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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---

FORM 10-K

|                                            |  |                                                                                             
|------------------------------------------- |  | --------------------------------------------------------------------------------------------
|(Mark One)                                  |  |                                                                                             
|x                                           |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|                                           
|For the fiscal year ended June 30,
    2002
|                                           
|o                                           |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|                                           
|                                            |  | For the transition period
    from           to           .                                 

Commission file number 0-15086

SUN MICROSYSTEMS, INC.

(Exact name of registrant as specified in its
charter)


|                                                                                                                  |  |                                                                                                           
|----------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------
|Delaware                                                                                                          |  | 94-2805249                                                                                                
|(State of incorporation)                                                                                          |  | (I.R.S. Employer Identification No.)                                                                      
|                                                                                                                 
|4150 Network Circle
    Santa Clara, CA 95054(Address of principal executive
    offices,
    including zip code) |  | (650) 960-1300(Registrants telephone number,
    including area code)http://www.sun.com(Registrants url)

Securities registered pursuant to
Section 12(b) of the
Act:     None

Securities registered pursuant to
Section 12(g) of the Act:


* Common
Stock


* Share Purchase Rights


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     o

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of the Registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to
this
Form 10-K.     o

The aggregate market value of the voting stock
(Common Stock) held by non-affiliates of the Registrant, as of
September 10, 2002, was approximately $11.0 billion
based upon the last sale price reported for such date on The
Nasdaq National Market. For purposes of this disclosure, shares
of Common Stock held by persons who hold more than 5% of the
outstanding shares of Common Stock and shares held by officers
and directors of the Registrant have been excluded because such
persons may be deemed to be affiliates. This determination is
not necessarily conclusive.

The number of shares of the Registrants
Common Stock (par value $0.00067) outstanding as of
September 10, 2002 was 3,135,404,506.

DOCUMENTS INCORPORATED BY REFERENCE

Parts of the Proxy Statement for the 2002 Annual
Meeting of Stockholders are incorporated by reference into
Items 10, 11, 12 and 13 hereof.



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TABLE OF CONTENTS



|                  |                                                                                               |                                                 |  |  |  |  |  | 
|----------------- | --------------------------------------------------------------------------------------------- | ----------------------------------------------- |  |  |  |  |  | 
|PART I           
|                  | ITEM 1. BUSINESS                                                                             
|                  | ITEM 2. PROPERTIES                                                                           
|                  | ITEM 3. LEGAL PROCEEDINGS                                                                    
|                  | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                  | EXECUTIVE OFFICERS OF THE REGISTRANT                                                         
|PART II          
|                  | ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS            
|                  | ITEM 6. SELECTED FINANCIAL DATA                                                              
|                  | ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                  | ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                          
|                  | ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                          
|                  |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS          
|                  |                                                                                               | CONSOLIDATED BALANCE SHEETS                    
|                  |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS          
|                  |                                                                                               | CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
|                  |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS     
|                  | ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 
|PART III         
|                  | ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                  
|                  | ITEM 11. EXECUTIVE COMPENSATION                                                              
|                  | ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                      
|                  | ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                      
|                  | ITEM 14. CONTROLS AND PROCEDURES                                                             
|PART IV          
|                  | ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                    
|SIGNATURES       
|INDEX TO EXHIBITS
|EXHIBIT 3.4      
|EXHIBIT 10.87    
|EXHIBIT 10.97    
|EXHIBIT 10.98    
|EXHIBIT 10.99    
|EXHIBIT 10.100   
|EXHIBIT 10.101   
|EXHIBIT 10.102   
|EXHIBIT 10.103   
|EXHIBIT 10.104   
|EXHIBIT 21.0     
|EXHIBIT 23.1     
|EXHIBIT 99.1     
|EXHIBIT 99.2     



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INDEX

|                                                                                 |          |                                                     |                                                                                                  |    |   
|-------------------------------------------------------------------------------- | -------- | --------------------------------------------------- | ------------------------------------------------------------------------------------------------ | -- | --
|PART I                                                                           |          |                                                    
|                                                                                 | Item 1.  |                                                     | Business                                                                                         |    | 3 
|                                                                                 | Item 2.  |                                                     | Properties                                                                                       |    | 15
|                                                                                 | Item 3.  |                                                     | Legal Proceedings                                                                                |    | 16
|                                                                                 | Item 4.  |                                                     | Submission of Matters to a Vote of Security
    Holders
    Executive Officers of the Registrant |    | 17
|PART II                                                                          |          |                                                    
|                                                                                 | Item 5.  |                                                     | Market for Registrants Common Equity and
    Related Stockholder Matters                        |    | 20
|                                                                                 | Item 6.  |                                                     | Selected Financial Data                                                                          |    | 21
|                                                                                 | Item 7.  |                                                     | Managements Discussion and Analysis of
    Financial Condition and Results of Operations        |    | 22
|                                                                                 | Item 7A. |                                                     | Quantitative and Qualitative Disclosures About
    Market Risk                                   |    | 48
|                                                                                 | Item 8.  |                                                     | Financial Statements and Supplementary Data                                                      |    | 50
|                                                                                 |          | Consolidated
    Statements of Operations           |                                                                                                  | 51
|                                                                                 |          | Consolidated
    Balance Sheets                     |                                                                                                  | 52
|                                                                                 |          | Consolidated
    Statements of Cash Flows           |                                                                                                  | 53
|                                                                                 |          | Consolidated
    Statements of Stockholders Equity |                                                                                                  | 54
|                                                                                 |          | Notes to
    Consolidated Financial Statements      |                                                                                                  | 55
|                                                                                 | Item 9.  |                                                     | Changes in and Disagreements With Accountants on
    Accounting and Financial Disclosure         |    | 89
|PART III                                                                         |          |                                                    
|                                                                                 | Item 10. |                                                     | Directors and Executive Officers of the Registrant                                               |    | 89
|                                                                                 | Item 11. |                                                     | Executive Compensation                                                                           |    | 89
|                                                                                 | Item 12. |                                                     | Security Ownership of Certain Beneficial Owners
    and Management                               |    | 89
|                                                                                 | Item 13. |                                                     | Certain Relationships and Related Transactions                                                   |    | 89
|                                                                                 | Item 14. |                                                     | Controls and Procedures                                                                          |    | 89
|PART IV                                                                          |          |                                                    
|                                                                                 | Item 15. |                                                     | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K                             |    | 89
|SIGNATURES                                                                       |          | 91                                                 
|SECURITIES EXCHANGE ACT RULE 13a-14 AND
    15d-14 CERTIFICATIONS OF CEO AND CFO |          | 92                                                 

2



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PART I




ITEM
1.     BUSINESS

GENERAL

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

Our products are based on several core
technologies including our SolarisTM Operating
Environment, our UltraSPARC® (UltraSPARC Scalable Processor
Architecture) microprocessor architecture, and the
JavaTM programming language. Key brands associated
with Sun in addition to these are SunTM ONE (Open Net
Environment), our software architecture, products and associated
services for the creation of Services on Demand, the Sun
FireTM series of computer servers, the Sun
StorEdgeTM family of storage hardware and software,
and our Sun BladeTM series of workstations. In August
of 2002, we extended this product line with our first entry
level server, the Sun LX-50 capable of running both the
Solaris Operating Environment and the Linux operating system.

For the fiscal year ended June 30, 2002, we
had revenues of $12.5 billion, employed approximately
39,400 employees, and conducted business in over
100 countries. We were incorporated in California in
February 1982 and reincorporated in Delaware in July 1987.

BUSINESS STRATEGY

Our business strategy is built around our single
focus on network computing, and the computer systems, storage,
software and services to enable our customers to achieve
competitive advantages through the strategic use of information
technology. The core elements of our business strategy include:



|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | An end-to-end architecture that extends our
    common Java technology based programming environment from
    devices as small as smart cards and cell phones to large
    multi-million dollar servers.                                                                                                                                                                                                                                                       
| 
| | On-going innovation in microprocessor
    architecture, systems design, and software to help ensure
    continuing technology leadership and resulting price-performance
    advantage.                                                                                                                                                                                                                                                                        
| 
| | Commitment to open public application programming
    interfaces. Sun believes that our customers are best served when
    they have a choice and a competitive vendor environment. This
    requires that the industry agree on programming standards and
    compete to create the highest quality implementation.                                                                                                                                           
| 
| | A robust partner community. We cultivate a large
    community of commercial software developers, system integrators,
    and resellers to add value to Sun products and services and to
    extend our reach and expertise. Our partner community enables us
    to deliver an increasing level of integration of our systems,
    storage, software and services to make our solutions faster to
    deploy and to help ensure the best possible performance.
| 
| | A direct sales organization for large customer
    accounts increasingly organized to deliver a single point of
    contact with Sun.                                                                                                                                                                                                                                                                                                                          
| 
| | A mission-critical support organization staffed
    worldwide to help ensure high satisfaction and profitable use of
    our products.                                                                                                                                                                                                                                                                                                                         

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| |                        
| | -----------------------
| | End-to-End Architecture

Developing and deploying services over the
network requires an infrastructure platform that is enterprise
ready, developer rich and economically compelling. This means
that rather than offering the customer the cheapest server or
storage array, we are focused on providing the combination of
software and hardware that will give them the best value
including: (1) minimize porting and migration costs when
upgrading; (2) maximize system uptime and availability; and
(3) provide the richest applications suite to a growing
developer community. With this strategy, we believe we are able
to offer the customer a platform that entails less annual
administrative costs, developer training costs, and downtime
costs, which decreases customers total cost of
ownership.

In fiscal 2002, we introduced a number of new
products supporting our strategy as an end-to-end infrastructure
platform company and we completed the roll out of our
UltraSPARC III microprocessor across our low, mid and
high-end server lines. The UltraSPARC III processor is
fully binary compatible with our previous generation processor,
so customers can run existing applications without the time and
cost of rewriting applications. In addition, we released our
Solaris 9 operating system, which has created significant
benefits to customers as it reduces system downtime and upgrade
costs because it is designed to run all existing applications
currently running on previous Solaris OE releases.

We also introduced a new line of low-end servers
running the Linux Operating System on our UltraSPARC
microprocessor as well as the Solaris Operating Environment on
the X86 platform edition microprocessor architecture. These
servers are part of our larger strategy to deliver highly dense
racks of low cost and very manageable server groups that are
based on open application programming interfaces.

Our Sun ONE platform consists of a number of
Suns powerful and scalable products, including the Solaris
Operating Environment, Sun ONE middleware products, and the Sun
ONE Studio development environment. It also builds upon our
well-established Java technology to help enable the creation and
deployment of Sun ONE Services on Demand (i.e., the ability to
provide information, data and applications anywhere, anytime and
on any device, using open application programming interfaces
that will work with a wide array of operating systems and
applications).



| |           
| | ----------
| | Innovation

We believe that in order to be a leading
developer of enterprise and network computing products and
technologies, we must continue to invest and innovate. As
indicated by our research and development investments of
approximately 10-15% of annual revenues during each of the last
three fiscal years, we are continually focused on technological
innovation. Over the past few years, we have made significant
investments in several of our product technologies. These
investments include:



|  |                                                                                                                                                                                                                       
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | the highly scalable UltraSPARC processor and
    systems architecture;                                                                                                                                                
| 
| | our highly reliable and scalable Solaris
    Operating Environment;                                                                                                                                                   
| 
| | mission critical clustering, messaging, directory
    and web services infrastructure;                                                                                                                                
| 
| | the cross-platform Java software development
    environment, spanning smart cards, cellular handsets, set top
    boxes, desktop computers, and servers  used by our
    customers and independent software vendors;
| 
| | our highly scalable enterprise servers, from
    entry level to data center class, and workstations; and                                                                                                              
| 
| | network-based storage systems and software,
    including Sun HighGroundTM storage management
    software and SunTM QFS and SunTM SAM-FS
    software.                                                               

In addition, during the first quarter of fiscal
year 2003, we introduced our first line of X86 microprocessor
general purpose entry level servers that can run either the
Solaris Operating Environment or Linux open-source operating
system. We intend to continue our investments into new computing
technologies and are focused on continuing to develop and
deliver leading-edge network computing products based upon our
innovations.

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Many of these technologies provide us with a
competitive advantage and differentiation in the marketplace. We
believe by investing in research and development, we are able to
develop and deliver more valuable systems technology to our
customers, and therefore, are able to generate better long-term
profit margins on our products.



| |                                                   
| | --------------------------------------------------
| | Open Application Programming Interfaces
    (APIs)

From inception, we have focused on developing
products and technologies based upon open APIs. We coined the
phrase, The Network is the ComputerTM.
Behind that simple phrase is the belief that the real power in
computing lies in the ability to freely access and share
information over the network, while unconstrained by proprietary
software and hardware standards. In short, the network has
become an integral part of our personal lives and our economy.
Individuals access e-mail, the Internet, or private corporate
networks through multiple devices including personal computers,
cell phones, personal digital assistants, and even automobiles.
Companies are interested in using networking technologies to
link various constituencies across their organizations to better
share information and intelligence, to streamline processes,
gain efficiencies, accelerate time to market for key products,
improve customer service, and ultimately gain competitive
advantage.

The need for open APIs is at the heart of the
Internets development. We believe that without them, too
many proprietary software and hardware protocols cause both
incompatibility and cost issues, making it too difficult and
uneconomical for individuals and organizations to fully access
and harness the network. Through open APIs, we believe
application adoption and service deployments over the network
will grow more quickly, which will increase the workload on the
network, leading to increased demand for our computer systems.
In addition, by adhering to open APIs, we are able to deliver
more flexible and compatible systems products to our customers,
reducing administrative costs and adding to the demand for our
systems. For example, we have created technologies, such as the
Network File System (NFS), UltraSPARC architecture and the Java
technologies, providing customers with flexibility for their
networking environments, and facilitating industry growth. In
addition, through our Sun ONE software platform, we have
extended our well-established Java technology platform and
utilized Web industry standards including XML (Extensible Markup
Language), SOAP (Simple Object Access Protocol), UDDI (Universal
Description, Discovery and Integration) and WSDL (Web Services
Description Language).

Partner Community

While our product and service offerings are very
broad, we recognize that no single supplier of computing
solutions can meet all of the needs of all of its customers. We
have established relationships with leading value-added
resellers, original equipment manufacturers, channel development
providers, independent distributors, independent software
vendors, and computer systems integrators to deliver solutions
that our customers demand. Through these relationships, we are
able to provide the end-to-end solutions that customers require
to compete. As an extension of this strategy, in fiscal 2002, we
entered into an OEM agreement with Hitachi Data Systems to
provide highly reliable and available storage to the datacenter
through the offering of the Sun StorEdge 9900 series of storage
systems.



| |             
| | ------------
| | Direct Sales

Our sales force serves the telecommunications,
financial services, government, manufacturing, education,
retail, life sciences, media and entertainment and healthcare.
Our direct sales organization for large customer accounts are
increasingly organized to deliver a single point of contact with
Sun. We have approximately 140 sales and service offices in
the United States and 150 sales and service offices in
45 countries.



| |                         
| | ------------------------
| | Mission Critical Support

We provide expertise in network computing through
a broad range of global services, including support services
(systems support for hardware and software), professional
services (IT consulting, systems integration and system/
network management), and educational services (education
consulting, skills migration and training).

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BUSINESS ORGANIZATION

To facilitate innovation and provide world-class
support for our global client base, we have focused our
organization on the following products and services businesses.
Each provides products and services for commercial and technical
computing. The primary competitive differentiators for these
products in the marketplace are their price/performance,
scalability and reliability.



| |                            
| | ---------------------------
| | Enterprise Systems Products

The Enterprise Systems Products group provides an
integrated family of mid-range and high-end enterprise servers
systems for mission critical and high-performance computing
environments. These products run application environments,
directories, databases, web sites and many other applications.



| |                        
| | -----------------------
| | Volume Systems Products

The Volume Systems Products group provides entry
enterprise servers, blade computing (management of a pool of
modular, single board servers, as one computing environment,
which allows companies to dynamically allocate and re-allocate
resources to changing workloads) and workstations with low price
point and high computing density for horizontally scalable
environments (large computing environments composed of clusters
of smaller servers). The entry servers deliver network computing
in a compact package, with a range of options in processing
power, form factor and scalability.



| |                                   
| | ----------------------------------
| | Processor and Network
    Products

The Processor and Network Products group develops
UltraSPARC microprocessors, associated companion application
specific integrated circuits (ASICS), and leading-edge Network
and Cryptographic products and technologies. At the heart of Sun
systems, these components deliver world-class performance,
scalability, and security to products ranging in price from less
than $1,000 to multi-million dollar solutions, while maintaining
binary compatibility across the entire spectrum.



| |                
| | ---------------
| | Network Storage

The Network Storage group directly, and through
third party relationships, provides complete storage solutions
for an end-to-end IT infrastructure, from the operating system
to servers, storage, software, services, and support. Suns
complete Sun StorEdge arrays are optimized for Suns
end-to-end infrastructure, while supporting heterogeneous
environments.



| |         
| | --------
| | Software

The Software group designs, develops and brings
to market our Sun ONE software offerings, including the Solaris
Operating Environment, the Java platform, Sun ONE middleware,
our core technologies for consumer and embedded markets, which
utilize the Java technology, JiniTM network
technology, software development tools and our
StarOfficeTM application software, which are based
upon open source standards, including XML technology.



| |                                                 
| | ------------------------------------------------
| | Sun Services (formerly Enterprise Services
    )

The Sun Services group provides a broad range of
worldwide services for our network computing environment. These
services include design, implementation and operation of
enterprise and Internet computing environments, systems
integration and support, professional services and education.

PRODUCTS

Our products and technologies, from our
microprocessors to our Solaris Operating Environment to our full
line of low-end and high-end scalable workgroup and enterprise
servers, are designed, developed and produced for the network
computing environment.

6



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Enterprise Systems Products

Data Center/ High-Performance Computing
Servers.In
the data center/high-performance computing server group, we
offer the Sun Fire 15K, the Sun Fire 12K, and the Sun
EnterpriseTM 10000 servers. The Sun Fire 15K is
one of the most scalable UNIX® platform-based systems in
the marketplace, which incorporates our UltraSPARC III
microprocessor, mainframe features such as dynamic partitioning
(Dynamic System Domains) and a supercomputer-class
Gigaplane-XBTM interconnect. The Sun Fire 15K
server and the Sun Fire 12K are designed to offer greater
performance and lower total cost of ownership than mainframe
products. They are used for consolidations, application
migrations, data mining and warehousing, custom applications,
on-line transaction support, enterprise resource planning, high
performance technical computing and databases. The Sun
Enterprise 10000 server is our legacy product offering
similar features as our Sun Fire 15K while running on our
UltraSPARC II processor.

Mid-Range
Servers.We
offer nine midrange server products. Midrange servers provide
reliability, availability and scalability to address the needs
of data centers and enterprise-scale network computing at a
moderate cost. Our Sun Fire 3800, Sun Fire 4800, Sun
Fire 4810, and Sun Fire 6800 servers were introduced
in fiscal 2001 and utilize the UltraSPARC III processor and
the Solaris 8 Operating Environment. With these servers, we
have enhanced processing power and various options available in
processor and memory expandability, hardware redundancy and
component accessibility. The Sun Fire 880R server was released
in fiscal 2002 and uses the UltraSPARC III processor. It is
built to deliver the most enhanced multiprocessing capability to
the low-end of our family of Sun Fire servers. The Sun
Enterprise 3500, Sun Enterprise 4500, Sun Enterprise
5500, and Sun Enterprise 6500 servers are our legacy systems
that offer similar features while utilizing the
UltraSPARC II processor and Solaris 7 Operating
Environment.

Volume Systems Products

Entry Servers.We offer four high-end entry server
products: the Sun Fire 880, Sun Fire 480R, Sun Enterprise
420R, and the NetraTM t 1400/1405 servers. In
addition, we offer 10 low-end entry server products: the
Sun Fire V100, Sun Fire V120, Sun Fire 280R, Sun
Enterprise 250, Netra 120, Netra t1 200/205,
Netra t 1120/1125, Netra 20, CT400 and
Netra CT800. Low-end entry servers deliver network
computing in a compact, low-cost package. The Netra CT servers
are high density rack mountable servers, based on the Compact
PCI standard, for telecommunication and network equipment
providers.

In fiscal 2003, we introduced our first line of
entry level X86 servers, the Sun LX50, which provide
high density scalable solutions for Solaris and the Linux
operating environments. This line is in addition to the Sun
Linux-based Cobalt Appliance Servers, which include the Sun
Cobalt QubeTM and the Sun Cobalt RaQTM
series (4, 4i, 4r, XTR and 550), which have been
designed to run Internet-related applications including file
serving and web hosting, and support software applications such
as electronic mail and electronic commerce.

Workstations and Information
Appliances.Our workstation products include the
Sun Blade 100 and Sun Blade 2000 workstations. Sun
information appliances include Sun RayTM 100 and
Sun Ray 150 enterprise appliances.



| |                                   
| | ----------------------------------
| | Processor and Network
    Products

UltraSPARC s-Series processors power the high-end
and midrange server products from Sun, as well as, power
desktops. These CPUs offer our highest level of performance,
unmatched scalability and leading-edge RAS.

UltraSPARC i-Series processors offer a higher
level of integration on the central processing unit enabling the
price and performance design points deployed in Suns
workgroup servers, rack mount servers, and high performance
desktops.

UltraSPARC e-Series processors balance cost,
power consumption and performance enabling economical, 64-bit
server and desktop solutions, while maintaining binary
compatibility with all SPARC® processors, past and present.

7



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Suns Network and Cryptographic portfolio
includes solutions based on technologies such as Ethernet, SSL
(secure socket layer) and IPSec VPN (virtual private network),
enabling high speed, secure network solutions.



| |                
| | ---------------
| | Network Storage

High-End Data Center
Storage.In
fiscal 2002, we signed an OEM agreement with Hitachi Data
Systems to distribute their high-end storage product with our
resource management and file management software as the Sun
StorEdge 9900 series. Designed for extreme availability,
performance, scalability, connectivity, and manageability, Sun
StorEdge 9900 series systems offer lower total cost of
ownership because of storage consolidation and heterogeneous
data sharing. These products provide a platform for direct
attach storage or storage area network (SAN) solutions. The
latest additions to the product family, Sun StorEdge 9980
and 9970 systems, incorporate our highest levels of performance
and capacity, along with a functional blade architecture.

