review; and products that do not process or
manipulate date data or have no date-related technology. We update this list
periodically as our analysis of additional products is completed.

The review and evaluation of our products, services and systems and any
remediation necessary was complete on September 30, 1999, except for the
evaluation of a small number of subcomponents for our products. We believe that
the state of Year 2000 compliance for these components is immaterial to Sun,
however, Sun expects to complete our evaluation and any remediation necessary to
the components by December 31, 1999. As of September 30, 1999, we had not
identified any items or areas that would require material remediation efforts.
Although we believe we have successfully modified our products, services, and
systems as necessary to be Year 2000 compliant, we cannnot be sure that our
products do not contain undetected errors or defects associated with Year 2000
functions that may result in material costs to us. Our business could suffer if
we fail to make our products, services, and systems Year 2000 compliant in time.
In addition, some of our customers are running products that are not Year 2000
compliant and will require an upgrade or other remediation to become Year 2000
compliant. We provide limited warranties as to Year 2000 compliance on certain
of our products and services. Except as specifically provided for in the limited
warranties, we do not believe that we are legally responsible for costs incurred
by customers to achieve Year 2000 compliance. We have been taking steps to
identify affected customers, raise customer awareness related to noncompliance
of our older products and encourage such customers to migrate to current
products or product versions. It is possible that we may experience increased
expenses if we need to upgrade or perform other remediation on products that our
customers are using that are not Year 2000 compliant. Our business may also
materially suffer if customers become concerned about or are dissatisfied with
our products and services as a result of Year 2000 issues.

We also face risks to the extent that suppliers of products, services, and
systems purchased by us or the suppliers of others with whom we transact
business cannot timely provide us with products, components, services, or
systems that meet Year 2000 requirements. To the extent that we are not able to
test technology provided by third-party hardware or software vendors, we are in
the process of carrying out audits and obtaining Year 2000 compliance
certifications from each of our major vendors that their products and internal
systems, as applicable, are Year 2000 compliant. In the event that any such
third parties cannot timely provide us with products, services, or systems that
meet the Year 2000 requirements, our business could be harmed. Furthermore, a
reasonably likely worst-case scenario would be if one of our major vendors
experienced a material disruption in business, which caused us to experience a
material disruption in business. If either our internal systems or the internal
systems, products, or services of one or more of our major vendors (including
banks, energy suppliers, and transportation providers) fail to achieve Year 2000
compliance, our business could be seriously harmed. We have developed
contingency plans to deal with potential Year 2000 problems related to our
internal systems that are deemed to be mission-critical and with respect to
products and services provided by outside vendors. If these plans are not
successful or if new Year 2000 problems not covered by our contingency plans
emerge, our business and operating results may be seriously harmed.

                                       23
<PAGE>   24

Although we believe that the cost of Year 2000 modifications for both internal
use software and systems, as well as Sun's products is not material, we cannot
be sure that various factors relating to the Year 2000 compliance issues will
not seriously harm our business or operating results. For example, a significant
amount of litigation may arise out of Year 2000 compliance issues and we cannot
be sure about the extent to which we may be affected by any of this litigation.
Even though we do not believe that we are legally responsible for our customers'
Year 2000 compliance obligations, it is unclear whether different governments or
governmental agencies may decide to allocate liability relating to Year 2000
compliance to us without regard to specific warranties or warranty disclaimers.
Our business could suffer in any given quarter if any liability is allocated to
us. Furthermore, we do not know how customer spending patterns may be affected
by Year 2000 issues. We believe, however, that many customers could focus on
preparing their businesses for the Year 2000 and that their capital budgets will
be spent in large part on remediation efforts, potentially delaying the purchase
and implementation of new systems, thereby creating less demand for our products
and services. Our business could be harmed if customers delay purchasing our
products during the second quarter of our fiscal Year 2000 because of Year 2000
concerns, or if our customers are unable to conduct their business or are
prevented from placing orders or paying us because of their own Year 2000
problem. A significant disruption of our financial management and control
systems or a lengthy interruption in our operations caused by a Year 2000
related issue could also result in a material adverse impact on our operating
results and financial condition.

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 formed alliances, including
our recent alliance with AOL. Acquisitions and alliance activities often involve
risks, including: we may experience difficulty in assimilating the acquired
operations and employees; we may experience difficulty in managing product
codevelopment activities with our alliance partners; we may be unable to retain
the key employees of the acquired operation; the acquisition or investment may
disrupt our ongoing business; we may not be able to incorporate successfully the
acquired technology and operations into our business and maintain uniform
standards, controls, policies, and procedures; and we may lack the experience to
enter into new markets, products, or technologies.