Midrange Storage.We offer a wide range of flexible,
scalable storage systems that scale from the midrange to the
data center, supporting high-performance computing and
enterprise SAN implementations, as well as storage
virtualization technology. In fiscal 2002, we introduced the
StorEdge 6900 series and 3900 series storage systems.
For midrange storage consolidation, Sun StorEdge 6900
series systems have built-in virtualization for management of
open-SAN storage pools. The Sun StorEdge 3900 series delivers
exceptional performance and high availability for clustered
environments and focused applications, such as high-performance
computing and decision support systems. In addition, we offer
the Sun StorEdge T3 and Sun StorEdge A5200 arrays for the
enterprise.

Workgroup
Storage.Sun
StorEdge products for workgroup applications offer a flexible,
compact, cost-effective approach for growing storage demands.
Their building-block architecture is designed to allow users to
expand and customize as needed, for increased return on
investment. The Sun StorEdge T3 array for the workgroup combines
advanced RAID technology with industry-standard fiber-channel
technology in a scalable package. In addition to the T3 array,
we offer the Sun StorEdge D2 and Sun StorEdge A1000/ D1000
arrays, which offer performance and flexibility at low cost for
a variety of environments.

Tape Backup and
Restore.Our
tape automation products provide the flexibility, scalable
capacity, and high performance to meet the full range of needs
from the desktop to the data center. Sun offers tape
autoloaders, small-footprint libraries, and large-capacity,
fast-access tape backup and restore solutions for
mission-critical data centers. The complete family of Sun
StorEdge tape libraries has been designed using leading robotics
technology.

Storage Software.As an integral part of our complete
storage solutions, we have implemented Storage ONE, a storage
management strategy to provide an open, integrated, and
automated storage management family. Built on Sun ONE, Storage
ONE is based on industry standards and allows customers to
choose best-of-class management components to provide automation
and service-level management capabilities. Current Storage ONE
software products include:



|  |                                                                                                                                                                                                                                   
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Sun StorEdge Availability Suite software provides
    local and remote data replication services that are designed to
    reduce planned and unplanned disruptions and provide rapid
    recovery from disasters.                 
| 
| | Sun StorEdge Performance Suite (Sun StorEdge QFS)
    software provides a shared file-system service with quick data
    access for high-performance, data-intensive environments with
    very large volumes.                    
| 
| | Sun StorEdge Resource Management Suite software
    provides central monitoring, reporting, and analysis for
    proactive capacity management, cost charge-back, and strategic
    planning.                                     
| 
| | Sun StorEdge Utilization Suite (Sun StorEdge
    SAM-FS) software provides fully integrated backup, archiving,
    remote copy, and volume management software to improve storage
    utilization and IT operational efficiencies.

SAN Solutions.The Sun StorEdge Open SAN Architecture
provides a comprehensive set of products and services to help
ease storage area network management and to allow the
consolidation of storage resources on

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the network for better, more cost-effective
management of data growth. New products introduced in fiscal
2002 include, the Sun StorEdge Network 2 Gb FC Switch-16,
the Sun StorEdge 2 Gb PCI Fiber Channel Network Host Bus Adapter
(HBA), as well as, Sun StorEdge Traffic Manager software and Sun
StorEdge Diagnostic Expert software.




| |         
| | --------
| | Software



| |                  
| | -----------------
| | Sun ONE Platform:

Solaris Operating
Environment.The Solaris OE product line includes
desktop, intranet, Internet Service Provider (ISP) and
enterprise operating environments for SPARC and Intel platforms.
The Solaris Operating Environment is a high performance, highly
reliable, scalable and secure operating environment that is easy
to install and use, is optimized for the Java platform and
supports more than 12,000 applications. The Solaris Operating
Environment is optimized for enterprise computing, Internet and
intranet business requirements, powerful databases and high
performance technical computing environments.

In fiscal 2002, we introduced the Solaris 9
Operating Environment (Solaris 9 OE). The Solaris 9 OE
creates a services platform by combining traditional operating
systems functionality, application services, and identity
management (management of user identities over the Internet or
complex corporate networks, so that users can use a single
sign-on to be authenticated and authorized to access certain
files). It also delivers the security, manageability and
performance to assist IT professionals in increasing service
levels and decreasing costs and risks.

The Solaris 9 OE features the integration of
the new J2EETM 1.3 software compliant Sun ONE
Application Server 7, Platform Edition with a single server
development and deployment license for use on Sun systems. The
Application Server includes the high performance http engine and
web infrastructure from the Sun ONE Web Server and the Sun ONE
Message Queue. It also integrates the Sun ONE Directory Server,
an industry-leading foundation for open, scalable identity
management. The integration of these Sun ONE middleware elements
into the Solaris 9 OE makes it easier to build and deploy
application and web services based on Java, XML and SOAP
technologies, while helping customers to save on acquisition,
integration, testing, support, and management costs.

We also provide software solutions that focus on
network management and network security that complement our
server and storage product offerings. In addition, we provide
Solaris Operating Environment and Java technology-based tools
for software developers who create high performance applications
for enterprises, telecommunications and the Internet.

Java Technology.Our Java platform is one of the first
widely accepted application environments to allow development of
application software independent of the underlying operating
system or microprocessor. Sun expanded the definition and
availability of the Java platform and extended it to small
devices including mobile phones, smart cards, digital set top
boxes, and residential gateways with the Java 2 Platform,
Micro Edition (J2METM platform), Java
CardTM, and Java 2 Platform, Enterprise Edition
(J2EE) technologies. These Java platforms address very different
markets yet share a common core architecture. These platforms
complement our Java 2 Platform, Standard Edition
(J2SETM) technology, which is used on personal
computers and workstation clients. The Java 2 Software
Development Kit enables developers to create and run both
applets (miniature applications written in the Java programming
language) that run inside a web browser, as well as applications
that run outside a browser.

JiniTMNetwork Technology.JiniTM network technology
is an open architecture that enables developers to create
network-centric services, whether implemented in hardware or
software, that are highly adaptive to change. Jini technology
can be used to build adaptive networks that are scalable,
flexible and can evolve as typically required in dynamic
computing environments. There are two Jini network technology
offerings: the Jini Starter Kit and the Jini Technology Core
Platform Compatibility Kit.

StarOfficeTMProductivity Suite.StarOfficeTM is an office
productivity suite which runs on most major operating
environments and platforms including the Solaris Operating
Environment, Microsoft Windows 95/98/ NT, Linux, OS/2, and Java
platform. It has a fully integrated set of applications which
provide word

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processing, spreadsheet, graphic design,
presentations, database access, HTML editor, mail/news reader,
event planner, and formula editor tools. In fiscal 2002, we
launched our StarOffice 6.0 software, the full-featured office
productivity suite that provides customers with an economical
alternative to proprietary office productivity suites that are
expensive and have restrictive licensing policies.


Sun ONE Developer
Tools.We
develop and market software development tools designed to aid in
application development and integration. The Sun ONE Developer
Platform provides a desktop-to-mainframe development and test
environment that spans portal, identity, application and
integration functionality. Sun ONE development environments for
programming in C, C++, and Java programming languages help
developers to be more productive in creating fast, reliable, and
scalable applications.

Sun ONE Middleware (formerly
iPlanetTMsoftware).The Sun ONE middleware products
include Sun ONE Directory Server, Sun ONE Identity Server, Sun
ONE Meta-Directory Server, Sun ONE Integration Server, EAI
Edition, Sun ONE Portal Server, Sun ONE Web Server, Sun ONE
Application Server, as well as Sun ONE Calendar Server, Sun ONE
Messaging Server and various other applications, all of which
enable enterprises to leverage their information and
applications into services offered on intranets and the
Internet. Sun ONE middleware products support the Solaris
Operating Environment, Windows NT, HP-UX, AIX and Linux
operating systems.

SERVICES

Our Sun Services team (formerly Enterprise
Services) provides expertise in network computing through a
broad range of global services, including support services
(systems support for hardware and software), professional
services (IT consulting, systems integration and system/network
management), and educational services (education consulting,
skills migration and training). Sun assists both technical and
commercial customers, supporting more than 1.6 million
systems in more than 100 countries, training more than
400,000 students annually, and providing consulting,
integration and operations assistance to IT organizations
worldwide.



| |                 
| | ----------------
| | Support Services

The SunSpectrumSM support services
product offerings allow customers the power and flexibility to
customize their support services contracts. Customers can choose
from four levels of support that range from mission-critical to
self-support. This service is sold separately or packaged with
hardware, software and peripherals in a single price support
service. Each contract type is specifically designed to provide
our customers with high availability and continuous operation.
We have invested resources in the field for direct service
delivery. Higher levels of field resources are important to the
overall investments being made in mission critical support
capability. Our direct services are complemented by third-party
service providers who primarily deliver hardware support
services. Software support continues to be primarily delivered
by our software support engineers. Third-party service providers
provide additional support to important field resources (such as
parts inventories and staff) to meet the service requirements of
our installed base. Investments by these third-party service
providers help us expand geographic coverage without additional
fixed cost investment on our part.

We offer a variety of warranties for parts and
labor on hardware products, ranging from one year to five years
from date of sale, and a limited warranty on software, generally
for 90 days from date of sale. We service products during
the warranty period and provide contract service after the
initial product warranty has expired. Post-warranty and warranty
upgrade support services are primarily offered through the
SunSpectrum service. Warranty and post-warranty services are
provided through approximately 50 solution centers worldwide.



| |                      
| | ---------------------
| | Professional Services

Sun Professional Services provides a suite of
technical consulting and systems integration services to help
customers plan, implement, and manage complex distributed
network computing environments. Our professional services team
specializes in providing customers with advanced systems,
storage, and network architecture design consulting, platform
integration, enterprise systems management and operation, and
advanced Sun ONE and Java software integration. We provide the
people, processes and technology and we

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partner with best of breed third-party systems
integrators, to deliver single point-of-contact solutions
tailored to meet customer needs. Our technical and project
management experts help design IT architectures and plan
migrations from legacy systems to network computing or help
customers upgrade existing network computing environments.


To implement solutions, our integration experts
help customers develop and deploy distributed computing
environments for new applications, with an emphasis on solutions
built on the Sun ONE platform and Java technology. To keep
customer computing environments operating at peak performance,
operations experts help customers manage the complexity of
heterogeneous systems and networks. The Sun Professional
Services team also delivers highly technical assistance to
customers in critical areas such as network security and
identity management, wireless network-based systems, and storage
area networks.



| |                     
| | --------------------
| | Educational Services

Our Educational Services group develops and
delivers integrated learning solutions for enterprises, IT
organizations, and individual IT professionals. These solutions
help ensure that the necessary talent is available and properly
aligned to meet our clients network computing needs, as
well as business objectives. Sun learning solutions include:
(1) education consulting services; (2) learning
management technologies; (3) multi-mode learning content;
and (4) professional certifications. In order to recommend
an educational solution, we evaluate our customers unique
individual and organizational learning needs. For example, we
assess individual and team skills and identify gaps that may
pose risks to business, project, or career objectives. We then
conduct job, work, and role analyses to help ensure the right
people with the right skills are performing the right jobs. We
provide specific recommendations to assist customers in
acquiring and retaining the knowledge and talent that can help
increase their overall business success. When additional skill
development is required, we offer products and services to
deliver training in a variety of formats. Learning products
include: (1) Sun or partner online content and
comprehensive eLibraries; (2) instructor-led learning at
over 400 Sun and Sun-authorized centers in more than
60 countries; (3) custom and third-party learning
content; and (4) professional certification to validate
skills learned. To help customers manage the knowledge and
skills throughout their organization, we offer a web-based
learning platform that makes it easy to manage, track, deliver,
and forecast needed skills.

SALES, DISTRIBUTION AND MARKETING

The Global Sales Operations group manages field
sales organizations and all field marketing organizations. We
sell our products, services and solutions in most major markets
worldwide through a combination of direct and indirect channels.
We also offer component products such as CPU chips, ASICs and
embedded boards on an OEM basis to other hardware manufacturers,
and supply after-market and peripheral products to their
end-user installed base, both directly and through independent
distributors and resellers.

Our sales force serves the telecommunications,
financial services, government, manufacturing, education,
retail, life sciences, media and entertainment and healthcare
industries. We have approximately 140 sales and service offices
in the United States and 150 sales and service offices in
45 countries. In addition, we use independent distributors
in over 100 countries. In general, our sales coverage model
calls for independent distributors to be deployed in partnership
with our direct sales force but in some smaller markets
independent distributors may be our sole means of distribution.

Our relationship with resellers and distributors
(collectively our Channel Partners) is very
important to our future revenues and profitability. Channel
relationships accounted for more than 65% of our revenues during
fiscal 2002 and more than 60% in fiscal 2001. Our sales force is
compensated on a channel-neutral basis to reduce potential
conflict between our sales force and channel partners. Our
partners include:



|  |                                                                                                                                                                                                                         
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | systems integrators, both government and
    commercial, who serve the market for large commercial projects
    requiring substantial analysis, design, development,
    implementation and support of custom solutions;
| 
| | channel development providers who supply product
    and provide product marketing and technical support services to
    our smaller resellers;                                                                         

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|  |                                                                                                                                                                                                                                          
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | resellers who provide added value in the form of
    software packages, proprietary software development, high-end
    networking integration, vertical integration, vertical industry
    expertise, training, installation and support;
| 
| | OEMs who integrate our products with their
    hardware and software; and                                                                                                                                                                
| 
| | independent distributors who primarily serve
    foreign markets in which we do not have a direct presence.                                                                                                                              

Revenues from outside the United States were
approximately 54% of our total net revenues in fiscal 2002 and
53% and 48% in fiscal 2001 and 2000, respectively. Direct sales
we make outside of the United States are generally priced in
local currencies and can be subject to currency exchange
fluctuations. The net impact of currency fluctuations on net
revenues and operating results cannot be precisely measured as
our product mix and pricing change over time in various markets,
partially in response to currency movements. We are primarily
exposed to changes in exchange rates for the euro, Japanese yen,
and British pound. We are a net receiver of currencies other
than the U.S. dollar and, as such, can benefit from a
weaker dollar, and can be 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 minimize currency exposure gains and losses, we often borrow
funds in local currencies, enter into forward exchange
contracts, purchase foreign currency options and promote natural
hedges by purchasing components and incurring expenses in local
currencies. Currently, we have no plans to discontinue our
hedging programs. However, these programs are discretionary and
they could be discontinued in the future.

Some of our sales to foreign customers are made
under export licenses that must be obtained from the
United States Department of Commerce. In addition, all of
our export transactions are subject to U.S. export control
laws, and certain transactions could require prior approval of
the U.S. Dept of Commerce. Protectionist trade legislation in
either the United States or other countries, such as a
change in the current tariff structures, export compliance laws
or other trade policies, could adversely affect our ability to
sell or to manufacture in international markets. Furthermore,
revenues from outside the United States are subject to
inherent risks, including the general economic and political
conditions in each country.

Japan represents the largest portion of our
international sales (approximately 9% of our total net revenues
in fiscal 2002, and 10% in both fiscal 2001 and 2000). Sales to
telecommunication and information technology manufacturing
industries together represent a significant portion of
Suns revenues in Japan. Sales to or through C. Itoh
Technoscience Co. Ltd., Fujitsu, Ltd. and Toshiba Corporation
together represent a significant portion of Suns revenues
in Japan. Economic conditions in Japan have declined
substantially in recent years and have adversely impacted our
sales in this region. If the economic trends in Japan
significantly worsen in a quarter or decline over an extended
period of time, our results of operations and cash flows could
be further adversely affected.

Sales to General Electric Company (GE) and
its subsidiaries in the aggregate accounted for approximately
12%, 13% and 19% of our fiscal 2002, 2001 and 2000 total net
revenues, respectively. Our Chairman of the Board of Directors,
President and Chief Executive Officer, Scott McNealy, is a
member of GEs Board of Directors. More than 90% of the
revenue attributed to GE was generated through GE subsidiaries
acting as either a reseller or financier of our products. Sales
through MRA Systems, Inc., a master reseller and a GE
subsidiary, consisted of 8%, 10% and 16% of total net revenues
in 2002, 2001 and 2000, respectively, and sales to GE Capital, a
finance/ leasing company and a GE subsidiary, consisted of 2%,
2%, and 3% of total net revenues in fiscal 2002, 2001 and 2000,
respectively. As a master reseller, MRA Systems, Inc. acts as a
distributor of our products to resellers who in turn sell those
products to end users. Revenue is generated from GE Capital
whenever our customers elect to lease equipment through GE
Capital; in such cases, we sell the equipment to GE Capital,
which in turn, leases that equipment to customers. Our business
could be adversely affected if GE or another significant
customer terminated its business relationship with us or
significantly reduced the amount of business it did with us.
Also, see Note 15 to the Consolidated Financial Statements for
additional information concerning sales to foreign customers and
business segments.

Our marketing activities include advertising in
computer publications and the business press, direct mailings to
customers and prospects, televised programs and attendance at
trade shows. We also sponsor a series of

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seminars to specific resellers, university
customers, end-users and government customers and prospects
designed to familiarize attendees with the capabilities of the
Sun product line.


Our product order backlog at June 30, 2002
was $841 million, as compared with $853 million at
June 30, 2001. Our backlog includes orders for which a
delivery schedule within six months has been specified by the
customer and shipped products for which revenue has not been
recognized. Backlog levels vary with demand, product
availability and our delivery lead times, and are subject to
significant decreases as a result of, among other things,
customer order delays, changes or cancellations. As such,
backlog levels are not a reliable indicator of future operating
results.

PRODUCT DEVELOPMENT

Our research and product development programs are
intended to sustain and enhance our competitive position by
incorporating the latest worldwide advances in hardware,
software, graphics, networking, data communications and storage
technologies. Suns product development continues to focus
on enhancing the performance, reliability, availability, and
serviceability of our existing hardware and systems software
standards and the development of new technology standards.
Additionally, we remain focused on system software platforms for
Internet and intranet applications, telecommunications and
next-generation service provider networks, developing advanced
workstation, server and storage architectures, as well as
designing application-specific integrated circuits and software
for networking and distributed computing.

We conduct research and development principally
in the United States, United Kingdom, France, Ireland, Germany,
Japan, India, and Israel. Research and development (R&D)
expenses were $1,832 million, $2,016 million and
$1,630 million in fiscal 2002, 2001 and 2000, respectively.
R&D expenses reflected our continued development of a broad
line of scalable and reliable systems, including servers,
desktop systems, storage technologies and UltraSPARC (most
recently, SPARC III) microprocessors, as well as software
products which utilize the Java platform, Solaris Operating
Environment software, the Sun ONE, N1, Jini and JXTA software
and network technology. We believe that software development
provides and will continue to provide significant competitive
differentiation. Therefore, we devote substantial resources to
the development of operating system software and middleware;
networking and data communications software; high availability
software; video graphics, disk array and storage management
software; object technology software; security software and a
software development environment and developer tools.

MANUFACTURING AND SUPPLY



| |                     
| | --------------------
| | Worldwide Operations

Worldwide Operations Supplier Management manages
Sun-wide purchasing of materials used in producing Sun
products. Our manufacturing operations consist primarily of
final assembly, test and quality control of systems. We
manufacture in California, Oregon and Scotland, and distribute
from California, the Netherlands and Japan. We have continued
efforts to simplify the manufacturing process by reducing the
diversity of system configurations offered and increasing the
standardization of components across product types. However, our
costs could be increased and product shipments delayed by
reliance on single source suppliers. Similarly, our ability to
purchase components in sufficient quantities to meet customer
demand could impact our future operating results.

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

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COMPETITION

Our competitors are some of the largest, most
successful companies in the world. They include International
Business Machines Corporation (IBM), Hewlett-Packard Company
(HP) which now owns Compaq Computer Corporation, EMC
Corporation (EMC) Fujitsu and the Fujitsu-Siemens joint
venture company. We also compete with distributors and resellers
of systems based on microprocessors manufactured by Intel
Corporation (Intel) and the Windows family of operating systems
software developed by Microsoft Corporation (Microsoft). These
competitors include Dell Computer Corporation, and HP, in
addition to Intel and Microsoft. This competition creates
increased pressure, including pricing pressure on our
workstation and certain server product lines. We expect this
competitive pressure to continue to intensify during fiscal year
2003 with the anticipated releases of new products from our
competitors.

We compete in the hardware and software products
and services markets. Our competitors compete with us primarily
on price, service, warranty and product performance. These
markets are intensely competitive. If we fail to compete
successfully in these markets 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 have encouraged the use of SPARC technology as
a standard in the computer marketplace by licensing much of the
technology, and promoting open interfaces to the Solaris
Operating Environment, as well as by offering microprocessors
and enabling technologies to third party customers. As a result,
several licensees, including Fujitsu and the Fujitsu-Siemens
joint venture company, also offer products based on the Solaris
Operating Environment and the SPARC architecture that compete
directly with our products. We have also worked to make our Java
programming language a standard for complex networks. We develop
applications, tools and systems platforms, as well as work with
third-parties to create products and technologies, in order to
continue to enhance the Java platforms capabilities. As
part of this effort, we license Java technology which widely
encourages competitors of Sun to also develop products competing
with these applications, tools and platforms. If we are unable
to compete effectively, our business could be harmed.

PATENTS, TRADEMARKS AND INTELLECTUAL PROPERTY
LICENSES

We have used, registered, and/or applied to
register certain trademarks and service marks to distinguish
genuine Sun products, technologies and services from those of
our competitors in the U.S. and in foreign countries and
jurisdictions. We enforce our trademark, service mark and trade
name rights in the U.S. and abroad.