Some of these factors are beyond our control. Failure to manage these alliance
activities effectively and to integrate acquisitions could affect our operating
results or financial condition.

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

Our employees are vital to our success, and our key management, engineering, and
other employees are difficult to replace. We generally do not have employment
contracts with our key employees. Further, we do not maintain key person life
insurance on any of our employees. The expansion of high technology companies in
Silicon Valley and Colorado, as well as many other cities, has increased demand
and competition for qualified personnel. We may not be able to attract,
assimilate, or retain additional highly qualified employees in the future. These
factors could harm our business.

ITEM 3 -- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our market risk disclosures set forth in the 1999 Form 10-K have not changed
significantly through the first quarter ended September 26, 1999.

                                       24
<PAGE>   25

                          PART II -- OTHER INFORMATION

ITEM 1 -- LEGAL PROCEEDINGS

1.  LEGAL PROCEEDINGS

     On October 7, 1997, we filed suit against Microsoft in the United States
District Court for the Northern District of California alleging breach of
contract, trademark infringement, false advertising, unfair competition,
interference with prospective economic advantage and inducing breach of
contract. We filed an amended complaint on October 14, 1997. Microsoft filed its
answer, affirmative defenses and counterclaims to the amended complaint. The
counterclaims include breach of contract, breach of the covenant of good faith
and fair dealing, violation of the California Business & Professions Code and
declaratory judgment. We believe that the counterclaims are without merit and/or
that we have affirmative defenses and intend vigorously to defend ourselves with
respect thereto. On March 24, 1998 the United States District Court judge ruled
in our favor granting a preliminary injunction directing Microsoft to cease
using our Java Compatible Logo(TM) on Microsoft products that failed to pass the
applicable test suites from Sun. In addition, on May 12, 1998, we filed a second
amended complaint alleging copyright infringement by Microsoft and motions
requesting further preliminary injunctive relief directed against the planned
release by Microsoft of additional products that failed to pass our applicable
test suites. The Court held hearings and arguments on such motions on September
8, 9, and 10, 1998. On November 17, 1998, the District Court issued an Order
granting, in substantial part, our request for preliminary injunctions. On
December 15, 1998 Microsoft filed notice of its intent to appeal the District
Court's Order and on December 18, 1998 Microsoft filed Motions with the District
Court to extend the time for compliance with the Order and to clarify or modify
the Order. On January 13, 1999, Microsoft filed an appeal to the District
Court's Order issued on November 17, 1998. On January 22, 1999, Sun and
Microsoft filed numerous motions for summary judgment with the District Court.
On May 24, 1999, the District Court issued tentative rulings on three pending
motions for summary judgment which were argued on June 24, 1999.

An appellate argument before the Ninth Circuit Court of Appeals relating to the
November 1998 preliminary injunction granted in our favor occurred on June 16,
1999. On August 23, 1999, a three-judge panel of the Ninth Circuit Court of
Appeals issued an opinion and ruling on Microsoft's appeal to that Court of the
November 1998 preliminary injunction issued by the District Court. The Ninth
Circuit panel, in its ruling, found sufficient evidence in the record to support
the District Court's conclusion that Sun is likely to prevail on the merits of
its breach of contract claims against Microsoft. However, the panel vacated the
copyright infringement-based injunction that the District Court had entered and
remanded the case back to the District Court for further consideration. The
Remand Order and the lifting of the injunction took effect on September 13,
1999. The District Court held a hearing regarding the Remand Order on October
15, 1999. If the injunction is not reinstated, Microsoft may, during the
pendency of the case, elect to offer products that fail to pass the applicable
test suites from Sun. We believe that the outcome of this matter will not have a
material adverse impact on our financial condition, results of operations or
cash flows in any given fiscal period.