We hold a number of U.S. and foreign patents
relating to various aspects of our products and technology.
While we believe that patent protection is important, we also
believe that patents are of less competitive significance than
factors such as innovative skills and technological expertise.
From time to time we have been notified that we may be
infringing certain patents or other intellectual property rights
of others. Several pending claims are in various stages of
evaluation. With the exception of a current pending claim
further disclosed at ITEM 3. Legal Proceedings, no material
litigation has arisen from these claims. We are evaluating the
desirability of entering into licensing agreements in certain of
these cases. Based on industry practice, we believe that any
necessary licenses or other rights could be obtained on
commercially reasonable terms. However, no assurance can be
given that licenses can be obtained on acceptable terms or that
litigation will not occur. The failure to obtain necessary
licenses or other rights, or litigation arising out of such
claims, could adversely affect our business.

EMPLOYEES

As of September 10, 2002, we had
approximately 39,100 employees (at June 30, 2002 we had
approximately 39,400 employees). We depend on key employees and
face competition in hiring and retaining qualified employees.
Our employees are vital to our success, and our key management,
engineering and other employees are difficult to replace.
Although we have entered into a limited number of employment
contracts with certain current and former executive officers, 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 decrease in IT spending

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and resulting decrease in our revenue has put
pressure on our stock price and because we offer equity-based
incentive compensation, our ability to continue to offer
competitive compensation packages to current employees has been
negatively impacted. Consequently, these pressures have affected
our ability to attract and retain highly qualified technical
personnel. If these adverse conditions continue, we may not be
able to retain highly qualified employees in the future and this
could harm our business. In addition, new regulations proposed
by The Nasdaq National Market requiring shareholder approval for
all stock option plans as well as new regulations proposed by
the New York Stock Exchange prohibiting NYSE member
organizations from giving a proxy to vote on equity-compensation
plans unless the beneficial owner of the shares has given voting
instructions could make it more difficult for us to grant
options to employees in the future. To the extent that new
regulations make it more difficult or expensive to grant options
to employees, we may incur increased cash compensation costs or
find it difficult to attract, retain and motivate employees,
either of which could materially and adversely affect our
business.





ITEM
2.     PROPERTIES

At June 30, 2002, Suns facilities in
the United States represented aggregate floor space of
12.3 million square feet, of which 4.8 million was
owned and 7.5 million square feet was leased. Of these
amounts, 1.4 million square feet was vacant and
0.3 million square feet was being leased to non-Sun
businesses. Similar facilities in 45 other countries totaled
4.9 million square feet, of which 0.6 million square
feet was owned and 4.3 million square feet was leased. Of
these amounts, 0.3 million square feet was vacant and
0.1 million square feet was being leased to non-Sun
businesses.

At June 30, 2002, our owned properties
consisted of:

|                          |       |            |           |                |  |  |         |         | 
|------------------------- | ----- | ---------- | --------- | -------------- |  |  | ------- | ------- | 
|                          |       | Square     |           | Square Footage
|                          |       | Footage of |           | Under         
|Location                  |       | Facility   |           | Construction  
|                          |       |            |           |               
|Bagshot, England          |       |            | 30,000    |                |  |  | n/a     |        
|Broomfield, Colorado      |       |            | 950,000   |                |  |  | n/a     |        
|Burlington, Massachusetts |       |            | 680,000   |                |  |  | 240,000 |        
|Farnborough, England      |       |            | 330,000   |                |  |  | n/a     |        
|Linlithgow, Scotland      |       |            | 230,000   |                |  |  | 210,000 |        
|Menlo Park, California    |       |            | 1,050,000 |                |  |  | n/a     |        
|Newark, California        |       |            | 1,300,000 |                |  |  | 140,000 |        
|Santa Clara, California   |       |            | 840,000   |                |  |  | n/a     |        
|                          |       |            |           |                |  |  |         |        
|                          | Total |            |           | 5,410,000      |  |  |         | 590,000 | 
|                          |       |            |           |                |  |  |         |        

In addition to the above-noted Square
Footage Under Construction, we have approximately
1.6 million square feet of facilities available for future
construction. We continually evaluate our facility requirements
in light of our business needs and stage the future construction
accordingly. In addition, we own approximately 38 acres of
undeveloped land in Austin, Texas.

We currently have a plan to vacate 56 facilities
(consisting of 2.0 million square feet of space) around the
world, of which 30 are in the United States. At June 30,
2002, 1.1 million square feet of that leased space was
vacant and 0.2 million square feet was subleased to non-Sun
businesses. We plan to vacate the remaining 0.7 million
square feet by no later than December 31, 2002. See
Note 6 to the Consolidated Financial Statements for further
discussion.

Substantially all of our facilities are used
jointly by our Computer Systems and Network Storage, Enterprise
Services, iPlanet and Other operating segments. Our
manufacturing facilities are located in Linlithgow, Scotland,
Beaverton, Oregon and Newark, California.

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ITEM 3.     LEGAL
PROCEEDINGS

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

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

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

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believe the evidence would support the extreme
sanction of a denial of export privileges or exclusion from
practice before the BIS, any such penalties would have a
material adverse effect on our business.





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

No matters were submitted to a vote of
stockholders of Sun during the fourth quarter of fiscal 2002.




EXECUTIVE OFFICERS OF THE REGISTRANT

The following sets forth certain information
regarding our Executive Officers as of September 10, 2002.
All of our executive officers are at-will employees.

|                        |  |     |    |          |  |                                                                                   
|----------------------- |  | --- | -- | -------- |  | ----------------------------------------------------------------------------------
|Name                    |  | Age |    | Position
|                        |  |     |    |         
|Scott G. McNealy        |  |     | 47 |          |  | Chairman of the Board of Directors, President and
    Chief Executive Officer     
|William T. Agnello      |  |     | 53 |          |  | Senior Vice President, Workplace Resources                                        
|Crawford W. Beveridge   |  |     | 56 |          |  | Executive Vice President, People and Places, and
    Chief Human Resources Officer
|Mark A. Canepa          |  |     | 47 |          |  | Executive Vice President, Network Storage Products                                
|John D. Croll           |  |     | 45 |          |  | Senior Vice President, General Counsel and
    Secretary                          
|H. William Howard       |  |     | 68 |          |  | Senior Vice President, Chief Information Officer                                  
|William N. Joy          |  |     | 47 |          |  | Executive Vice President, Co-Founder and Chief
    Scientist                      
|Neil A. Knox            |  |     | 49 |          |  | Executive Vice President, Volume Systems Products                                 
|Clark H. Masters        |  |     | 53 |          |  | Executive Vice President, Enterprise Systems
    Products                         
|Stephen T. McGowan      |  |     | 54 |          |  | Chief Financial Officer and Executive Vice
    President, Corporate Resources     
|Michael H. Morris       |  |     | 54 |          |  | Senior Vice President, Special Counsel                                            
|Gregory M. Papadopoulos |  |     | 44 |          |  | Senior Vice President and Chief Technology Officer                                
|Marissa T. Peterson     |  |     | 40 |          |  | Executive Vice President, Worldwide Operations
    and Chief Customer Advocate    
|Michael L. Popov        |  |     | 56 |          |  | Vice President and Corporate Controller                                           
|Eva Sage-Gavin          |  |     | 44 |          |  | Senior Vice President, Global Talent Organization                                 
|Jonathan I. Schwartz    |  |     | 36 |          |  | Executive Vice President, Software                                                
|Patricia C. Sueltz      |  |     | 49 |          |  | Executive Vice President, Sun Services                                            
|Mark E. Tolliver        |  |     | 50 |          |  | Executive Vice President, Marketing and Strategy
    and Chief Strategy Officer   
|David W. Yen            |  |     | 50 |          |  | Executive Vice President, Processor and Network
    Products                      
|Robert H. Youngjohns    |  |     | 50 |          |  | Executive Vice President, Global Sales Operations                                 

Mr. McNealyis
a Founder of Sun and has served as Chairman of the Board of
Directors, President and Chief Executive Officer since July
2002, as Chairman of the Board and Chief Executive Officer from
April 1999 to June 2002, as Chairman of the Board of Directors,
President and Chief Executive Officer from December 1984 to
April 1999, as President and Chief Operating Officer from
February 1984 to December 1984 and as Vice President of
Operations from February 1982 to February 1984. Mr. McNealy
has served as a Director of the Company since the incorporation
of the Company in February 1982.

Mr. Agnellohas
served as Senior Vice President, Workplace Resources of Sun
since July 2000, as Vice President, Workplace Resources from
August 1999 to July 2000 and as Vice President, Real Estate and
the Workplace from March 1994 to August 1999.

Mr. Beveridgehas served as Executive Vice
President, People and Places, and Chief Human Resources Officer
of Sun since July 2002, as Executive Vice President and Chief
Human Resources Officer from March 2000 to

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June 2002 and as Vice President, Corporate
Resources from March 1985 to December 1990. From January 1991 to
February 2000, Mr. Beveridge served as Chief Executive,
Scottish Enterprise, a Scottish quasi-autonomous
non-governmental organization involved in economic development
in Scotland.


Mr. Canepahas
served as Executive Vice President, Network Storage Products of
Sun since April 2001, as Vice President and General Manager,
Internet Desktop and Server Products from June 2000 to April
2001 and as Vice President, Workgroup Server Products from
October 1996 to June 2000.

Mr. Crollhas
served as Senior Vice President, General Counsel and Secretary
of Sun since April 2002, as Vice President, Legal; General
Counsel, Global Sales Organization from July 2001 to March 2002,
as Vice President, Sales Operations, Global Sales Organization
from July 2000 to March 2002, as Vice President and General
Counsel of Sun Microsystems Computer Corporation, a wholly-owned
subsidiary of the Company from August 1995 to June 2000, and as
Vice President, Corporate Development and Strategy, and General
Counsel, SunSoft, Inc., a wholly-owned subsidiary of Sun, from
September 1994 to August 1995. Mr. Croll held various
positions in the corporate development and legal organizations
of SunSoft, Inc. from April 1991 to August 1994.

Mr. Howardhas
served as Senior Vice President, Chief Information Officer of
Sun since July 2000 and as Vice President, Chief Information
Officer from September 1998 to July 2000. From September 1990 to
September 1998, he served as Corporate Vice President,
Information Technology and Chief Information Officer for Inland
Steel Industries, Inc.

Mr. Joyis a
Co-Founder of Sun. He has served as Executive Vice President,
Co-Founder and Chief Scientist since December 1998, as Executive
Vice President from July 1996 to December 1998, as Vice
President, Corporate Executive Officer from December 1990 to
June 1996, as Executive Vice President from May 1990 to December
1990, as Vice President, Research and Development from June 1984
to May 1990 and as Director of Software from July 1982 to May
1984.

Mr. Knoxhas
served as Executive Vice President, Volume System Products of
Sun since July 2002, as Vice President and General Manager,
Volume System Products from July 2001 to July 2002, and as Vice
President and General Manager, Network Systems of the Company
from July 1995 to July 2001.

Mr. Mastershas
served as Executive Vice President, Enterprise Systems Products
of Sun since July 2002, as Vice President, Enterprise Systems
Products from June 2000 to July 2002, and as Vice President,
Data Center and High Performance Computing from July 1996 to
June 2000.

Mr. McGowanhas
served as Executive Vice President, Corporate Resources and
Chief Financial Officer of Sun since July 2002, as Vice
President, Finance, Global Sales Operations from July 2001 to
June 2002, as Vice President, Staff Operations, Global Sales
Operations from June 2000 to June 2001 as Vice President,
Finance; Computer Systems, Network Storage and Network Service
Providers of the Company from February 1998 to June 2000, as
Vice President, Finance, Worldwide Financial Operations of Sun
Microsystems Computer Corporation (SMCC), a wholly-owned
subsidiary of the Company, from July 1994 to February 1998 and
as Vice President, Finance, North America and Australia Field
Operations of SMCC from October 1992 to July 1994.

Mr. Morrishas
served as Senior Vice President, Special Counsel of Sun since
April 2002, as Senior Vice President General Counsel and
Secretary from April 2000 to March 2002 and as Vice President,
General Counsel and Secretary from October 1987 to July 2000.

Mr. Papadopouloshas served as Senior Vice President
and Chief Technology Officer of Sun since July 2000 and as Vice
President and Chief Technology Officer from April 1998 to July
2000. He served as Vice President and Chief Technology Officer
of Sun Microsystems Computer Corporation (SMCC), a wholly-owned
subsidiary of Sun from March 1996 to April 1998, as Chief
Technology Officer of SMCC from December 1995 to March 1996 and
as Chief Scientist, Server Systems Engineering from September
1994 to December 1995. Mr. Papadopoulos has a part-time,
non-compensated appointment as a Visiting Professor of
Electrical Engineering and Computer Science at the Massachusetts
Institute of Technology.

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Ms. Petersonhas served as Executive Vice
President, Worldwide Operations and Chief Customer Advocate of
Sun since July 2002, as Executive Vice President, Worldwide
Operations from January 2000 to July 2002, and as Vice
President, Worldwide Operations from April 1998 to December
1999. She served as Vice President, Worldwide Operations,
Logistics from December 1995 to April 1998 and as Director,
U.S. Manufacturing from December 1993 to April 1995.

Mr. Popovhas
served as Vice President and Corporate Controller of Sun since
April 1999, as Vice President, Chief Operating Officer, Staff
Operations from April 1998 to April 1999, as Vice President,
Finance, SunService from June 1994 to April 1998 and as
Assistant Corporate Controller from January 1992 to June 1994.

Ms. Sage-Gavinhas served as Senior Vice President,
Global Talent Organization of Sun since July 2002 and as Vice
President, Human Resources Computer Systems, Network Storage and
Worldwide Operations from August 2000 to June 2002. From August
1997 to July 2000, Ms. Sage-Gavin served as Senior Vice
President, Human Resources at Disney Consumer Products.

Mr. Schwartzhas served as Executive Vice
President, Software of Sun since July 2002, as Senior Vice
President, Corporate Strategy and Planning from July 2000 to
July 2002, as Vice President, Ventures Fund from October 1999 to
July 2000, as Vice President, Internet and Application Products
of the Company from May 1999 to October 1999, as Vice President,
Enterprise Products Group from July 1998 to May 1999 and as
Director, Product Marketing, Javasoft, from July 1997 to July
1998.

Ms. Sueltzhas
served as Executive Vice President, Sun Services since July
2002, as Executive Vice President, Software Systems Group of Sun
from July 2000 to June 2002 and as President, Software Products
& Platforms from September 1999 to June 2000.
Ms. Sueltz served in various management capacities at IBM
Corporation from 1979 to 1999.

Mr. Tolliverhas served as Executive Vice
President, Marketing and Strategy and Chief Strategy Officer of
Sun since July 2002, as Executive Vice President and President,
iPlanet, Sun-Netscape Alliance of the Company from July 2000 to
July 2002, as President and General Manager, Sun-Netscape
Alliance of the Company from March 1999 to July 2000, as
President, Consumer and Embedded Division of the Company from
April 1998 to March 1999, as Vice President, Market Development
from July 1996 to April 1998 and as Vice President, Strategy
from December 1995 to July 1996.

Mr. Yenhas
served as Executive Vice President, Processor and Network
Products of Sun since July 2002, as Vice President and General
Manager, Processor Products Group from February 2001 to June
2002, as Vice President and General Manager, Integrated Products
Group from July 2000 to January 2001, and as Vice President and
General Manager, Enterprise Servers Products from September 1996
to June 2000. Mr. Yen held various positions in the Server
Systems Engineering and Networked Resources Group organizations
of the Company from October 1988 to August 1996.

Mr. Youngjohnshas served as Executive Vice
President, Global Sales Operations of Sun since July 2002, as
Vice President, Europe Middle East and Africa from April 1998 to
July 2002, and as Vice President, UK from November 1995 to April
1998.

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##### Table of Contents






PART II






|        |                                                                              
|------- | -----------------------------------------------------------------------------
|ITEM 5. | MARKET FOR THE REGISTRANTS COMMON
    EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock trades on The Nasdaq National
Market under the symbol SUNW. As of
September 10, 2002, there were approximately
23,000 stockholders and the closing price of Suns
common stock was $3.51 per share as reported by The Nasdaq
National Market.

The following table sets forth for the fiscal
periods indicated the high and low sale prices for our common
stock as reported by The Nasdaq National Market:

|               |  |             |       |             |  |      |      |     |  |   |       |  |  |   |       | 
|-------------- |  | ----------- | ----- | ----------- |  | ---- | ---- | --- |  | - | ----- |  |  | - | ----- | 
|               |  |             |       |            
|               |  | Fiscal 2002 |       | Fiscal 2001
|               |  |             |       |            
|               |  | High        |       | Low         |  | High |      | Low
|               |  |             |       |             |  |      |      |    
|First Quarter  |  | $           | 18.24 |             |  | $    | 7.52 |     |  | $ | 64.66 |  |  | $ | 41.13 | 
|Second Quarter |  |             | 14.72 |             |  |      | 7.81 |     |  |   | 61.00 |  |  |   | 25.13 | 
|Third Quarter  |  |             | 14.41 |             |  |      | 7.88 |     |  |   | 35.13 |  |  |   | 14.10 | 
|Fourth Quarter |  |             | 9.55  |             |  |      | 4.55 |     |  |   | 23.57 |  |  |   | 12.85 | 

No cash dividends were declared or paid in fiscal
2002 or fiscal 2001. We anticipate retaining all available funds
to finance future internal growth and product development.

Effective July 1, 2002, we modified our
policies concerning Certification, to eliminate the
need for the Section 16 Officer and Board of Director
certificate regarding trading on insider information, and
concerning Sale of Stock by Certain Company Directors and
Employees, to eliminate the reporting in our periodic
reports of the sales of stock for the last quarter. The
modification was approved by the majority of independent
directors.

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##### Table of Contents






ITEM
6.     SELECTED FINANCIAL
DATA

The following selected financial data should be
read in conjunction with Item 7. Management
Discussion and Analysis of Financial Condition and Results of
Operations and Item 8. Financial Statements and
Supplementary Data.

|                                                                                    |                                     |                                               |        |       |   |         |       |      |   |         |        |       |    |         |       |      |     |         |        |       |    |  |       |      |     |   |        |       |     |  |       |      |     |   |       |       |     |  |       |      |     | 
|----------------------------------------------------------------------------------- | ----------------------------------- | --------------------------------------------- | ------ | ----- | - | ------- | ----- | ---- | - | ------- | ------ | ----- | -- | ------- | ----- | ---- | --- | ------- | ------ | ----- | -- |  | ----- | ---- | --- | - | ------ | ----- | --- |  | ----- | ---- | --- | - | ----- | ----- | --- |  | ----- | ---- | --- | 
|                                                                                    |                                     |                                              
|                                                                                    |                                     | Fiscal Years Ended June 30,                  
|                                                                                    |                                     |                                              
|                                                                                    |                                     |                                               |        |       |   |         |       |      |   |        
|                                                                                    |                                     | 2002                                          |        | 2001  |   | 2000    |       | 1999 |   | 1998   
|                                                                                    |                                     |                                               |        |       |   |         |       |      |   |        
|                                                                                    |                                     | Dollars                                       |        | %     |   | Dollars |       | %    |   | Dollars |        | %     |    | Dollars |       | %    |     | Dollars |        | %    
|                                                                                    |                                     |                                               |        |       |   |         |       |      |   |         |        |       |    |         |       |      |     |         |        |      
|                                                                                    |                                     |                                              
|                                                                                    |                                     | (In millions, except per share amounts)      
|Net revenues                                                                        |                                     | $                                             | 12,496 |       |   |         | 100.0 |      |   | $       | 18,250 |       |    |         | 100.0 |      |     | $       | 15,721 |       |    |  | 100.0 |      |     | $ | 11,806 |       |     |  | 100.0 |      |     | $ | 9,862 |       |     |  | 100.0 |     
|Cost of sales                                                                       |                                     |                                               | 7,580  |       |   |         | 60.7  |      |   |         | 10,041 |       |    |         | 55.0  |      |     |         | 7,549  |       |    |  | 48.0  |      |     |   | 5,670  |       |     |  | 48.0  |      |     |   | 4,713 |       |     |  | 47.8  |     
|                                                                                    |                                     |                                               |        |       |   |         |       |      |   |         |        |       |    |         |       |      |     |         |        |       |    |  |       |      |     |   |        |       |     |  |       |      |     |   |       |       |     |  |       |     
|Gross margin                                                                        |                                     | $                                             | 4,916  |       |   |         | 39.3  |      |   | $       | 8,209  |       |    |         | 45.0  |      |     | $       | 8,172  |       |    |  | 52.0  |      |     | $ | 6,136  |       |     |  | 52.0  |      |     | $ | 5,149 |       |     |  | 52.2  |     
|Operating Expense:                                                                  |                                     |                                               |        |       |   |         |       |      |   |         |        |       |    |         |       |      |     |         |        |       |    |  |       |      |     |   |        |       |     |  |       |      |     |   |       |       |     |  |       |     
|                                                                                    | Research and development            |                                               |        | 1,832 |   |         |       | 14.7 |   |         |        | 2,016 |    |         |       | 11.0 |     |         |        | 1,630 |    |  |       | 10.4 |     |   |        | 1,280 |     |  |       | 10.8 |     |   |       | 1,029 |     |  |       | 10.4 |    
|                                                                                    | Selling, general and administrative |                                               |        | 3,812 |   |         |       | 30.5 |   |         |        | 4,445 |    |         |       | 24.4 |     |         |        | 4,065 |    |  |       | 25.9 |     |   |        | 3,192 |     |  |       | 27.1 |     |   |       | 2,826 |     |  |       | 28.7 |    
|                                                                                    | Restructuring charges               |                                               |        | 517   |   |         |       | 4.1  |   |         |        | 75    |    |         |       | 0.4  |     |         |        |      |    |  |       |     |     |   |        |      |     |  |       |     |     |   |       |      |     |  |       |     |    
|                                                                                    | Goodwill amortization               |                                               |        |      |   |         |       |     |   |         |        | 285   |    |         |       | 1.6  |     |         |        | 72    |    |  |       | 0.4  |     |   |        | 23    |     |  |       | 0.2  |     |   |       | 4     |     |  |       |     |    
|                                                                                    |                                     | Purchased in-process research and development |        |       | 3 |         |       |      |  |         |        |       | 77 |         |       |      | 0.4 |         |        |       | 12 |  |       |      | 0.1 |   |        |       | 121 |  |       |      | 1.0 |   |       |       | 176 |  |       |      | 1.8 | 
|                                                                                    |                                     |                                               |        |       |   |         |       |      |   |         |        |       |    |         |       |      |     |         |        |       |    |  |       |      |     |   |        |       |     |  |       |      |     |   |       |       |     |  |       |     
|Total operating expense                                                             |                                     |                                               | 6,164  |       |   |         | 49.3  |      |   |         | 6,898  |       |    |         | 37.8  |      |     |         | 5,779  |       |    |  | 36.8  |      |     |   | 4,616  |       |     |  | 39.1  |      |     |   | 4,035 |       |     |  | 40.9  |     
|                                                                                    |                                     |                                               |        |       |   |         |       |      |   |         |        |       |    |         |       |      |     |         |        |       |    |  |       |      |     |   |        |       |     |  |       |      |     |   |       |       |     |  |       |     
|Operating income (loss)                                                             |                                     |                                               | (1,248 | )     |   |         | (10.0 | )    |   |         | 1,311  |       |    |         | 7.2   |      |     |         | 2,393  |       |    |  | 15.2  |      |     |   | 1,520  |       |     |  | 12.9  |      |     |   | 1,114 |       |     |  | 11.3  |     
|Gain (loss) on equity investments, net                                              |                                     |                                               | (99    | )     |   |         | (0.8  | )    |   |         | (90    | )     |    |         | (0.5  | )    |     |         | 208    |       |    |  | 1.3   |      |     |   |       |       |     |  |      |      |     |   |      |       |     |  |      |     
|Interest income, net                                                                |                                     |                                               | 299    |       |   |         | 2.4   |      |   |         | 363    |       |    |         | 2.0   |      |     |         | 170    |       |    |  | 1.1   |      |     |   | 85     |       |     |  | 0.7   |      |     |   | 48    |       |     |  | 0.5   |     
|                                                                                    |                                     |                                               |        |       |   |         |       |      |   |         |        |       |    |         |       |      |     |         |        |       |    |  |       |      |     |   |        |       |     |  |       |      |     |   |       |       |     |  |       |     
|Income (loss) before taxes                                                          |                                     |                                               | (1,048 | )     |   |         | (8.4  | )    |   |         | 1,584  |       |    |         | 8.7   |      |     |         | 2,771  |       |    |  | 17.6  |      |     |   | 1,605  |       |     |  | 13.6  |      |     |   | 1,162 |       |     |  | 11.8  |     
|Provision (benefit) for income taxes                                                |                                     |                                               | (461   | )     |   |         | (3.7  | )    |   |         | 603    |       |    |         | 3.3   |      |     |         | 917    |       |    |  | 5.8   |      |     |   | 575    |       |     |  | 4.9   |      |     |   | 407   |       |     |  | 4.1   |     
|Cumulative effect of change in accounting
    principle, net                        |                                     |                                               |       |       |   |         |      |      |   |         | (54    | )     |    |         | (0.3  | )    |     |         |       |       |    |  |      |      |     |   |       |       |     |  |      |      |     |   |      |       |     |  |      |     
|                                                                                    |                                     |                                               |        |       |   |         |       |      |   |         |        |       |    |         |       |      |     |         |        |       |    |  |       |      |     |   |        |       |     |  |       |      |     |   |       |       |     |  |       |     
|Net income (loss)                                                                   |                                     | $                                             | (587   | )     |   |         | (4.7  | )    |   | $       | 927    |       |    |         | 5.1   |      |     | $       | 1,854  |       |    |  | 11.8  |      |     | $ | 1,030  |       |     |  | 8.7   |      |     | $ | 755   |       |     |  | 7.7   |     
|                                                                                    |                                     |                                               |        |       |   |         |       |      |   |         |        |       |    |         |       |      |     |         |        |       |    |  |       |      |     |   |        |       |     |  |       |      |     |   |       |       |     |  |       |     
|Net income (loss) per common
    share-diluted(2)                                   |                                     | $                                             | (0.18  | )     |   |         |       |      |   | $       | 0.27   |       |    |         |       |      |     | $       | 0.55   |       |    |  |       |      |     | $ | 0.31   |       |     |  |       |      |     | $ | 0.24  |       |     |  |       |     
|Shares used in the calculation of net income
    (loss) per common share-diluted(2) |                                     |                                               | 3,242  |       |   |         |       |      |   |         | 3,417  |       |    |         |       |      |     |         | 3,379  |       |    |  |       |      |     |   | 3,282  |       |     |  |       |      |     |   | 3,180 |       |     |  |       |     
|Cash, cash equivalents and marketable debt
    securities                           |                                     | $                                             | 5,864  |       |   |         |       |      |   | $       | 6,171  |       |    |         |       |      |     | $       | 6,436  |       |    |  |       |      |     | $ | 2,692  |       |     |  |       |      |     | $ | 1,333 |       |     |  |       |     
|Total assets                                                                        |                                     | $                                             | 16,522 |       |   |         |       |      |   | $       | 18,181 |       |    |         |       |      |     | $       | 14,152 |       |    |  |       |      |     | $ | 8,499  |       |     |  |       |      |     | $ | 5,794 |       |     |  |       |     
|Long-term debt                                                                      |                                     | $                                             | 1,653  | (3)   |   |         |       |      |   | $       | 1,565  |       |    |         |       |      |     | $       | 1,523  |       |    |  |       |      |     | $ | 37     |       |     |  |       |      |     | $ | 1     |       |     |  |       |     
|Deferred income taxes and other non-current
    obligations                         |                                     | $                                             | 215    |       |   |         |       |      |   | $       | 884    |       |    |         |       |      |     | $       | 774    |       |    |  |       |      |     | $ | 347    |       |     |  |       |      |     | $ | 76    |       |     |  |       |     



---



|    |                                                                                                                                                                
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Fiscal years ended June 30. All historical
    financial information has been restated to reflect the merger
    with Forte Software, Inc. on October 19, 1999.
|   
|(2) | Share and per share amounts for all periods
    presented have been adjusted to reflect stock splits through
    June 30, 2002.                                
|   
|(3) | Includes approximately $204 million
    classified as current portion of long-term debt.                                                                       

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|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS
    OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This annual report contains forward-looking
statements within the meaning of the Private Securities
Litigation Reform Act of 1995, particularly statements relating
to Suns business strategy; our intention to continue
investments into new computing technologies and to focus on
delivering leading-edge network computing products based on our
innovations; our belief that our investment in research and
development will generate better long-term profit margins; our
plans to continue our hedging programs; our belief that software
development will continue to provide significant competitive
differentiation; our belief that we will be able to obtain
licenses in certain cases where we have received patent and
intellectual property infringement claims; our plan to exit
56 facilities around the world; and our expectation to exit
certain leases by December 31, 2002; our belief that the
Kodak suit is without merit; our belief regarding our ability to
reach a negotiated settlement with the BIS; the potential
non-cash goodwill impairment charge of approximately
$2.2 billion; our belief that to maintain our competitive
position, we must invest significant resources in new systems,
software, and microprocessor development; our long-term
objective to invest 10-11% of net revenues in R&D;
managements objective to reduce SG&A expenses to
approximately 25% of net revenues and our near-term expectations
regarding SG&A expenses; statements regarding sublease
income and termination of lease obligations; our intention to
pay the remaining cash expenditures relating to the workforce
reductions and termination of leases by the second quarter of
fiscal 2003; our expectation to generate positive cash flow from
operations in fiscal 2003; our expectations regarding the
volatility of our marketable securities portfolio; statements
regarding our liquidity and capital resources; our belief that
Fujitsu intends to continue as our strategic channel partner;
and as set forth in the section entitled Purchased
In-Process Research and Development, statements regarding
percentage of completion, expected product release dates, dates
for which we expect to begin generating benefits from projects,
projected revenues, costs of sales, SG&A expenses and
R&D expenses, and discount rates we used to calculate
discounted cash flows, and our expectations to continue to
successfully complete product development as well as realize our
expected economic return. These statements are just predictions
and involve risks and uncertainties, and the cautionary
statements below and those contained in this report under
Risk Factors identify important factors that could
cause actual results and performance to differ materially.
Factors that might cause such a difference include increased
competition, continued adverse macroeconomic conditions in the
U.S. and internationally, including adverse business conditions
in specific markets for our products, lack of acceptance of new
products, pricing pressures, lack of success in technological
advancements, failure to reduce costs or improve operating
efficiencies, and our ability to retain key employees.

Changes to Previously Announced Fiscal 2002
Fourth Quarter and Annual Results

On July 18, 2002, we announced our fiscal
2002 fourth quarter and annual results. Subsequent to that date,
we became aware of additional information related to our
vacation and commission accruals that indicated that our initial
estimates of these costs should be reduced. In the case of the
vacation accrual, we learned that one element of underlying
source data for a limited number of employees was not correct.
In the case of the sales commission accrual, actual individual
performance compared to established goals was different from
what we expected. After reviewing and evaluating the
information, we reduced vacation and sales commission costs,
along with the related accrual balances at June 30, 2002,
by $19 million and $42 million, respectively. Out of
the $19 million related to the vacation costs,
$1 million reduced cost of sales, $4 million reduced
research and development costs and $14 million reduced
selling, general and administrative costs. In addition, we also
recorded the effects of an intercompany shipment that was
inadvertently processed incorrectly. As a result of this
adjustment, gross margin increased by $7 million. For our
fiscal 2002 fourth quarter and fiscal 2002 year, these
adjustments increased our net income, and reduced our net loss,
respectively, by approximately $41 million, net of
$27 million in tax.

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Below is a reconciliation of the effects of these
changes on the reported results in our July 18, 2002 press
release to amounts reported in this Annual Report on
Form 10-K (in millions except per share data):

|                                           |  |                                  |       |                          |  |             |      |            |  |            |       |             |  |   |        |   |  |   |       |   |  |   |        |  
|------------------------------------------ |  | -------------------------------- | ----- | ------------------------ |  | ----------- | ---- | ---------- |  | ---------- | ----- | ----------- |  | - | ------ | - |  | - | ----- | - |  | - | ------ | -
|                                           |  |                                  |       |                         
|                                           |  | Three Months Ended June 30, 2002 |       | Year Ended June 30, 2002
|                                           |  |                                  |       |                         
|                                           |  | Previously                       |       | Increase                 |  | Reported in |      | Previously |  | Increase   |       | Reported in
|                                           |  | Announced                        |       | (Decrease)               |  | Form 10-K   |      | Announced  |  | (Decrease) |       | Form 10-K  
|                                           |  |                                  |       |                          |  |             |      |            |  |            |       |            
|Gross margin                               |  | $                                | 1,406 |                          |  | $           | 8    |            |  | $          | 1,414 |             |  | $ | 4,908  |   |  | $ | 8     |   |  | $ | 4,916  |  
|Income (loss) before taxes                 |  |                                  | 22    |                          |  |             | 68   |            |  |            | 90    |             |  |   | (1,116 | ) |  |   | (68   | ) |  |   | (1,048 | )
|Net income (loss)                          |  | $                                | 20    |                          |  | $           | 41   |            |  | $          | 61    |             |  | $ | (628   | ) |  | $ | (41   | ) |  | $ | (587   | )
|Net income (loss) per common share-basic   |  | $                                | 0.01  |                          |  | $           | 0.01 |            |  | $          | 0.02  |             |  | $ | (0.19  | ) |  | $ | (0.01 | ) |  | $ | (0.18  | )
|Net income (loss) per common share-diluted |  | $                                | 0.01  |                          |  | $           | 0.01 |            |  | $          | 0.02  |             |  | $ | (0.19  | ) |  | $ | (0.01 | ) |  | $ | (0.18  | )

Critical Accounting Policies

The accompanying discussion and analysis of our
financial condition and results of operations are based upon our
consolidated financial statements, which have been prepared in
accordance with generally accepted accounting principles in the
United States (US GAAP). The preparation of these financial
statements requires us to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and
liabilities. These estimates form the basis for making judgments
about the carrying values of assets and liabilities that are not
readily apparent from other sources. We base our estimates and
judgments on historical experience and on various other
assumptions that we believe are reasonable under the
circumstances. However, future events are subject to change and
the best estimates and judgments routinely require adjustment.
US GAAP requires us to make estimates and judgments in
several areas, including those related to fair value of
derivative financial instruments, recording various accruals
(including our accrual for restructuring charges), the useful
lives of long lived assets such as property and equipment,
income taxes, warranty obligations and potential losses from
contingencies and litigation, however, we believe the policies
discussed below are the most critical to our financial
statements because their application places the most significant
demands on managements judgment. Our critical accounting
policies are described in the following paragraphs.



| |                    
| | -------------------
| | Revenue Recognition

As discussed in Note 2 to our Consolidated
Financial Statements, we enter into agreements to sell hardware,
software, services and other arrangements (multiple element
arrangements) that include any combination of products and/or
services. While the vast majority of our sales transactions
contain standard business terms and conditions, there are
transactions that contain non-standard business terms and
conditions. As a result, significant contract interpretation is
sometimes required to determine the appropriate accounting
including: (1) whether an arrangement exists; (2) how
the price should be allocated among the deliverables if there
are multiple deliverables; (3) whether undelivered elements
are essential to the functionality of delivered elements; and
(4) when to recognize revenue. In addition, our revenue
recognition policy requires an assessment as to whether
collectibility is probable, which inherently requires us to
evaluate the creditworthiness of our customers.

Channel Partners selling our high volume products
generally carry Sun products as inventory and we recognize
revenue when we sell to the Channel Partners, if our revenue
recognition criteria are met. Channel Partners selling our
high-end products generally purchase our products at the time an
end user is identified. The revenue we recognize associated with
channel sales transactions requires us to make estimates in
several areas including: (1) creditworthiness; (2) the
amount of credits we will give to the Channel Partners for
subsequent changes in our price list (i.e., price protection);
and (3) customer returns.

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| |         
| | --------
| | Goodwill

As discussed in Note 4 to our Consolidated
Financial Statements, we adopted Statement of Financial
Accounting Standard No. 142 (SFAS 142), Goodwill
and Other Intangible Assets on July 1, 2001. This
standard requires that goodwill no longer be amortized, and
instead, be tested for impairment on a periodic basis. At
June 30, 2002, we had $2.2 billion in goodwill.

In testing for a potential impairment of
goodwill, SFAS 142 requires us to: (1) allocate goodwill to
the various Sun businesses to which the acquired goodwill
relates; (2) estimate the fair value of those Sun
businesses to which goodwill relates; and (3) determine the
carrying value (book value) of those businesses, as some assets
and liabilities related to those businesses, such as inventory
and accounts receivable, are not held by those businesses but by
functional departments (for example, our Global Sales Operations
and World Wide Operations organizations). Furthermore, if the
estimated fair value is less than the carrying value for a
particular business, then we are required to estimate the fair
value of all identifiable assets and liabilities of the
business, in a manner similar to a purchase price allocation for
an acquired business. This requires independent valuations of
certain internally generated and unrecognized intangible assets
such as in-process research and development and developed
technology. Only after this process is completed, is the amount
of goodwill impairment determined.

Accordingly, the process of evaluating the
potential impairment of goodwill is highly subjective and
requires significant judgment at many points during the
analysis. In estimating the fair value of the businesses with
recognized goodwill for the purposes of our fiscal 2002
financial statements, we made estimates and judgments about the
future cash flows of these businesses. Our cashflow forecasts
were based on assumptions that are consistent with the plans and
estimates we are using to manage the underlying businesses. In
addition, we made certain judgments about allocating shared
assets such as accounts receivable and inventory to the
estimated balance sheet for those businesses. We also considered
our market capitalization (adjusted for unallocated monetary
assets such as cash, marketable debt securities and debt) on
July 1, 2001 ($15.97 per share) and April 1, 2002
($9.52 per share), representing the dates of our impairment
tests under SFAS 142, in determining the fair value of the
respective businesses.

Based on our best estimates, we have concluded
that there is no impairment of our goodwill. However, changes in
these estimates, including our market capitalization, could
cause one or more of the businesses to be valued differently.
For example, during the fourth quarter of 2002, while our
long-term business projections did not change, we experienced a
significant decline in our market capitalization. In the second
quarter of fiscal 2003, if our market capitalization does not
recover to the levels of April 2002 ($29.1 billion), then
we will perform another impairment analysis. This analysis could
potentially result in a non-cash goodwill impairment charge, for
the entire goodwill balance at June 30, 2002, of up to
approximately $2.2 billion, depending on the estimated
value of the businesses to which the goodwill relates and the
value of the other assets and liabilities attributed to those
businesses at that time.

Other Intangible Assets

In accordance with US GAAP, we perform tests for
impairment of intangible assets other than goodwill (Other
Intangible Assets) whenever events or circumstances suggest that
Other Intangible Assets may be impaired. We recognized
$6 million, $1 million and $21 million in fiscal
years 2002, 2001 and 2000, respectively, as impairment charges
against the carrying value of Other Intangible Assets. At
June 30, 2002, we had Other Intangible Assets with a
carrying value of approximately $215 million. These
consisted of Other Intangible Assets related to business
combinations of approximately $104 million and an
intangible asset with a carrying value of $111 million
related to a revenue generating technology license, acquired as
part of the Strategic Alliance with AOL, see Note 5 to the
Consolidated Financial Statements for further discussion. To
evaluate potential impairment, US GAAP requires us to
assess whether the future cash flows related to the asset will
be greater than its carrying value at the time of the test.
Accordingly, while our cashflow assumptions are consistent with
the plans and estimates we are using to manage the underlying
businesses, there is significant judgment in determining the
cashflows attributable to our Other Intangible Assets over their
respective estimated useful lives. For example, if we reduced
the estimated useful life of all intangible

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assets by one year or reduced the projected cash
flows by 20%, approximately $188 million of our Other
Intangible Assets would be considered to be impaired and we
would be required to recognize an impairment based on the
difference between the fair value of these Other Intangible
Assets and their carrying value.


Bad Debt Reserves

At June 30, 2002, our bad debt reserve was
approximately $114 million. We evaluate the collectibility
of our accounts receivable based on a combination of factors. In
cases where we are aware of circumstances that may impair a
specific customers ability to meet its financial
obligations to us, we record a specific allowance against
amounts due to us, and thereby reduce the net recognized
receivable to the amount we reasonably believe will be
collected. For all other customers, we recognize allowances for
doubtful accounts based on the length of time the receivables
are past due, industry and geographic concentrations, the
current business environment and our historical experience. If
the financial condition of our customers deteriorates or if
economic conditions worsen, additional allowances may be
required in the future.

Inventory Reserves

At June 30, 2002, our inventory balance of
$591 million was net of an approximate write-down of
$90 million for slow moving and excess inventory. We
evaluate our ending inventories for estimated excess quantities
and obsolescence. This evaluation includes analyses of sales
levels by product and projections of future demand within
specific time horizons (generally six months or less).
Inventories in excess of future demand, as defined, are
reserved. In addition, we assess the impact of changing
technology on our inventory-on-hand and we write off inventories
that are considered obsolete. Remaining inventory balances are
adjusted to approximate the lower of our standard manufacturing
cost or market value. If future demand or market conditions are
less favorable than our projections, additional inventory
write-downs may be required and would be reflected in cost of
sales in the period in which the revision is made.

Equity Investments in Privately-Held
Companies

In 1999, we formed Suns Venture &
Strategic Investment Fund to invest in companies developing
products, markets and services that are strategic to Sun. As
discussed in Note 2 to our Consolidated Financial
Statements, investments in privately-held companies were made as
part of Suns Venture & Strategic Investment
Funds strategy. These equity investments were generally
made in connection with a round of financing with other third
party investors. At June 30, 2002, we had approximately
$229 million (book value) of equity investments in
privately-held companies. As our equity investments generally do
not permit us to exert significant influence or control over the
entity in which we are investing, these amounts generally
represent our cost of the investment, less any adjustments we
make when we determine that an investments net realizable
value is less than its carrying cost.

The process of assessing whether a particular
equity investments net realizable value is less than its
carrying cost requires a significant amount of judgment. In
making this judgment, we carefully consider the investees
cash position, projected cashflows (both short and long-term),
financing needs, most recent valuation data, the current
investing environment, management/ ownership changes, and
competition. This evaluation process is based on information
that we request from these privately-held companies. This
information is not subject to the same disclosure and audit
requirements as the reports required of U.S. public
companies, and as such, the reliability and accuracy of the data
may vary. Based on our evaluation, we recorded impairment
charges related to our investments in privately-held companies
of $64 million, $72 million and none in fiscal years
2002, 2001 and 2000, respectively.

Estimating the net realizable value of
investments in privately-held early-stage technology companies
is inherently subjective and may contribute to significant
volatility in our reported results of operations. For example,
if the current weak investing environment continues throughout
fiscal 2003, we may incur additional impairments to our equity
investments in privately-held companies.