                                       25
<PAGE>   26

ITEM 5 -- OTHER INFORMATION

SCHEDULE OF SALES BY EXECUTIVE OFFICERS DURING THE QUARTER

     The following is a summary of all sales of our Common Stock by our
     executive officers and directors who are subject to Section 16 of the
     Securities Exchange Act of 1934, as amended, during the fiscal quarter
     ended September 26, 1999:

<TABLE>
<CAPTION>
OFFICER/                                                        NUMBER OF
DIRECTOR                       DATE            PRICE           SHARES SOLD
--------                     -------          --------         -----------
<S>                          <C>              <C>              <C>
William T. Agnello           8/31/99          $79.3958          15,000

Mel Friedman                 8/25/99          $74.9995          57,632
                             8/27/99          $76.0240          52,000

Lawrence W. Hambly           8/12/99          $71.6250          12,072
                             8/24/99          $74.0026          24,000
                             8/25/99          $74.5000          20,000
                             8/26/99          $77.2500          20,000

Masood A. Jabbar             8/26/99          $76.2604          45,000
                             8/27/99          $76.2500          7,500
                             8/27/99          $76.0000          40,000
                             8/27/99          $76.1875          7,500

James Judson                 8/6/99           $70.0687          10,000
                             8/24/99          $74.0000          10,000

Michael E. Lehman            8/6/99           $70.2344          40,000

John E. Marselle             8/26/99          $77.2500          30,000

John S. McFarlane            8/5/99           $70.1250          18,000

Stephen T. McGowan           8/3/99           $71.3750          6,000
                             8/27/99          $77.0000          4,000
                             8/27/99          $76.0000          4,000
                             8/31/99          $79.0000          2,000

Michael H. Morris            7/28/99          $70.9688          16,000
</TABLE>

                                       26
<PAGE>   27

<TABLE>
<S>                          <C>              <C>               <C>
                             8/2/99           $71.3750          16,000

Michael A. Murray            8/25/99          $75.0000          16,000

Alton D. Page                8/11/99          $71.5457          10,000
                             8/31/99          $77.8750          5,000

Gregory M. Papadopoulos      8/27/99          $76.1875          12,000
                             8/31/99          $78.3750          8,000

Frank A. Pinto               8/24/99          $74.0446          70,000

George Reyes                 8/2/99           $70.5000          28,000
                             8/9/99           $70.6250          8,000

Janpieter T. Scheerder       7/28/99          $70.3750          16,000
                             7/28/99          $70.7500          16,000
                             7/30/99          $68.3313          12,000
                             8/2/99           $70.1250          12,000
                             8/2/99           $70.7500          28,000
                             8/2/99           $70.5416          30,000
                             8/9/99           $70.5000          10,400
                             8/11/99          $71.0000          24,000
                             8/25/99          $75.0000          30,000
                             8/25/99          $74.0000          30,000
                             8/31/99          $77.0000          36,000

John C. Shoemaker            8/24/99          $73.6275          14,000
                             8/24/99          $73.6900          5,000
                             8/24/99          $73.8150          5,000
                             8/27/99          $76.7905          24,000

Mark E. Tolliver             8/30/99          $77.5625          10,000

Kevin Walsh                  8/31/99          $78.8750          48,000

Edward J. Zander             7/28/99          $71.0938          25,000
                             7/28/99          $70.9406          10,000
                             7/28/99          $70.6250          15,000
                             8/6/99           $70.3750          25,000
                             8/12/99          $71.4375          12,500
                             8/12/99          $71.0000          12,500
</TABLE>

                                       27
<PAGE>   28

ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K

     a)   EXHIBITS

     27.0 Financial Data Schedule for the period ended September 26, 1999


     b)   REPORTS ON FORM 8-K

     8-K filed with the Securities and Exchange Commission (SEC) on July 23,
     1999, reporting Registrant's earnings for the quarter and fiscal year ended
     June 30, 1999, including condensed consolidated financial statements for
     such periods.

     8-K filed with SEC on August 6, 1999, announcing the completion of a
     multi-tranche debt offering of $1.5 billion aggregate principal amount of
     Senior Notes and filing exhibits related thereto.

     8-K filed with SEC on September 15, 1999, announcing that William J.
     Raduchel, the Registrant's Chief Strategy Officer, had resigned his
     employment with the Registrant effective September 13, 1999.

<PAGE>   29

                                   SIGNATURES

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

SUN MICROSYSTEMS, INC.

BY

                                        /s/ Michael E. Lehman

                                        Michael E. Lehman

                                        Vice President, Corporate Resources

                                        and Chief Financial Officer



                                        /s/ Michael L. Popov

                                        Michael L. Popov

                                        Vice President and Corporate Controller,

                                        Chief Accounting Officer

Dated: November 8, 1999

<PAGE>   30

                                 EXHIBIT INDEX


<TABLE>
<CAPTION>
No.          DESCRIPTION
---          -----------
<S>          <C>
27           Financial Data Schedule
</TABLE>