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RESULTS OF OPERATIONS

Net Revenues(dollars in millions)

|                                              |                                  |      |        |        |   |      |         |          |  |      |        |      |   |  |       |          |  |   |        |      |  
|--------------------------------------------- | -------------------------------- | ---- | ------ | ------ | - | ---- | ------- | -------- |  | ---- | ------ | ---- | - |  | ----- | -------- |  | - | ------ | ---- | -
|                                              |                                  | 2002 |        | Change |   | 2001 |         | Change   |  | 2000
|                                              |                                  |      |        |        |   |      |         |          |  |     
|Computer Systems and Network Storage products |                                  | $    | 8,574  |        |   |      | (39.6)% |          |  | $    | 14,196 |      |   |  | 10.6% |          |  | $ | 12,841 |     
|Other products                                |                                  |      | 519    |        |   |      | (36.6)% |          |  |      | 819    |      |   |  | 41.2% |          |  |   | 580    |     
|                                              |                                  |      |        |        |   |      |         |          |  |      |        |      |   |  |       |          |  |   |        |     
|Products net revenue                          |                                  | $    | 9,093  |        |   |      | (39.4)% |          |  | $    | 15,015 |      |   |  | 11.9% |          |  | $ | 13,421 |     
|                                              | Percentage of total net revenues |      |        | 72.8   | % |      |         | (9.5)pts |  |      |        | 82.3 | % |  |       | (3.1)pts |  |   |        | 85.4 | %
|Services net revenue                          |                                  | $    | 3,403  |        |   |      | 5.2%    |          |  | $    | 3,235  |      |   |  | 40.7% |          |  | $ | 2,300  |     
|                                              | Percentage of total net revenues |      |        | 27.2   | % |      |         | 9.5pts   |  |      |        | 17.7 | % |  |       | 3.1pts   |  |   |        | 14.6 | %
|Total net revenues                            |                                  | $    | 12,496 |        |   |      | (31.5)% |          |  | $    | 18,250 |      |   |  | 16.1% |          |  | $ | 15,721 |     

Products Net Revenue

Products net revenue consists of revenue
generated from the sale of our computing systems and storage
products, and our operating system and other software for
network computing.

In fiscal 2002, our products net revenue
decreased, as compared with fiscal 2001, primarily as a result
of the adverse macroeconomic conditions that began at the end of
the second quarter of fiscal 2001 and continued throughout
fiscal 2002. These conditions led to significant reductions and
deferrals in information technology (IT) spending, particularly
by customers in the telecommunications and financial services
industries. Our business is highly dependent upon both
IT spending and these industries. As a result, we
experienced lower sales volumes, and increased competitive
pricing pressure on substantially all of our product lines.

In fiscal 2001, our products net revenue
increased as compared with fiscal 2000, primarily due to
significant revenue growth in the first half of fiscal 2001, as
a result of increased IT spending during the period.

Services Net Revenue

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

In fiscal 2002, the 5.2% growth in services net
revenue, as compared with fiscal 2001, was due to an increase in
revenue from Support Services, partially offset by decreases in
revenue from Professional Services and Educational Services.
Support Services revenue, which represents over 65% of services
net revenue for all periods presented, consists of maintenance
contract revenue, which is recognized ratably over the
contractual period. Support Services revenue growth was
primarily a result of: (1) an increase in our installed
base of servers; and (2) a better mix of platinum, gold,
silver and bronze service level contracts in our portfolio
(i.e. more premium services with higher revenue value). Sun
Professional Services revenue is generated from technical
consulting and systems integration services to help customers
plan, implement, and manage distributed network computing
environments. Sun Educational Services revenue is generated by
developing and delivering integrated learning solutions for
enterprises, IT organizations, and individual IT professionals.
The Professional Services and the Educational Services revenue
decrease was due to a combination of: (1) a reduction in
customers discretionary spending, and (2) a decline
in new product sales.

In fiscal 2001, the 40.7% growth in services net
revenue, as compared with fiscal 2000, was primarily the result
of: (1) a continuing shift towards premium service and
support contracts generated from a larger installed base of
high-end server products and an overall shift in customer demand
for higher levels of support; (2) a larger installed base
of product units; and (3) an increase in revenues
associated with our professional and educational services.

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

Net Revenues by Geographic Area(dollars in millions)

|                                                |                            |      |        |        |   |      |         |          |  |      |        |      |   |  |       |          |  |   |        |      |  
|----------------------------------------------- | -------------------------- | ---- | ------ | ------ | - | ---- | ------- | -------- |  | ---- | ------ | ---- | - |  | ----- | -------- |  | - | ------ | ---- | -
|                                                |                            | 2002 |        | Change |   | 2001 |         | Change   |  | 2000
|                                                |                            |      |        |        |   |      |         |          |  |     
|U.S. (United States)                            |                            | $    | 5,812  |        |   |      | (32.8)% |          |  | $    | 8,647  |      |   |  | 6.3%  |          |  | $ | 8,134  |     
|Americas  Other (Canada and Latin
    America) |                            |      | 663    |        |   |      | (30.6)% |          |  |      | 955    |      |   |  | 38.8% |          |  |   | 688    |     
|                                                |                            |      |        |        |   |      |         |          |  |      |        |      |   |  |       |          |  |   |        |     
|Americas  Total                                |                            | $    | 6,475  |        |   |      | (32.6)% |          |  | $    | 9,602  |      |   |  | 8.8%  |          |  | $ | 8,822  |     
|                                                | Percentage of net revenues |      |        | 51.8   | % |      |         | (0.8)pts |  |      |        | 52.6 | % |  |       | (3.5)pts |  |   |        | 56.1 | %
|EMEA (Europe, Middle East and Africa)           |                            | $    | 3,844  |        |   |      | (30.3)% |          |  | $    | 5,515  |      |   |  | 22.6% |          |  | $ | 4,498  |     
|                                                | Percentage of net revenues |      |        | 30.8   | % |      |         | 0.6pts   |  |      |        | 30.2 | % |  |       | 1.6pts   |  |   |        | 28.6 | %
|APAC (Asia, Australia and New Zealand)          |                            | $    | 2,177  |        |   |      | (30.5)% |          |  | $    | 3,133  |      |   |  | 30.5% |          |  | $ | 2,401  |     
|                                                | Percentage of net revenues |      |        | 17.4   | % |      |         | 0.2pts   |  |      |        | 17.2 | % |  |       | 1.9pts   |  |   |        | 15.3 | %
|Total net revenues                              |                            | $    | 12,496 |        |   |      | (31.5)% |          |  | $    | 18,250 |      |   |  | 16.1% |          |  | $ | 15,721 |     



|                   |                            |      |        |        |   |      |         |           |  |      |        |      |   |  |       |           |  |   |        |      |  
|------------------ | -------------------------- | ---- | ------ | ------ | - | ---- | ------- | --------- |  | ---- | ------ | ---- | - |  | ----- | --------- |  | - | ------ | ---- | -
|                   |                            | 2002 |        | Change |   | 2001 |         | Change    |  | 2000
|                   |                            |      |        |        |   |      |         |           |  |     
|U.S.               |                            | $    | 5,812  |        |   |      | (32.8)% |           |  | $    | 8,647  |      |   |  | 6.3%  |           |  | $ | 8,134  |     
|                   | Percentage of net revenues |      |        | 46.5   | % |      |         | (0.9) pts |  |      |        | 47.4 | % |  |       | (4.3) pts |  |   |        | 51.7 | %
|International      |                            | $    | 6,684  |        |   |      | (30.4)% |           |  | $    | 9,603  |      |   |  | 26.6% |           |  | $ | 7,587  |     
|                   | Percentage of net revenues |      |        | 53.5   | % |      |         | 0.9pts    |  |      |        | 52.6 | % |  |       | 4.3 pts   |  |   |        | 48.3 | %
|Total net revenues |                            | $    | 12,496 |        |   |      | (31.5)% |           |  | $    | 18,250 |      |   |  | 16.1% |           |  | $ | 15,721 |     

At the end of the second quarter of fiscal 2001,
there was an unexpected and significant reduction in capital
spending in many industries, which resulted in decreased demand
in the U.S. for our products and a decline in our products net
revenue. The weak U.S. economic situation evolved into adverse
global macroeconomic conditions beginning in the fourth quarter
of fiscal 2001, resulting in reductions in capital spending in
many countries within the international regions in which we do
significant business and negatively impacting our non-U.S.
product net revenues. These adverse global macroeconomic
conditions have continued throughout fiscal 2002, resulting in a
32.8% decrease in U.S. net revenues, and a 30.4% decrease in
international net revenues in fiscal 2002, as compared with
fiscal 2001. Overall, during fiscal 2001, as compared with
fiscal 2000, we experienced net revenue growth in the U.S. as
well as in the majority of the countries within the
international regions.

In fiscal 2002, within the Americas-Other region,
net revenues decreased by 30.6% as compared with fiscal 2001,
primarily because of decreases in net revenues in Canada and
Brazil. The ongoing financial crisis in Argentina had an
insignificant impact on our overall revenues for fiscal 2002.

In fiscal 2002, within the EMEA region, net
revenues decreased by 30.3% as compared with fiscal 2001,
primarily because of decreases in net revenues in the United
Kingdom, Northern Europe and Germany. Northern Europe consists
primarily of the Scandinavian countries, the Netherlands,
Belgium/ Luxembourg, Eastern European countries and Russia.

In fiscal 2002, within the APAC region, net
revenues decreased by 30.5% as compared with fiscal 2001,
primarily because of decreases in net revenues in Japan, China
and Korea. Economic conditions in Japan have declined
substantially in recent years and have adversely impacted our
sales in this region. If the economic

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trends in Japan significantly worsen in a quarter
or decline over an extended period of time, our results of
operations and cash flows could be further adversely affected.


In fiscal 2002, decreases in net revenues in
Japan, the United Kingdom, Northern Europe, and Germany
collectively accounted for approximately 63% of the total
decrease in international net revenues, as compared with fiscal
2001.

In fiscal 2001, within the Americas-Other region,
net revenues increased by 38.8% (primarily contributed by Canada
and Brazil) as compared with fiscal 2000. In fiscal 2001, within
the APAC region, net revenues increased by 30.5% (primarily
contributed by Japan and China) as compared with fiscal 2000. In
fiscal 2001 within the EMEA region, net revenues increased by
22.6% (primarily contributed by the United Kingdom, Northern
Europe and Germany) as compared with fiscal 2000.

In fiscal 2001, net revenues in the United
Kingdom, Germany, Japan and China collectively accounted for
more than 40% of the total increase in international net
revenues for fiscal 2001. Also, see Note 15 to the Consolidated
Financial Statements.

Gross Margin(dollars in millions)

|                      |                                    |      |       |        |   |      |         |          |  |      |       |      |   |  |        |          |  |   |       |      |  
|--------------------- | ---------------------------------- | ---- | ----- | ------ | - | ---- | ------- | -------- |  | ---- | ----- | ---- | - |  | ------ | -------- |  | - | ----- | ---- | -
|                      |                                    | 2002 |       | Change |   | 2001 |         | Change   |  | 2000
|                      |                                    |      |       |        |   |      |         |          |  |     
|Products gross margin |                                    | $    | 3,587 |        |   |      | (49.1)% |          |  | $    | 7,054 |      |   |  | (3.7)% |          |  | $ | 7,325 |     
|                      | Percentage of products net revenue |      |       | 39.4   | % |      |         | (7.6)pts |  |      |       | 47.0 | % |  |        | (7.6)pts |  |   |       | 54.6 | %
|Services gross margin |                                    | $    | 1,329 |        |   |      | 15.1%   |          |  | $    | 1,155 |      |   |  | 36.4%  |          |  | $ | 847   |     
|                      | Percentage of services net revenue |      |       | 39.1   | % |      |         | 3.4 pts  |  |      |       | 35.7 | % |  |        | (1.1)pts |  |   |       | 36.8 | %
|Total gross margin    |                                    | $    | 4,916 |        |   |      | (40.1)% |          |  | $    | 8,209 |      |   |  | 0.5%   |          |  | $ | 8,172 |     
|                      | Percentage of net revenues         |      |       | 39.3   | % |      |         | (5.7)pts |  |      |       | 45.0 | % |  |        | (7.0)pts |  |   |       | 52.0 | %

Products Gross Margin

In fiscal 2002, products gross margin decreased
by 7.6 percentage points, as compared with fiscal 2001.
Substantially all of the 7.6 percentage point decline in
products gross margin was due to reductions in product pricing
(normal price list reductions and competitive transaction
pricing) and higher platform transition costs associated with
conversion of a majority of our product lines to
UltraSPARC III. These transition costs primarily consisted
of write-offs for excess and obsolete inventory and costs
associated with rework. However, the resulting decline in
products gross margin was partially offset by lower purchased
component costs. Our products gross margin was 36.9% for the
first half of fiscal 2002, and 41.8% for the second half of
fiscal 2002. The majority of the 4.9 percentage point
increase in our products gross margin in the second half of
fiscal 2002, as compared with the first half of fiscal 2002, was
attributable to: (1) a reduction in the platform transition
costs associated with the conversion of a majority of our
product lines to UltraSPARC III that were incurred during
the first half of fiscal 2002; and (2) reductions in our
fixed manufacturing costs as a result of lower production
volumes.

In fiscal 2001, products gross margin decreased
by 7.6 percentage points as compared with fiscal 2000.
Substantially all of the 7.6 percentage point decrease in
products gross margin was due to: (1) higher purchased
component costs; (2) lower volumes of products
manufactured; and (3) competitive transaction pricing.

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

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Services Gross Margin

In fiscal 2002, the 3.4 percentage point
increase in services gross margin, as compared with fiscal 2001,
reflected the impact of: (1) variable costs decreasing as a
result of discretionary spending controls; (2) support
services revenue increasing as a percentage of total services
net revenue (support services typically generates a higher gross
margin than professional services or educational services); and
(3) infrastructure headcount-related costs decreasing due
to the workforce reduction in the second quarter of fiscal 2002
(direct services headcount decreased by 2% or approximately 240
employees while services revenue continued to grow). The impact
of these favorable items on services gross margin in fiscal
2002, as compared with fiscal 2001, was partially offset by:
(1) increased fixed infrastructure costs; and
(2) increased third party costs necessary to support global
customer service expectations. For the first half of fiscal
2002, our services gross margin was 36.5%, while our services
gross margin was 41.5% for the second half of fiscal 2002. The
majority of the 5.0 percentage point increase in our
services gross margin in the second half of fiscal 2002, as
compared with the first half of fiscal 2002, was attributable
to: (1) lower overall costs generated by the workforce
reduction, and (2) other actions taken to reduce services
infrastructure.

In fiscal 2001, the 1.1 percentage point
decrease in services gross margin, as compared with fiscal 2000,
reflected the impact of: (1) increased fixed and variable
costs to support our services infrastructure; (2) increased
capital and operating expenditures related to the deployment of
service delivery technologies and processes; (3) expanded
field service delivery headcount to support increased customer
service expectations and expected future growth in the service
business; and (4) increased pricing pressure. During fiscal
2001, approximately 2,300 of Suns total increase in global
headcount of 7,000 personnel represented service employees.

Operating Expenses

(dollars in millions)

|                                              |                            |      |       |        |   |      |         |           |  |      |       |      |   |  |        |           |  |   |       |      |  
|--------------------------------------------- | -------------------------- | ---- | ----- | ------ | - | ---- | ------- | --------- |  | ---- | ----- | ---- | - |  | ------ | --------- |  | - | ----- | ---- | -
|                                              |                            | 2002 |       | Change |   | 2001 |         | Change    |  | 2000
|                                              |                            |      |       |        |   |      |         |           |  |     
|Research and development                      |                            | $    | 1,832 |        |   |      | (9.1)%  |           |  | $    | 2,016 |      |   |  | 23.7%  |           |  | $ | 1,630 |     
|                                              | Percentage of net revenues |      |       | 14.7   | % |      |         | 3.7 pts   |  |      |       | 11.0 | % |  |        | 0.6 pts   |  |   |       | 10.4 | %
|Selling, general and administrative           |                            | $    | 3,812 |        |   |      | (14.2)% |           |  | $    | 4,445 |      |   |  | 9.3%   |           |  | $ | 4,065 |     
|                                              | Percentage of net revenues |      |       | 30.5   | % |      |         | 6.1 pts   |  |      |       | 24.4 | % |  |        | (1.5) pts |  |   |       | 25.9 | %
|Restructuring charges                         |                            | $    | 517   |        |   |      | 589.3%  |           |  | $    | 75    |      |   |  | N/M    |           |  | $ |      |     
|                                              | Percentage of net revenues |      |       | 4.1    | % |      |         | 3.7 pts   |  |      |       | 0.4  | % |  |        | 0.4 pts   |  |   |       |     | %
|Goodwill amortization                         |                            | $    |      |        |   |      | N/M     |           |  | $    | 285   |      |   |  | 295.8% |           |  | $ | 72    |     
|                                              | Percentage of net revenues |      |       |       | % |      |         | (1.6) pts |  |      |       | 1.6  | % |  |        | 1.2 pts   |  |   |       | 0.4  | %
|Purchased in-process research and development |                            | $    | 3     |        |   |      | (96.1)% |           |  | $    | 77    |      |   |  | 541.7% |           |  | $ | 12    |     
|                                              | Percentage of net revenues |      |       |       | % |      |         | (0.4) pts |  |      |       | 0.4  | % |  |        | 0.3 pts   |  |   |       | 0.1  | %



| |                                            
| | -------------------------------------------
| | Research and Development (R&D)
    Expenses

In fiscal 2002, R&D expenses, as a percentage
of total net revenues, increased to 14.7% from 11.0% and 10.4%
for fiscal 2001 and 2000, respectively. The increase in the
percentage of R&D expenses to total net revenues is the
result of a decrease in revenues in fiscal 2002, as compared
with fiscal 2001 and 2000. In dollars, R&D expenses
decreased by 9.1% to $1,832 million in fiscal 2002, as
compared with $2,016 million in fiscal 2001 and increased
by 23.7% to $2,016 million in fiscal 2001, as compared with
$1,630 in fiscal 2000.

In dollars, the decrease in R&D expenses for
fiscal 2002, as compared with fiscal 2001, was a result of:
(1) significant cost cutting measures in the areas of
consulting, travel and other types of discretionary spending;
(2) lower costs incurred for prototype development;
(3) a decrease in compensation costs as a result of our one
week mandatory shutdown in July 2001; (4) a reduction in
incentive compensation costs; and (5) a reduction in
headcount (during fiscal 2002, approximately 500 employees of
Suns workforce reduction were

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engineering employees). These reductions were
partially offset by higher depreciation costs. In general,
fluctuations in R&D expenses will occur depending on the
timing of product introductions, among other factors.


In fiscal 2001, the increase in R&D expenses
was a result of an increase in compensation and
compensation-related costs related to higher levels of R&D
staffing. During fiscal 2001, approximately 1,700 of Suns
increase in global headcount of 7,000 personnel were
engineering employees.

Our R&D spending reflects our continued
development of a broad line of scalable and reliable systems,
including servers, desktop systems, storage technologies and
SPARC® microprocessors, as well as software products that
utilize the Java platform, SolarisTM Operating
Environment software and JiniTM network technology.
We believe that to maintain our competitive position in a market
characterized by rapid rates of technological advancement, we
must continue to invest significant resources in new systems,
software, and microprocessor development, as well as continue to
enhance existing products. While it is managements
long-term objective to invest 10-11% of net revenues in R&D,
the sharp decline in fiscal 2002 net revenues resulted in higher
investment levels, as a percentage of total net revenues.



| |                                                        
| | -------------------------------------------------------
| | Selling, General and Administrative (SG&A)
    Expenses

In fiscal 2002, SG&A expenses, as a
percentage of total net revenues, increased to 30.5% from 24.4%
in fiscal 2001. The increase in the percentage of SG&A
expenses to total net revenues is the result of a decrease in
revenues in fiscal 2002, as compared with fiscal 2001. In
dollars, SG&A expenses decreased $633 million to
$3,812 million in fiscal 2002, as compared with
$4,445 million in fiscal 2001, as a result of:
(1) significant cost cutting measures in the areas of
travel, advertising, marketing, facilities and other types of
discretionary spending; (2) lower headcount-related costs
as a result of our workforce reduction that began in the second
quarter of fiscal 2002; and (3) a decrease in compensation
costs. These reductions were partially offset by higher
depreciation costs.

In fiscal 2001, SG&A expenses, as a
percentage of total net revenues, decreased to 24.4% from 25.9%
in fiscal 2000, which was a result of the slower SG&A
expense growth rate (9.3% in fiscal 2001) as compared with the
revenue growth rate (16% in fiscal 2001). During the first half
of fiscal 2001, we invested in our infrastructure based on
expectations of continued economic growth; late in the second
quarter of fiscal 2001, we experienced a sharp decline in
product demand and we responded by reducing variable SG&A
costs. The dollar increase in SG&A expenses in fiscal 2001,
as compared with fiscal 2000, was due to the continued growth in
headcount-related costs (principally in the sales organization)
and marketing costs related to promotional programs. During the
second half of fiscal 2001, our SG&A expenses were lower
than the corresponding period of fiscal 2000, which was
primarily the result of: (1) lower variable compensation
such as commissions and bonuses, net of increased incremental
headcount costs for the same period; and (2) significant
cost cutting measures in the areas of travel, advertising,
marketing, facilities and other types of discretionary spending.

We are continuing to focus our efforts on
achieving additional operating efficiencies by reviewing and
improving upon existing business processes and evaluating our
cost structure. It is managements long-term objective to
reduce SG&A expenses to approximately 25% of net revenues.
However, in the near-term, we expect SG&A expenses for
fiscal 2003 to remain higher than 25% of total net revenues.



| |                      
| | ---------------------
| | Restructuring Charges

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

We committed to a restructuring plan in fiscal
2002 (Fiscal 2002 Restructuring Plan) and a facility exit plan
in fiscal 2001 (Fiscal 2001 Facility Exit Plan). We recorded
initial restructuring charges in fiscal 2002 and 2001 based on
assumptions and related estimates that we deemed appropriate for
the economic environment that existed at the time these
estimates were made. However, due to the continued deterioration
of the commercial real estate market, primarily in the U.S., and
the final settlement of certain lease obligations, we have made
the appropriate adjustments to the initial restructuring charges
recorded in fiscal

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2002 and 2001. During fiscal 2001, we recorded a
charge of $75 million for the Fiscal 2001 Facility Exit
plan. During fiscal 2002, we recorded a net charge of
$517 million, $26 million of additional charges
related to our Fiscal 2001 Facility Exit Plan and the remaining
net charges of $491 million related to our Fiscal 2002
Restructuring Plan. At June 30, 2002, we had an accrued
liability of $241 million with respect to the Fiscal 2002
Restructuring Plan and Fiscal 2001 Facility Exit Plan. Details
about each of these plans are discussed below.


Our accrued liability of $241 million at
June 30, 2002, is net of $207 million of estimated
sublease income. Our ability to generate this amount of sublease
income, as well as our ability to terminate lease obligations at
the amounts we have estimated, is highly dependent upon the
economic conditions, particularly lease market conditions in
certain geographies, at the time we negotiate the lease
termination and sublease arrangements with third parties. While
the amount we have accrued is our best estimate, estimates are
subject to change and may require routine adjustment as
conditions and facts change through the implementation period.
If macroeconomic conditions, particularly as they pertain to the
commercial real estate market, continue to be negative, we may
be required in the future to increase our estimated cost to exit
certain facilities.

Fiscal 2002 Restructuring Plan

In response to the continuing global economic
slowdown, we implemented a workforce reduction and facility exit
plan in the second quarter of fiscal 2002. This restructuring
resulted in a charge of $511 million (consisting of a
$146 million workforce reduction charge and a
$365 million excess facility charge as discussed below) in
the second quarter of fiscal 2002. The goal of the restructuring
was to reduce costs and improve operating efficiencies in order
to adjust to the current business environment. Specifically, we
reduced our headcount by approximately 9% (or
3,400 employees and 500 contractors) and eliminated
excess facilities in light of revised facility requirements.

Worldwide
Workforce Reduction

As part of the restructuring, we recorded a
workforce reduction charge of $146 million related to
severance and fringe benefits for terminated employees. The
restructuring resulted in the termination of approximately
3,400 employees across all employee levels, business
functions, operating units, and geographic regions.

Consolidation of
Excess Facilities

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



|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | $282 million of estimated future obligations
    for non-cancelable lease payments or termination fees generated
    by exiting excess leased facilities. We estimated the cost of
    exiting and terminating the facility leases based on the
    contractual terms of the agreements and then current real estate
    market conditions. In addition, we intend to sublease certain
    leased facilities and estimated the sublease income based on
    then current real estate market conditions or, where applicable,
    amounts being negotiated;
| 
| | $66 million for the impairment of in-process
    construction costs related to the termination of certain
    building construction projects; and                                                                                                                                                                                                                                                                                                                                                                                                         
| 
| | $17 million for the impairment of property
    and equipment (primarily leasehold improvements) that were no
    longer in use. The property and equipment impairment was
    determined based on the difference between the assets
    estimated fair value and their carrying value.                                                                                                                                                                                                                                                                   

We expect to exit the facilities relating to the
amounts accrued under the restructuring by no later than
December 31, 2002.

During the second half of fiscal 2002, we reduced
our estimate of the total cost of $511 million associated
with this restructuring activity and recorded an adjustment of
$20 million. This adjustment primarily reflects the
settlement of certain lease obligations. As of June 30,
2002, the revised total estimated cost for the Fiscal 2002
Restructuring Plan of $491 million was net of approximately
$180 million of estimated sublease income.

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Fiscal 2001 Facility Exit Plan

In the fourth quarter of fiscal 2001, we elected
to exit certain building leases and building projects. We
charged approximately $75 million for facility exit costs
associated with this decision, of which $46 million was
reflected as an accrual as of June 30, 2001. As a result of
the continued deterioration of certain commercial real estate
markets, we reduced our sublease income assumptions and,
accordingly, recorded an additional $26 million charge in
fiscal 2002 to reflect this change in estimates. As of
June 30, 2002, the revised total estimated facility exit
cost of $101 million was net of approximately
$27 million in estimated sublease income.

The following table sets forth an analysis of the
restructuring accrual activity for the fiscal years ending
June 30, 2001 and 2002 (in millions):

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

The remaining cash expenditures relating to
workforce reductions and the termination of lease agreements are
expected to be paid by the second quarter of fiscal 2003. The
current estimates accrued for abandoned leases (net of
anticipated sublease proceeds) will be paid over their
respective lease terms through fiscal 2018. As of June 30,
2002, $90 million of the $241 million accrual was
classified as current and the remaining $151 million was
classified as non-current.

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



| |                      
| | ---------------------
| | Goodwill Amortization

Sun adopted Statement of Financial Accounting
Standards 141, Business Combinations, and SFAS 142, Goodwill and
Intangible Assets, effective July 1, 2001, and discontinued
amortization of goodwill in fiscal 2002. For fiscal 2001, the
dollar increase in goodwill amortization expense, as compared
with fiscal 2000, was primarily attributable to the acquisition
of Cobalt Networks, Inc. in December 2000, which resulted in
approximately $213 million of additional goodwill expense
in fiscal 2001.

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##### Table of Contents





| |                                                         
| | --------------------------------------------------------
| | Purchased In-Process Research and Development
    (IPRD)

Overview

IPRD of $3.2 million, $77.4 million,
and $11.5 million in fiscal 2002, 2001, and 2000,
respectively, represent the write-offs of in-process
technologies associated with our acquisitions of ISOPIA, Inc.
(Isopia) in fiscal 2002; LSC, Incorporated (LSC), HighGround
Systems, Inc. (HighGround), InfraSearch, Inc. (InfraSearch),
Cobalt Networks, Inc. (Cobalt) and grapeVINE Technologies,
L.L.C. (grapeVINE) in fiscal 2001; Innosoft International, Inc.
(Innosoft), Trustbase Limited, the parent company of JCP
Computer Services Limited (collectively, the Trustbase
Companies) and Star Division Corporation and Star Division
Software Entwicklung und Vertriebs GmbH (collectively, the Star
Companies) in fiscal 2000 (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 IPRD had no alternative future
uses. Accordingly, these amounts were expensed on the respective
acquisition dates of each of the Acquired Companies. Also see
Note 3 to the Consolidated Financial Statements for further
discussion.

Valuation of IPRD

General:

We used independent third-party sources to
calculate the amounts allocated to IPRD. In calculating IPRD,
the independent third party used established valuation
techniques accepted in the high technology industry. These
calculations gave consideration to relevant market sizes and
growth factors, expected industry trends, the anticipated nature
and timing of new product introductions by us and our
competitors, individual product sales cycles, and the estimated
lives of each of the products underlying technology. 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 of completing the
remaining development, costs already incurred, and the expected
cost to complete the project in determining the value assigned
to IPRD.

Approach Used for Valuation of IPRD in the
Purchase Acquisitions Presented:

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

33



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##### Table of Contents



Valuation Assumptions:

The following table summarizes the significant
assumptions underlying the valuations related to the IPRD from
each of the Acquired Companies in fiscal years 2002, 2001, and
2000 (dollars in millions):

|                          |  |      |      |                |  |                  |     |         |  |                       |     |          |  |         |      |      |  |  |     |  |  |  |     |  |  |  |    |  |  |  |     | 
|------------------------- |  | ---- | ---- | -------------- |  | ---------------- | --- | ------- |  | --------------------- | --- | -------- |  | ------- | ---- | ---- |  |  | --- |  |  |  | --- |  |  |  | -- |  |  |  | --- | 
|                          |  |      |      |                |  |                  |     |         |  |                      
|                          |  |      |      | Estimated Cost |  |                  |     |         |  | Percentage of Revenue
|                          |  |      |      | to Complete    |  |                  |     | Average |  |                      
|                          |  |      |      | Technology at  |  | Percentage       |     | Revenue |  |                       |     | Discount
|                          |  |      |      | Time of        |  | Complete at Time |     | Growth  |  | Average               |     | Average  |  | Average |      | Rate
|Acquired Company/Business |  | IPRD |      | Acquisition    |  | of Acquisition   |     | Rate    |  | COS                   |     | SG&A     |  | R&D     |      | Used
|                          |  |      |      |                |  |                  |     |         |  |                       |     |          |  |         |      |     
|Fiscal 2002               |  |      |      |                |  |                  |     |         |  |                       |     |          |  |         |      |      |  |  |     |  |  |  |     |  |  |  |    |  |  |  |     | 
|Isopia                    |  | $    | 3.2  |                |  | $                | 0.6 |         |  |                       | 45% |          |  |         | 58%  |      |  |  | 13% |  |  |  | 35% |  |  |  | 2% |  |  |  | 26% | 
|Fiscal 2001               |  |      |      |                |  |                  |     |         |  |                       |     |          |  |         |      |      |  |  |     |  |  |  |     |  |  |  |    |  |  |  |     | 
|LSC                       |  | $    | 0.3  |                |  | $                | 0.5 |         |  |                       | 78% |          |  |         | 70%  |      |  |  | 10% |  |  |  | 40% |  |  |  | 2% |  |  |  | 24% | 
|HighGround                |  | $    | 4.8  |                |  | $                | 5.0 |         |  |                       | 58% |          |  |         | 54%  |      |  |  | 2%  |  |  |  | 60% |  |  |  | 2% |  |  |  | 26% | 
|InfraSearch               |  | $    | 1.0  |                |  | $                | 0.8 |         |  |                       | 75% |          |  |         | 247% |      |  |  | 18% |  |  |  | 50% |  |  |  | 1% |  |  |  | 30% | 
|Cobalt                    |  | $    | 70.8 |                |  | $                | 1.5 |         |  |                       | 67% |          |  |         | 50%  |      |  |  | 49% |  |  |  | 28% |  |  |  | 1% |  |  |  | 22% | 
|grapeVINE                 |  | $    | 0.5  |                |  | $                | 0.3 |         |  |                       | 83% |          |  |         | 10%  |      |  |  | 18% |  |  |  | 48% |  |  |  | 1% |  |  |  | 23% | 
|Fiscal 2000               |  |      |      |                |  |                  |     |         |  |                       |     |          |  |         |      |      |  |  |     |  |  |  |     |  |  |  |    |  |  |  |     | 
|Innosoft                  |  | $    | 3.1  |                |  | $                | 0.3 |         |  |                       | 80% |          |  |         | 18%  |      |  |  | 22% |  |  |  | 35% |  |  |  | 1% |  |  |  | 18% | 
|Trustbase Companies       |  | $    | 4.9  |                |  | $                | 1.2 |         |  |                       | 67% |          |  |         | 39%  |      |  |  | 15% |  |  |  | 33% |  |  |  | 2% |  |  |  | 30% | 
|Star Companies            |  | $    | 3.5  |                |  | $                | 7.5 |         |  |                       | 60% |          |  |         | 36%  |      |  |  | 20% |  |  |  | 40% |  |  |  | 3% |  |  |  | 23% | 

Overview of IPRD in fiscal 2002, 2001 and
2000

Included below are further details regarding the
nature of the significant amounts of purchased technology
acquired during fiscal 2002, 2001 and 2000.

Given the uncertainties of the commercialization
process, no assurance can be given that deviations from our
estimates will not occur. At the time of the acquisitions, we
believed there was a reasonable chance of realizing the economic
return expected from the acquired in-process technology.
However, as there is risk associated with the realization of
benefits related to commercialization of an in-process project
due to rapidly changing customer needs, the complexity of the
technology, and growing competitive pressures, there can be no
assurance that any project will meet commercial success. Failure
to successfully commercialize an in-process project would result
in the loss of the expected economic return inherent in the fair
value allocation. Additionally, the value of our intangible
assets acquired may become impaired.

Cobalt

On December 7, 2000, we acquired all of the
outstanding capital stock of Cobalt, a Delaware corporation, by
means of a merger transaction pursuant to which all of the
outstanding capital stock and options of Cobalt were converted
into the right to receive shares of and options to purchase our
common stock. The total purchase price for Cobalt was
approximately $2,061 million.

At the acquisition date, Cobalt was engaged in
development activity associated with development of its Cobalt
RaQ XTR, Qube ML and CacheRaQ server appliance products as well
as related software. These products perform critical
Internet-related applications including file serving, web
hosting, and providing software applications over the Internet,
such as electronic mail and electronic commerce. These products
also provide overflow file storage for network users, and
network caching products, which enable more efficient bandwidth
usage and improve speed of Internet content delivery. At the
acquisition date, Cobalt had made substantial progress in the
areas of product definition, architecture design and coding.
Remaining efforts necessary to complete these server appliance
products related primarily to additional coding, testing and
implementation. We released certain general availability
versions of these products in late January 2001 through April
2001, at which time we began to realize economic benefits
associated with these server appliance products. See

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Overall Status of Business Combinations
During Fiscal 2002, 2001 and 2000 for an update on the
product offerings.


Overall Status of Business Combinations During
Fiscal 2002, 2001, and 2000:

The following table provides information
regarding the status of IPRD projects upon acquisition and as of
June 30, 2002 (in millions):

|                          |  |                     |     |                       |  |                      |     |  |  |  |          | 
|------------------------- |  | ------------------- | --- | --------------------- |  | -------------------- | --- |  |  |  | -------- | 
|                          |  | Estimated Cost to   |     |                       |  |                     
|                          |  | Complete at Time of |     | Actual Costs Incurred |  | Actual              
|Acquired Company/Business |  | Acquisition         |     | as of June 30, 2002   |  | Product Release Date
|                          |  |                     |     |                       |  |                     
|Isopia                    |  | $                   | 0.6 |                       |  | $                    | 1.2 |  |  |  | Q3FY2002 | 
|LSC                       |  | $                   | 0.5 |                       |  | $                    | 1.1 |  |  |  | Q4FY2001 | 
|HighGround                |  | $                   | 5.0 |                       |  | $                    | 5.5 |  |  |  | Q4FY2001 | 
|InfraSearch               |  | $                   | 0.8 |                       |  | $                    | 0.8 |  |  |  | N/A(1)   | 
|Cobalt                    |  | $                   | 1.5 |                       |  | $                    | 2.5 |  |  |  | Q3FY2001 | 
|grapeVINE                 |  | $                   | 0.3 |                       |  | $                    | 1.1 |  |  |  | Q4FY2001 | 
|Innosoft                  |  | $                   | 0.3 |                       |  | $                    | 2.9 |  |  |  | Q2FY2001 | 
|Trustbase Companies       |  | $                   | 1.2 |                       |  | $                    | 9.3 |  |  |  | Q4FY2001 | 
|Star Companies            |  | $                   | 7.5 |                       |  | $                    | 7.5 |  |  |  | Q2FY2001 | 



---



|    |                                                                                                                                                                     
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The associated OpenSearch technology is being
    incorporated into Project JXTA, our incubation research effort
    addressing new styles of distributed computing.

With the exception of the acquisitions discussed
separately below, in managements judgment the projections
used in performing valuations with respect to each acquisition
are still appropriate; however, there can be no assurance that
the projected results will be achieved. 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. As of June 30, 2002,
and for each of the three fiscal years then ended, the impact
upon our consolidated results of operations or financial
position with respect to the success or lack thereof, related to
any acquisition, individually or in the aggregate, is not
considered significant, except as discussed below.

In fiscal 2001 and 2000, we determined that the
carrying value of certain intangible assets, including goodwill,
recognized in the acquisition of NetDynamics became impaired due
to changes in circumstances from those present at the time these
assets were acquired. At the time of the acquisition, the
technology acquired from NetDynamics was expected to be utilized
in a collaborative application. The current and future plans for
utilization of this technology have diminished materially such
that expected future cash flows from the use of
NetDynamics technology were less than the carrying value
of the underlying assets. Accordingly, impairment charges of
approximately $1 million in each of fiscal 2001 and 2000
were recognized in cost of sales and none and $32 million
in fiscal 2001 and 2000, respectively, were recognized in
selling, general and administrative, to reduce such carrying
values to the present value of the future expected cash flows.

The technology acquired from Encore Computer
Corporation in fiscal 1998 was intended to accelerate our
efforts to develop a high-end intelligent storage product.
Although all but one of the key products utilizing the acquired
technology from Encore commenced shipment in fiscal 2000,
certain factors, including delays and changes in packaging and
delivery strategy, diminished revenue expectations attributed to
the technology acquired from Encore. As a result, future cash
flows from the use of Encores technology was determined to
be negligible in fiscal 2000. Accordingly, impairment charges of
approximately $8 million were recognized in cost of sales
and $1 million was recognized in selling, general and
administrative, in fiscal 2000 to write-off the remaining
carrying value of technology acquired from Encore in 1998.

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Gain (Loss) on Equity Investments

(dollars in millions)

|                                       |                            |      |     |        |    |      |      |        |      |      |     |      |    |  |        |      |      |   |     |     |  
|-------------------------------------- | -------------------------- | ---- | --- | ------ | -- | ---- | ---- | ------ | ---- | ---- | --- | ---- | -- |  | ------ | ---- | ---- | - | --- | --- | -
|                                       |                            | 2002 |     | Change |    | 2001 |      | Change |      | 2000
|                                       |                            |      |     |        |    |      |      |        |      |     
|Gain (loss) on equity investments, net |                            | $    | (99 | )      |    |      | 10.0 | %      |      | $    | (90 | )    |    |  | (143.3 | )%   |      | $ | 208 |    
|                                       | Percentage of net revenues |      |     | (0.8   | )% |      |      | (0.3   | )pts |      |     | (0.5 | )% |  |        | (1.8 | )pts |   |     | 1.3 | %

Our equity investments portfolio, which primarily
consists of publicly traded and privately-held technology
companies contained within our internally-managed venture
capital fund, was negatively impacted by the decline in The
Nasdaq National Market and the adverse global macroeconomic
conditions of the technology sector during fiscal 2002 and
fiscal 2001. The loss on equity investments in fiscal 2002 of
$102 million, as compared with $142 million in fiscal
2001 and none in fiscal 2000, was related to a decline in value
that was considered other than temporary. This loss was
partially offset by realized gains of $3 million, as
compared with $52 million in fiscal 2001 and $208 million
in fiscal 2000, relating to the sale of certain marketable
equity securities. See Note 2 to the Consolidated Financial
Statements for further discussion.

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

Other Income, net

(dollars in millions)

|                                   |                            |      |     |        |   |      |         |         |  |      |      |     |   |  |        |         |  |   |     |     |  
|---------------------------------- | -------------------------- | ---- | --- | ------ | - | ---- | ------- | ------- |  | ---- | ---- | --- | - |  | ------ | ------- |  | - | --- | --- | -
|                                   |                            | 2002 |     | Change |   | 2001 |         | Change  |  | 2000
|                                   |                            |      |     |        |   |      |         |         |  |     
|Interest income                    |                            | $    | 243 |        |   |      | (40.0)% |         |  | $    | 405  |     |   |  | 62.0%  |         |  | $ | 250 |    
|Interest expense                   |                            |      | (58 | )      |   |      | (42.0)% |         |  |      | (100 | )   |   |  | 19.0%  |         |  |   | (84 | )  
|Gain on marketable debt securities |                            |      | 114 |        |   |      | 96.6%   |         |  |      | 58   |     |   |  | 13.5%  |         |  |   | 4   |    
|                                   |                            |      |     |        |   |      |         |         |  |      |      |     |   |  |        |         |  |   |     |    
|Other income, net                  |                            | $    | 299 |        |   |      | (17.6)% |         |  | $    | 363  |     |   |  | 113.5% |         |  | $ | 170 |    
|                                   | Percentage of net revenues |      |     | 2.4    | % |      |         | 0.4 pts |  |      |      | 2.0 | % |  |        | 0.9 pts |  |   |     | 1.1 | %

In fiscal 2002, the 17.6% decrease in Other
income, net as compared with fiscal 2001, is primarily due to a
combination of lower interest rates and lower cash and
marketable debt securities balances, partially offset by an
increase in the amount of gain realized on the sale of certain
fixed income marketable debt securities during fiscal 2002. Our
interest expense relates primarily to our issuance of
$1.5 billion of unsecured senior debt securities in August
1999.

In fiscal 2001, the 113.5% growth in Other
income, net, as compared with fiscal 2000, was primarily the
result of higher average balances of cash and marketable
securities, as well as higher yields resulting from additional
long-term securities.

The average duration of our portfolio of
marketable securities decreased to 0.89 years in fiscal
2002 from 1.51 years in fiscal 2001. In general, we would
expect the volatility of this portfolio to decrease as its
duration decreases.

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

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Income Taxes

(dollars in millions)

|                                     |                                                                                                      |      |      |        |   |      |          |         |  |      |     |      |   |  |         |         |  |   |     |      |  
|------------------------------------ | ---------------------------------------------------------------------------------------------------- | ---- | ---- | ------ | - | ---- | -------- | ------- |  | ---- | --- | ---- | - |  | ------- | ------- |  | - | --- | ---- | -
|                                     |                                                                                                      | 2002 |      | Change |   | 2001 |          | Change  |  | 2000
|                                     |                                                                                                      |      |      |        |   |      |          |         |  |     
|Provision (benefit) for income taxes |                                                                                                      | $    | (461 | )      |   |      | (176.5)% |         |  | $    | 603 |      |   |  | (34.2)% |         |  | $ | 917 |     
|                                     | Percentage of income (loss) before taxes and
    cumulative effect of change in accounting principle |      |      | 44.0   | % |      |          | 5.9 pts |  |      |     | 38.1 | % |  |         | 5.0 pts |  |   |     | 33.1 | %

Our effective income tax benefit rate was 44.0%
in fiscal 2002, as compared with effective income tax expense
rates of 38.1% and 33.1% in fiscal 2001 and 2000, respectively.

The difference between our fiscal 2002 and 2001
tax rates is primarily attributable to: (1) the elimination
of certain non-deductible accounting charges resulting from our
adoption of SFAS 142; (2) increased statutory credits (both
in dollars and as a percentage of income (loss) before
income taxes) generated in the current fiscal year; and
(3) a reduction in benefits resulting from decreased
profitability in certain low-tax, non-U.S. jurisdictions.

The difference between our fiscal 2001 and 2000
tax rates are due to the non-deductibility of certain accounting
charges associated with our merger and acquisitions activities,
such as IPRD and goodwill.

During fiscal 2002, we received federal refunds
of $311 million related to the carryback of our fiscal 2001
loss. The actual refunds received were significantly greater
than the amounts expected at the end of fiscal 2001. The
increase in the refunds were directly related to provisions
contained in legislation passed during fiscal 2002, which
increased the carryback period from two years to five years.

LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL
CONDITION

(dollars in millions)

|                                                         |                                                                 |      |       |        |   |      |        |        |     |      |        |       |   |   |        |       |      |   |        |       |  
|-------------------------------------------------------- | --------------------------------------------------------------- | ---- | ----- | ------ | - | ---- | ------ | ------ | --- | ---- | ------ | ----- | - | - | ------ | ----- | ---- | - | ------ | ----- | -
|                                                         |                                                                 | 2002 |       | Change |   | 2001 |        | Change |     | 2000
|                                                         |                                                                 |      |       |        |   |      |        |        |     |     
|Cash and cash equivalents                                |                                                                 | $    | 2,024 |        |   | $    | 552    |        |     | $    | 1,472  |       |   | $ | (377   | )     |      | $ | 1,849  |      
|Marketable debt securities                               |                                                                 |      | 3,840 |        |   |      | (859   | )      |     |      | 4,699  |       |   |   | 112    |       |      |   | 4,587  |      
|                                                         |                                                                 |      |       |        |   |      |        |        |     |      |        |       |   |   |        |       |      |   |        |      
|                                                         | Total cash, cash equivalents and marketable debt
    securities |      | $     | 5,864  |   |      | $      | (307   | )   |      | $      | 6,171 |   |   | $      | (265  | )    |   | $      | 6,436 |  
|                                                         |                                                                 |      |       |        |   |      |        |        |     |      |        |       |   |   |        |       |      |   |        |      
|                                                         | Percentage of total assets                                      |      |       | 35.5   | % |      |        | 1.6    | pts |      |        | 33.9  | % |   |        | (11.6 | )pts |   |        | 45.5  | %
|Days sales outstanding (DSO)                             |                                                                 |      | 72    |        |   |      |        |        |     |      | 67     |       |   |   |        |       |      |   | 48     |      
|Inventory turns-products only                            |                                                                 |      | 6.7   |        |   |      |        |        |     |      | 9.9    |       |   |   |        |       |      |   | 14.1   |      
|Cash provided by operating activities                    |                                                                 | $    | 880   |        |   | $    | (1,209 | )      |     | $    | 2,089  |       |   | $ | (1,665 | )     |      | $ | 3,754  |      
|Cash provided by (used in) investing activities          |                                                                 |      | 39    |        |   |      | 1,593  |        |     |      | (1,554 | )     |   |   | 2,671  |       |      |   | (4,225 | )    
|Cash (used in) provided by financing activities          |                                                                 |      | (367  | )      |   |      | 545    |        |     |      | (912   | )     |   |   | (2,131 | )     |      |   | 1,219  |      
|Net increase (decrease) in cash and cash
    equivalents |                                                                 | $    | 552   |        |   | $    | 929    |        |     | $    | (377   | )     |   | $ | (1,125 | )     |      | $ | 748    |      



| |                     
| | --------------------
| | Changes in Cash Flow

During the year ended June 30, 2002, our
operating activities generated cashflows of approximately
$880 million. However, during this same period our cash,
cash equivalents and marketable debt securities decreased by
$307 million. This decrease is primarily attributable to
the $354 million we spent on financing activities
($591 million to purchase our common stock in the open
market, less $237 million received as consideration for the
issuance of our common stock under our stock option and employee
stock purchase

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##### Table of Contents



plans) and the $559 million we spent for
real estate development and equipment additions to support
product development and infrastructure initiatives.


The decrease in cash flows provided by operating
activities resulted from decreases in accounts payable, accrued
liabilities and other liabilities and were partially offset by
decreases in accounts receivable (net), inventory, as well as
other assets. Accounts receivable (net) decreased to
$2,745 million at June 30, 2002 from
$2,955 million at June 30, 2001. The decrease in
accounts receivable (net) was primarily due to the lower
volume of sales, partially offset by an increase in days of
sales outstanding (DSO). DSO measures both the age, in terms of
days, of our accounts receivable and the average time it takes
to turn the receivable into cash. There are a number of factors
affecting DSO, including our payment terms and collection
ability. The increase in DSO was primarily attributable to the
timing of earning revenue towards the end of the quarter, as
well as the timing of customer payments. Inventory decreased to
$591 million at June 30, 2002 from $1,049 million
at June 30, 2001. Inventory turns is the number of times
our inventory turns over per year. Demand for our products and
our ability to efficiently manage our inventory are the major
components driving the inventory turns ratio. Our inventory
turns-products only at June 30, 2002, was 6.7 and 9.9 for
fiscal 2002 and fiscal 2001, respectively. The decrease in
inventory turns in fiscal 2002 as compared with 2001 was
primarily due to increased inventory for new product releases
and decrease in demand for our products due to adverse
macroeconomic conditions. Inventory management will continue to
be an area of focus as we balance the need to maintain strategic
inventory levels to help ensure competitive lead times with the
risk of inventory obsolescence because of rapidly changing
technology and customer requirements. Other current assets,
which consist of deferred and prepaid taxes and prepaid
expenses, decreased to $1,556 million at June 30, 2002 from
$2,071 million at June 30, 2001. This decrease was a
result of a reclassification of deferred tax assets to offset
deferred tax liabilities and a decrease in prepaid expenses
partially offset by an increase in tax refunds. Accounts payable
marginally decreased to $1,044 million at June 30,
2002 from $1,050 million at June 30, 2001. Accrued
liabilities decreased to $2,023 million at June 30,
2002 from $2,266 million at June 30, 2001. This
decrease was a result of the overall decrease in our sales and
related operations, and was reflected by reductions in accruals
related to employee payroll and discretionary spending in our
marketing organization. Other non-current liabilities decreased
to $215 million at June 30, 2002 from
$884 million at June 30, 2001. This decrease was
primarily attributed to a change in the deferred tax liability.



| |          
| | ---------
| | Liquidity

Based on our current plan, we expect to generate
positive cash flow from operations in the fiscal year ending
June 30, 2003. Our expected significant investing and
financing cash outlays for the fiscal year ending June 30,
2003 include capital expenditures for investment in our product
development and infrastructure initiatives, debt repayment of
approximately $200 million as well as for purchasing our
common stock. The board of directors has approved programs
authorizing management to repurchase shares of our common stock
in the open market at anytime. However, the timing and the
actual number of shares to repurchase are at the discretion of
our management and are contingent on numerous factors, including
our share price and cash flow. Also, we have $1.3 billion in
unsecured debt securities (the Senior Notes) that
are due at various times between August 2003 and August 2009
($200 million was paid on August 15, 2002 and bore
interest at 7%). The Senior Notes are subject to compliance with
certain covenants that do not contain financial ratios. As of
June 30, 2002, Sun was in material compliance with the
covenants. If we failed to be in compliance with these
covenants, the trustee of the Senior Notes or holders of not
less than 25% in principal amount of the Senior Notes would have
the ability to demand immediate payment of all amounts
outstanding.

The following table summarizes our contractual
obligations at June 30, 2002 (in millions):

|                                 |  |       |       |             |  |           |     |           |  |           |     |  |  |   |     |  |  |   |     | 
|-------------------------------- |  | ----- | ----- | ----------- |  | --------- | --- | --------- |  | --------- | --- |  |  | - | --- |  |  | - | --- | 
|                                 |  |       |       | Payments    |  | Payments  |     | Payments  |  | Payments 
|                                 |  |       |       | Due in Less |  | Due in    |     | Due in    |  | Due After
|Contractual Obligations          |  | Total |       | Than 1 Year |  | 1-3 Years |     | 4-5 Years |  | 5 Years  
|                                 |  |       |       |             |  |           |     |           |  |          
|Unsecured senior debt securities |  | $     | 1,500 |             |  | $         | 200 | (1)       |  | $         | 250 |  |  | $ | 500 |  |  | $ | 550 | 
|Non-cancelable operating leases  |  | $     | 1,550 |             |  | $         | 282 |           |  | $         | 452 |  |  | $ | 170 |  |  | $ | 646 | 



|    |                         
|--- | ------------------------
|(1) | paid on August 15, 2002.

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| |                                              
| | ---------------------------------------------
| | Capital Resources and Financial
    Condition

Our long-term strategy is to maintain a minimum
amount of cash and cash equivalents in subsidiaries for
operational purposes and to invest the remaining amount of our
cash in interest bearing and highly liquid cash equivalents and
marketable debt securities. Accordingly, in addition to the
$2,024 million in cash and cash equivalents we currently
have for shorter-term requirements, we have approximately
$3,840 million in marketable debt securities that are
available for future operating, financing and investing
activities, for a total cash and investments position of
$5,864 million. However, approximately $1,463 million
of this balance represents cash generated from operations
domiciled in foreign tax jurisdictions that are designated as
permanently invested in the respective tax jurisdictions. If
these funds are required for our operations in the U.S., we
would be required to accrue and pay additional taxes to
repatriate these funds. Currently, we do not anticipate a need
to repatriate these funds to our U.S. operations.

In addition, Sun and its subsidiaries had
uncommitted lines of credit aggregating approximately
$594 million. No amounts were drawn from these lines of
credit as of June 30, 2002. Interest rates and other terms
of borrowing under these lines of credit vary from country to
country depending on local market conditions at the time of
borrowing. There is no guarantee that the banks would approve
our request for funds under these uncommitted lines of credit.

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

DILUTIVE EFFECT OF STOCK OPTIONS ISSUED TO
DIRECTORS AND EMPLOYEES

Our stock option program is a broad-based,
long-term retention program that is intended to attract and
retain talented employees and align stockholder and employee
interests. We primarily rely on three stock option plans that
provide broad discretion to our Board of Directors to create
appropriate equity incentives for members of our board of
directors and our employees. Our 1990 Long-Term Equity Incentive
Plan is the primary plan under which most of our options are
granted. The 1996 Equity Compensation Acquisition Plan is the
plan under which we grant options to employees hired in
connection with the acquisition of another company, and the 1988
Directors Stock Option Plan provides for the automatic
grant of stock options to non-employee directors on the date
each person initially becomes a director, and on the date of
each annual meeting of stockholders to directors who are elected
and who have served as a member of our board of directors for at
least six months. Substantially all of our employees participate
in our stock option program.

We also have stock repurchase programs in place
to manage the dilutive effect generated by the exercise of stock
options. In implementing our stock option programs, we carefully
monitor both the potential and actual dilution associated with
our stock option programs. We view dilution from stock option
exercises as the difference between the number of options
exercised reduced by the number of shares repurchased in a given
fiscal year as a percentage of the number of shares outstanding
at the beginning of the year (exercise dilution). We also
monitor the potential dilution from net option grants in a given
year by comparing the option grants reduced by cancellations in
a given year to the number of shares outstanding at the
beginning of the year (grant dilution). In addition, we monitor
the net cash cost of our stock repurchase programs.

As of June 30, 2002, the total outstanding
options held by the five most highly compensated executive
officers identified in our 2002 Proxy Statement (the Named
Executive Officers) amounted to approximately
39 million or 7% of the approximately 556 million
outstanding options held by all employees. For a given year, the
percentage of options granted to the Named Executive Officers is
calculated by comparing the options granted to such executives
to net options granted.

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The following table illustrates the grant
dilution, exercise dilution and the net cash outlay for our
stock repurchase programs associated with our stock option
program (dollars in millions):

|                                                                                                  |  |      |       |      |  |      |       |      |  |      |       |   |  |   |       |   |  |   |       |  
|------------------------------------------------------------------------------------------------- |  | ---- | ----- | ---- |  | ---- | ----- | ---- |  | ---- | ----- | - |  | - | ----- | - |  | - | ----- | -
|                                                                                                  |  | 2002 |       | 2001 |  | 2000 |       | 1999 |  | 1998
|                                                                                                  |  |      |       |      |  |      |       |      |  |     
|Shares outstanding at beginning of year                                                           |  |      | 3,536 |      |  |      | 3,495 |      |  |      | 3,493 |   |  |   | 3,465 |   |  |   | 3,466 |  
|Less treasury stock outstanding at beginning of
    year                                          |  |      | (288  | )    |  |      | (301  | )    |  |      | (359  | ) |  |   | (432  | ) |  |   | (480  | )
|                                                                                                  |  |      |       |      |  |      |       |      |  |      |       |   |  |   |       |   |  |   |       |  
|Net shares outstanding                                                                            |  |      | 3,248 |      |  |      | 3,194 |      |  |      | 3,134 |   |  |   | 3,033 |   |  |   | 2,986 |  
|                                                                                                  |  |      |       |      |  |      |       |      |  |      |       |   |  |   |       |   |  |   |       |  
|Grants and assumptions                                                                            |  |      | 119   |      |  |      | 124   |      |  |      | 132   |   |  |   | 92    |   |  |   | 120   |  
|Less option cancellations                                                                         |  |      | (35   | )    |  |      | (18   | )    |  |      | (22   | ) |  |   | (26   | ) |  |   | (16   | )
|                                                                                                  |  |      |       |      |  |      |       |      |  |      |       |   |  |   |       |   |  |   |       |  
|Net option grants                                                                                 |  |      | 84    |      |  |      | 106   |      |  |      | 110   |   |  |   | 66    |   |  |   | 104   |  
|                                                                                                  |  |      |       |      |  |      |       |      |  |      |       |   |  |   |       |   |  |   |       |  
|Grant dilution                                                                                    |  |      | 2.6   | %    |  |      | 3.3   | %    |  |      | 3.5   | % |  |   | 2.2   | % |  |   | 3.5   | %
|                                                                                                  |  |      |       |      |  |      |       |      |  |      |       |   |  |   |       |   |  |   |       |  
|Options exercised                                                                                 |  |      | 28    |      |  |      | 63    |      |  |      | 70    |   |  |   | 88    |   |  |   | 74    |  
|Less shares repurchased                                                                           |  |      | (62   | )    |  |      | (52   | )    |  |      | (18   | ) |  |   | (18   | ) |  |   | (29   | )
|                                                                                                  |  |      |       |      |  |      |       |      |  |      |       |   |  |   |       |   |  |   |       |  
|Net shares issued (repurchased)                                                                   |  |      | (34   | )    |  |      | 11    |      |  |      | 52    |   |  |   | 70    |   |  |   | 45    |  
|                                                                                                  |  |      |       |      |  |      |       |      |  |      |       |   |  |   |       |   |  |   |       |  
|Exercise dilution                                                                                 |  |      | (1.1  | )%   |  |      | 0.3   | %    |  |      | 1.7   | % |  |   | 2.3   | % |  |   | 1.5   | %
|                                                                                                  |  |      |       |      |  |      |       |      |  |      |       |   |  |   |       |   |  |   |       |  
|Cost of shares repurchased                                                                        |  | $    | 554   |      |  | $    | 1,123 |      |  | $    | 505   |   |  | $ | 159   |   |  | $ | 157   |  
|Less proceeds from options exercised                                                              |  |      | (78   | )    |  |      | (202  | )    |  |      | (174  | ) |  |   | (143  | ) |  |   | (79   | )
|Less tax benefit from options exercised                                                           |  |      | (98   | )    |  |      | (816  | )    |  |      | (708  | ) |  |   | (222  | ) |  |   | (111  | )
|                                                                                                  |  |      |       |      |  |      |       |      |  |      |       |   |  |   |       |   |  |   |       |  
|Net cash (inflow) outflow                                                                         |  | $    | 378   |      |  | $    | 105   |      |  | $    | (377  | ) |  | $ | (206  | ) |  | $ | (33   | )
|                                                                                                  |  |      |       |      |  |      |       |      |  |      |       |   |  |   |       |   |  |   |       |  
|Options granted to the five most highly
    compensated executive officers                        |  |      | 3.8   |      |  |      | 2.9   |      |  |      | 2.9   |   |  |   | 5.4   |   |  |   | 5.0   |  
|                                                                                                  |  |      |       |      |  |      |       |      |  |      |       |   |  |   |       |   |  |   |       |  
|Options granted to the Named Executive Officers
    as a % of net options granted during the year |  |      | 4.5   | %    |  |      | 2.7   | %    |  |      | 2.6   | % |  |   | 8.2   | % |  |   | 4.8   | %
|                                                                                                  |  |      |       |      |  |      |       |      |  |      |       |   |  |   |       |   |  |   |       |  

NON-AUDIT SERVICES OF INDEPENDENT
AUDITORS

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

RISK FACTORS

Our business could continue to be adversely
affected as a result of general economic and other market
conditions.

Beginning in the second half of our fiscal 2001
and continuing throughout fiscal 2002, adverse economic,
business and industry conditions caused a decreased demand for
our products and services which resulted in lowering our
revenues and earnings in fiscal 2002 as compared with fiscal
2001. Our revenues and profits depend significantly on the
overall demand for information technology products and services.
Should these conditions continue or further deteriorate, our
results of operations could be negatively impacted. In addition,
the September 11, 2001 terrorist attacks on the United
States exacerbated the adverse macroeconomic conditions. There
can be no assurance that future terrorist attacks or acts of war
in the United States or abroad will not have a material adverse
effect on our business, results of operations or financial
condition.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

In addition, if customers decided to delay the
adoption and implementation of new releases of our Solaris
Operating Environment this could also delay customer acceptance
of new hardware products tied to that release. Adopting a new
release of an operating environment requires a great deal of
time and money for a

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customer to convert its systems to the new
release. The customer must also work with software vendors who
port their software applications to the new operating system and
make sure these applications will run on the new operating
system. As a result, customers may decide to delay their
adoption of a new release of an operating system because of the
cost of a new system and the effort involved to implement it.
Such delays in product development and customer acceptance and
implementation of new products could adversely affect our
business.


Our products may contain defects and
errors.

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

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

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

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

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

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

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

Business Practices, Processes and Information
Systems.In order to increase
efficiencies and remain competitive in a rapidly changing
industry, we are continually improving and changing our business
practices, processes and information systems. In this regard,
during the first month of fiscal 2003, we began the

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implementation process to upgrade our business
practices and related information systems affecting order entry,
order fulfillment and accounts receivable (the
Upgrade). The duration of that implementation is
subject to a number of risks due to the complexity of the
conversion process. This includes our ability to process the
business data and information in the new system after final
implementation and our ability to close our first quarter of
fiscal 2003. A delay in our ability to timely close our first
quarter of fiscal 2003 could affect our capacity to timely file
our first quarter financial reports with the SEC.


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

Goodwill.We
early-adopted the new Statement of Financial Accounting
Standards No. 142 (SFAS 142) Goodwill and Other
Intangible Assets, as of July 1, 2001. Accordingly,
our goodwill and other intangible assets that have an indefinite
useful life are no longer amortized but instead reviewed at
least annually for impairment. If we do not meet our long-term
forecasts, or if the trading price of our common stock does not
improve, we could be required to record impairment charges
related to goodwill and other intangible assets, which could
adversely affect our financial results. Based on our best
estimates, we have concluded that there is no impairment of our
goodwill. However, changes in these estimates, including our
market capitalization, could result in one or more of the
businesses being valued differently, or the carrying value to be
assessed differently. For example, during the fourth quarter of
2002, while our long-term business projections did not change,
we experienced a significant decline in our market
capitalization. In the second quarter of fiscal 2003, if our
market capitalization does not recover to the levels of April
2002, ($29.1 billion) we will perform another impairment
analysis. This analysis may result in a non-cash goodwill
impairment charge, for the entire goodwill balance at
June 30, 2002, of up to approximately $2.2 billion,
depending on the estimated value of the businesses to which the
goodwill relates and the value of the other assets and
liabilities at that time. Any such impairment charges could
prove adverse to our reported results.

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

Adverse Business Conditions in Specific
Industries.We depend on the
telecommunications, financial services and manufacturing
industries for a significant portion of our revenues.
Significant reduction in technology capital spending in these
industries, such as we experienced over the last two quarters of
fiscal 2001 and during fiscal 2002, may continue to result in
decreased revenues and earnings. Our revenues are dependent on
the level of technology capital spending in the U.S. and
international economies. A number of telecommunications
companies have recently filed for bankruptcy protection, and
others have announced significant reductions and deferrals in
capital spending. If the current adverse economic conditions
continue, we would expect that the significant diminishing
capital spending would continue. If capital spending

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continues to decline in these industries over an
extended period of time, our business will continue to be
adversely affected. We are implementing a strategy to reduce our
dependence on these industries, but no assurance can be given
that this strategy will be successful.


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

From time to time we have been notified that we
may be infringing certain patents or other intellectual property
rights of others. Responding to such claims, regardless of their
merit, can be time consuming, result in costly litigation,
divert managements attention and resources and cause us to
incur significant expenses. Several pending claims are in
various stages of evaluation. We are considering the
desirability of entering into licensing agreements in certain of
these cases. No assurance can be given that licenses can be
obtained on acceptable terms or that litigation will not occur.
In the event there is a temporary or permanent injunction
entered prohibiting us from marketing or selling certain of our
products, or a successful claim of infringement against us
requiring us to pay royalties to a third party, and we fail to
develop or license a substitute technology, our business,
results of operations or financial condition could be materially
adversely affected. See Item 3. Legal Proceedings for
further discussion.

Our acquisition and alliance activities could
disrupt our ongoing business.

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

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

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

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

Since our inception, we have used stock options
and other long-term equity incentives as a fundamental component
of our employee compensation packages. We believe that stock
options and other long-term equity incentives directly motivate
our employees to maximize long-term stockholder value and,
through the use of vesting, encourage employees to remain with
Sun. The Financial Accounting Standards Board (FASB), among
other agencies and entities, is currently considering changes to
US GAAP that, if implemented, would require us to record a
charge to earnings for employee stock option grants. This
proposal would negatively impact our earnings. For example, as
disclosed in Note 14 to the Consolidated Financial Statements,
recording a charge for employee stock options under
SFAS 123, Accounting for Stock-Based
Compensation would have increased after tax loss by
$647 million for fiscal year 2002 and reduced after tax
income by $533 million and $317 million for fiscal
years 2001 and 2000, respectively. In addition, new regulations
proposed by The Nasdaq National Market requiring shareholder
approval for all stock option plans as well as new regulations
proposed by the New York Stock Exchange prohibiting NYSE member
organizations from giving a proxy to vote on equity-compensation
plans unless the beneficial owner of the shares has given voting
instructions could make it more difficult for us to grant
options to employees in the future. To the extent that new
regulations make it more difficult or expensive to grant options
to employees, we may incur increased cash compensation costs or
find it difficult to attract, retain and motivate employees,
either of which could materially and adversely affect our
business.

Business interruptions could adversely affect
our business.

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

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

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

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

Some of our operations are subject to regulation
under various federal, state and international laws governing
the environment and hazardous substances. While we endeavor to
be in compliance with environmental laws at all times, any
failure to so comply can subject us to material liability. Also,
particularly in Europe, we may be subject to compliance with
developing product content requirements relating to recycling as
well as product take back requirements that would make us
responsible for recycling and/or disposing of products we have
sold. These and other environmental laws may become stricter
over time and require us to incur substantial costs for
compliance. In addition, we could be subject to liability for
investigation and remediation of hazardous substances if our
operations have caused contamination or any of our owned
properties are found to

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be contaminated. Although costs relating to
environmental matters have not resulted in a material adverse
effect on us to date, there can be no assurance that Sun will
not be required to incur such costs in the future.


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

From time to time, we make equity investments for
the promotion of business and strategic objectives in publicly
traded and privately-held companies. The market price and
valuation of the securities that we hold in these companies may
fluctuate due to market conditions and other circumstances over
which we have little or no control. Many of the companies in
which we have invested have experienced significant volatility
in their stock prices. We typically do not attempt to reduce or
eliminate this equity price risk, through hedging or similar
techniques, and market price and valuation fluctuations could
impact our financial results. To the extent that the fair value
of these securities was less than our cost over an extended
period of time, our net income would be reduced. See
Item 7A  Quantitative and Qualitative
Disclosures about Market Risk for further discussion.

Our stock price can be volatile.

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

Our credit rating is subject to
downgrade.

Standards & Poors and
Moodys Investor Services, the two credit agencies that
follow Sun (collectively, the Rating Agencies),
placed the Company on negative outlook beginning in the first
quarter of fiscal year 2001. This reflects the Rating
Agencies expectations that continued economic weakness and
reduced IT spending will continue over at least the near-term to
challenge Suns sales and profitability. Should the Rating
Agencies downgrade our rating from triple-B-plus,
the down grade could increase our costs of obtaining new
financing or issuing new debt.




ITEM
7A.     QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk related to changes
in interest rates, foreign currency exchange rates, and equity
security prices. To mitigate some of these risks, we utilize
derivative financial instruments to hedge these exposures. We do
not use derivative financial instruments for speculative or
trading purposes. All of the potential changes noted below are
based on sensitivity analyses performed on our financial
position at June 30, 2002. Actual results may differ
materially.

Interest Rate Sensitivity

Our investment portfolio consists primarily of
fixed income instruments with an average duration of
0.89 years as of June 30, 2002, as compared with
1.51 years as of June 30, 2001. The primary objective
of our investments in debt securities is to preserve principal
while maximizing yields, without significantly increasing risk.
These available-for-sale securities are subject to interest rate
risk. The fair market value of these securities may fluctuate
with changes in interest rates. A sensitivity analysis was
performed on this investment portfolio based on a modeling
technique that measures the hypothetical fair market value
changes (using a three month horizon) that would result from a
parallel shift in the yield curve of plus 150 basis points
(BPS). Based on this analysis, for example, a hypothetical 150
BPS increase in interest rates would result in an approximate
$52 million decrease in the fair value of our investments
in debt securities as of June 30, 2002, as compared with a
$59 million decrease as of June 30, 2001.

We also entered into various interest-rate swap
agreements to modify the interest characteristics of the Senior
Notes so that the interest payable on the Senior Notes
effectively becomes variable and thus matches the

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


Foreign Currency Exchange Risk

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

Based on our foreign currency exchange
instruments outstanding at June 30, 2002, we estimate a
maximum potential one-day loss in fair value of approximately
$8 million, as compared with $10 million as of
June 30, 2001, using a Value-at-Risk (VAR) model. In
addition, the average value at risk amount for the year was
approximately $11 million. The VAR model estimates were
made assuming normal market conditions and a 95% confidence
level. We used a Monte Carlo simulation type model that valued
foreign currency instruments against three thousand randomly
generated market price paths. Anticipated transactions, firm
commitments, receivables, and accounts payable denominated in
foreign currencies were excluded from the model. The VAR model
is a risk estimation tool, and as such is not intended to
represent actual losses in fair value that will be incurred by
us. Additionally, as we utilize foreign currency instruments for
hedging anticipated and firmly committed transactions, a loss in
fair value for those instruments is generally offset by
increases in the value of the underlying exposure. Foreign
currency fluctuations did not have a material impact on our
results of operations and financial position during fiscal years
2002, 2001 and 2000.

Equity Security Price Risk

We are exposed to price fluctuations on the
marketable portion of equity securities included in our
portfolio of equity investments. These investments are generally
in companies in the high-technology industry sector, many of
which are small capitalization stocks. We typically do not
attempt to reduce or eliminate the market exposure on these
securities. A 20% adverse change in equity prices would result
in an approximate $4 million decrease in the fair value of
our available-for-sale equity investments as of June 30,
2002, as compared with $12 million as of June 30,
2001. At June 30, 2002, three equity securities represented
approximately $14 million of the $18 million total
fair value of the marketable equity securities, as compared with
June 30, 2001, at which time, three equity securities
represented approximately $35 million of the
$62 million total fair value of the marketable equity
securities. Refer to Note 2 to the Consolidated Financial
Statements for additional discussion on Suns marketable
equity securities.

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ITEM
8.     FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

|                                                                 |                                                                                                                                                                                                                                                               |      |  |    | 
|---------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---- |  | -- | 
|                                                                 |                                                                                                                                                                                                                                                               | Page
|                                                                 |                                                                                                                                                                                                                                                               |     
|Consolidated Financial Statements of Sun
    Microsystems, Inc.: |                                                                                                                                                                                                                                                               |      |  |   
|                                                                 | Consolidated Statements of Operations for each of
    the three fiscal years ended June 30, 2002                                                                                                                                                              |      |  | 51 | 
|                                                                 | Consolidated Balance Sheets at June 30, 2002
    and June 30, 2001                                                                                                                                                                                            |      |  | 52 | 
|                                                                 | Consolidated Statements of Cash Flows for each of
    the three fiscal years ended June 30, 2002                                                                                                                                                              |      |  | 53 | 
|                                                                 | Consolidated Statements of Stockholders
    Equity for each of the three fiscal years ended June 30,
    2002                                                                                                                                                |      |  | 54 | 
|                                                                 | Notes to Consolidated Financial Statements                                                                                                                                                                                                                    |      |  | 55 | 
|                                                                 | Report of Ernst & Young LLP, Independent
    Auditors                                                                                                                                                                                                         |      |  | 88 | 
|Financial Statement Schedules:                                   |                                                                                                                                                                                                                                                               |      |  |   
|                                                                 | The following consolidated financial statement
    schedule of Sun Microsystems, Inc. is filed as part of this
    Annual Report on Form 10-K and should be read in
    conjunction with the Consolidated Financial Statements of Sun
    Microsystems, Inc.: |      |  |    | 
|                                                                 | Schedule II Valuation and Qualifying Accounts                                                                                                                                                                                                                 |      |  | 93 | 

Schedules not listed above have been omitted
since they are not applicable or are not required, or the
information required to be set forth therein is included in the
Consolidated Financial Statements or Notes thereto.

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SUN MICROSYSTEMS, INC.






CONSOLIDATED STATEMENTS OF
OPERATIONS


(in millions, except per share
amounts)


|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |       |        |        | 
|-------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------- | --------------------------------------------- | ------------------------ | ------ | ----- | ------ | ----- | ----- | ------ | ------ | ----- | ----- | ------ | ------ | 
|                                                                                 |                                                                                               |                                              
|                                                                                 |                                                                                               | Fiscal Years Ended June 30,                  
|                                                                                 |                                                                                               |                                              
|                                                                                 |                                                                                               | 2002                                          |                          | 2001   |       | 2000  
|                                                                                 |                                                                                               |                                               |                          |        |       |       
|Net revenues:                                                                    |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|                                                                                 |                                                                                               | Products                                      |                          | $      | 9,093 |        |       | $     | 15,015 |        |       | $     | 13,421 |       
|                                                                                 |                                                                                               | Services                                      |                          |        | 3,403 |        |       |       | 3,235  |        |       |       | 2,300  |       
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|                                                                                 |                                                                                               |                                               | Total net revenues       |        |       | 12,496 |       |       |        | 18,250 |       |       |        | 15,721 | 
|Cost of sales:                                                                   |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|                                                                                 |                                                                                               | Cost of sales-products                        |                          |        | 5,506 |        |       |       | 7,961  |        |       |       | 6,096  |       
|                                                                                 |                                                                                               | Cost of sales-services                        |                          |        | 2,074 |        |       |       | 2,080  |        |       |       | 1,453  |       
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|                                                                                 |                                                                                               |                                               | Total cost of sales      |        |       | 7,580  |       |       |        | 10,041 |       |       |        | 7,549  | 
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|                                                                                 |                                                                                               |                                               | Gross margin             |        |       | 4,916  |       |       |        | 8,209  |       |       |        | 8,172  | 
|Operating expenses:                                                              |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|                                                                                 |                                                                                               | Research and development                      |                          |        | 1,832 |        |       |       | 2,016  |        |       |       | 1,630  |       
|                                                                                 |                                                                                               | Selling, general and administrative           |                          |        | 3,812 |        |       |       | 4,445  |        |       |       | 4,065  |       
|                                                                                 |                                                                                               | Restructuring charges                         |                          |        | 517   |        |       |       | 75     |        |       |       |       |       
|                                                                                 |                                                                                               | Goodwill amortization                         |                          |        |      |        |       |       | 285    |        |       |       | 72     |       
|                                                                                 |                                                                                               | Purchased in-process research and development |                          |        | 3     |        |       |       | 77     |        |       |       | 12     |       
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|                                                                                 |                                                                                               |                                               | Total operating expenses |        |       | 6,164  |       |       |        | 6,898  |       |       |        | 5,779  | 
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|                                                                                 |                                                                                               |                                               | Operating income (loss)  |        |       | (1,248 | )     |       |        | 1,311  |       |       |        | 2,393  | 
|Gain (loss) on equity investments, net                                           |                                                                                               |                                               | (99                      | )      |       |        | (90   | )     |        |        | 208   |      
|Interest income                                                                  |                                                                                               |                                               | 243                      |        |       |        | 405   |       |        |        | 250   |      
|Interest expense                                                                 |                                                                                               |                                               | (58                      | )      |       |        | (100  | )     |        |        | (84   | )    
|Gain on marketable debt securities                                               |                                                                                               |                                               | 114                      |        |       |        | 58    |       |        |        | 4     |      
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|                                                                                 | Income (loss) before income taxes and
    cumulative effect of change in accounting principle |                                               |                          | (1,048 | )     |        |       | 1,584 |        |        |       | 2,771 |       
|Provision (benefit) for income taxes                                             |                                                                                               |                                               | (461                     | )      |       |        | 603   |       |        |        | 917   |      
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|                                                                                 | Income (loss) before cumulative effect of
    change in accounting principle                  |                                               |                          | (587   | )     |        |       | 981   |        |        |       | 1,854 |       
|Cumulative effect of change in accounting
    principle, net                     |                                                                                               |                                               |                         |        |       |        | (54   | )     |        |        |      |      
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|Net income (loss)                                                                |                                                                                               | $                                             | (587                     | )      |       | $      | 927   |       |        | $      | 1,854 |      
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|Net income (loss) per common share-basic:                                        |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|                                                                                 | Income (loss) before cumulative effect of
    change in accounting principle                  |                                               | $                        | (0.18  | )     |        | $     | 0.30  |        |        | $     | 0.59  |       
|                                                                                 | Cumulative effect of change in accounting
    principle                                       |                                               |                          |       |       |        |       | (0.02 | )      |        |       |      |       
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|Net income (loss) per common share-basic                                         |                                                                                               | $                                             | (0.18                    | )      |       | $      | 0.28  |       |        | $      | 0.59  |      
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|Net income (loss) per common share-diluted:                                      |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|                                                                                 | Income (loss) before cumulative effect of
    change in accounting principle                  |                                               | $                        | (0.18  | )     |        | $     | 0.29  |        |        | $     | 0.55  |       
|                                                                                 | Cumulative effect of change in accounting
    principle                                       |                                               |                          |       |       |        |       | (0.02 | )      |        |       |      |       
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|Net income (loss) per common share-diluted                                       |                                                                                               | $                                             | (0.18                    | )      |       | $      | 0.27  |       |        | $      | 0.55  |      
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|Shares used in the calculation of net income
    (loss) per common share-basic   |                                                                                               |                                               | 3,242                    |        |       |        | 3,234 |       |        |        | 3,151 |      
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      
|Shares used in the calculation of net income
    (loss) per common share-diluted |                                                                                               |                                               | 3,242                    |        |       |        | 3,417 |       |        |        | 3,379 |      
|                                                                                 |                                                                                               |                                               |                          |        |       |        |       |       |        |        |       |      

See accompanying notes.

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SUN MICROSYSTEMS, INC.






CONSOLIDATED BALANCE SHEETS


(in millions, except par values)


|                                                 |                                                                                                                                                                                        |                            |        |        |       |   |        |        |        | 
|------------------------------------------------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ------ | ------ | ----- | - | ------ | ------ | ------ | 
|                                                 |                                                                                                                                                                                        |                           
|                                                 |                                                                                                                                                                                        | June 30,                  
|                                                 |                                                                                                                                                                                        |                           
|                                                 |                                                                                                                                                                                        | 2002                       |        | 2001  
|                                                 |                                                                                                                                                                                        |                            |        |       
|ASSETS                                          
|Current assets:                                  |                                                                                                                                                                                        |                            |        |        |       |   |        |       
|                                                 | Cash and cash equivalents                                                                                                                                                              |                            | $      | 2,024  |       |   | $      | 1,472  |       
|                                                 | Short-term marketable debt securities                                                                                                                                                  |                            |        | 861    |       |   |        | 387    |       
|                                                 | Accounts receivable, net of bad debt reserves of
    $114 million in 2002 and $111 million in 2001                                                                                     |                            |        | 2,745  |       |   |        | 2,955  |       
|                                                 | Inventories                                                                                                                                                                            |                            |        | 591    |       |   |        | 1,049  |       
|                                                 | Deferred and prepaid tax assets                                                                                                                                                        |                            |        | 709    |       |   |        | 1,102  |       
|                                                 | Prepaid expenses and other current assets                                                                                                                                              |                            |        | 847    |       |   |        | 969    |       
|                                                 |                                                                                                                                                                                        |                            |        |        |       |   |        |       
|                                                 |                                                                                                                                                                                        | Total current assets       |        |        | 7,777 |   |        |        | 7,934  | 
|Property, plant and equipment, net               |                                                                                                                                                                                        |                            | 2,453  |        |       |   | 2,697  |       
|Long-term marketable debt securities             |                                                                                                                                                                                        |                            | 2,979  |        |       |   | 4,312  |       
|Goodwill                                         |                                                                                                                                                                                        |                            | 2,182  |        |       |   | 2,126  |       
|Other acquisition-related intangible assets, net |                                                                                                                                                                                        |                            | 104    |        |       |   | 185    |       
|Other non-current assets, net                    |                                                                                                                                                                                        |                            | 1,027  |        |       |   | 927    |       
|                                                 |                                                                                                                                                                                        |                            |        |        |       |   |        |       
|                                                 |                                                                                                                                                                                        | $                          | 16,522 |        |       | $ | 18,181 |       
|                                                 |                                                                                                                                                                                        |                            |        |        |       |   |        |       
|LIABILITIES AND STOCKHOLDERS
    EQUITY        
|Current liabilities:                             |                                                                                                                                                                                        |                            |        |        |       |   |        |       
|                                                 | Current portion of long-term debt and short-term
    borrowings                                                                                                                        |                            | $      | 205    |       |   | $      | 3      |       
|                                                 | Accounts payable                                                                                                                                                                       |                            |        | 1,044  |       |   |        | 1,050  |       
|                                                 | Accrued payroll-related liabilities                                                                                                                                                    |                            |        | 538    |       |   |        | 517    |       
|                                                 | Accrued liabilities                                                                                                                                                                    |                            |        | 1,201  |       |   |        | 1,435  |       
|                                                 | Deferred revenues and other                                                                                                                                                            |                            |        | 1,785  |       |   |        | 1,827  |       
|                                                 | Warranty reserve                                                                                                                                                                       |                            |        | 284    |       |   |        | 314    |       
|                                                 |                                                                                                                                                                                        |                            |        |        |       |   |        |       
|                                                 |                                                                                                                                                                                        | Total current liabilities  |        |        | 5,057 |   |        |        | 5,146  | 
|Long-term debt                                   |                                                                                                                                                                                        |                            | 1,449  |        |       |   | 1,565  |       
|Deferred income taxes                            |                                                                                                                                                                                        |                            |       |        |       |   | 744    |       
|Other non-current obligations                    |                                                                                                                                                                                        |                            | 215    |        |       |   | 140    |       
|Commitments and contingencies                    |                                                                                                                                                                                        |                            |        |        |       |   |        |       
|Stockholders equity:                            |                                                                                                                                                                                        |                            |        |        |       |   |        |       
|                                                 | Preferred stock, $0.001 par value, 10 shares
    authorized (1 share of which has been designated as
    Series A Preferred participating stock); no shares issued
    and outstanding |                            |        |       |       |   |        |       |       
|                                                 | Common stock and additional paid-in-capital,
    $0.00067 par value, 7,200 shares authorized; issued and
    outstanding: 3,537 shares in 2002 and 3,536 shares in 2001.               |                            |        | 6,485  |       |   |        | 6,238  |       
|                                                 | Treasury stock, at cost: 303 shares in 2002 and
    288 shares in 2001.                                                                                                                |                            |        | (2,905 | )     |   |        | (2,435 | )     
|                                                 | Unearned equity compensation                                                                                                                                                           |                            |        | (46    | )     |   |        | (73    | )     
|                                                 | Retained earnings                                                                                                                                                                      |                            |        | 6,298  |       |   |        | 6,885  |       
|                                                 | Accumulated other comprehensive loss                                                                                                                                                   |                            |        | (31    | )     |   |        | (29    | )     
|                                                 |                                                                                                                                                                                        |                            |        |        |       |   |        |       
|                                                 |                                                                                                                                                                                        | Total stockholders equity |        |        | 9,801 |   |        |        | 10,586 | 
|                                                 |                                                                                                                                                                                        |                            |        |        |       |   |        |       
|                                                 |                                                                                                                                                                                        | $                          | 16,522 |        |       | $ | 18,181 |       
|                                                 |                                                                                                                                                                                        |                            |        |        |       |   |        |       

See accompanying notes.

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SUN MICROSYSTEMS, INC.






CONSOLIDATED STATEMENTS OF CASH
FLOWS


(in millions)


|                                                         |                   |                                                                                                                                            |                                                                                                                                 |      |      |      |        |     |        |      |        |       |        |       |  
|-------------------------------------------------------- | ----------------- | ------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------- | ---- | ---- | ---- | ------ | --- | ------ | ---- | ------ | ----- | ------ | ----- | -
|                                                         |                   |                                                                                                                                           
|                                                         |                   | Fiscal Years Ended June 30,                                                                                                               
|                                                         |                   |                                                                                                                                           
|                                                         |                   | 2002                                                                                                                                       |                                                                                                                                 | 2001 |      | 2000
|                                                         |                   |                                                                                                                                            |                                                                                                                                 |      |      |     
|Cash flows from operating activities:                    |                   |                                                                                                                                            |                                                                                                                                 |      |      |      |        |     |        |      |        |      
|                                                         | Net income (loss) |                                                                                                                                            | $                                                                                                                               | (587 | )    |      | $      | 927 |        |      | $      | 1,854 |       
|                                                         |                   | Adjustments to reconcile net income
    (loss) to net cash provided by operating activities:                                               |                                                                                                                                 |      |      |      |        |     |        |      |        |       |        |      
|                                                         |                   | Depreciation and amortization                                                                                                              |                                                                                                                                 |      | 970  |      |        |     | 847    |      |        |       | 615    |      
|                                                         |                   | Amortization of acquisition-related goodwill
    (fiscal 2001 and 2000 only), other intangible assets and
    unearned equity compensation |                                                                                                                                 |      | 122  |      |        |     | 382    |      |        |       | 168    |      
|                                                         |                   | Tax benefits from employee stock plans                                                                                                     |                                                                                                                                 |      | 98   |      |        |     | 816    |      |        |       | 708    |      
|                                                         |                   | Deferred taxes                                                                                                                             |                                                                                                                                 |      | (673 | )    |        |     | (186   | )    |        |       | (86    | )    
|                                                         |                   | Loss (gain) on equity investments, net                                                                                                     |                                                                                                                                 |      | 99   |      |        |     | 90     |      |        |       | (208   | )    
|                                                         |                   | Other                                                                                                                                      |                                                                                                                                 |      | 3    |      |        |     | 131    |      |        |       | 11     |      
|                                                         |                   | Changes in operating assets and liabilities:                                                                                               |                                                                                                                                 |      |      |      |        |     |        |      |        |       |        |      
|                                                         |                   |                                                                                                                                            | Accounts receivable, net                                                                                                        |      |      | 211  |        |     |        | (253 | )      |       |        | (378  | )
|                                                         |                   |                                                                                                                                            | Inventories                                                                                                                     |      |      | 458  |        |     |        | (446 | )      |       |        | (249  | )
|                                                         |                   |                                                                                                                                            | Prepaids and other assets                                                                                                       |      |      | 389  |        |     |        | (438 | )      |       |        | (385  | )
|                                                         |                   |                                                                                                                                            | Accounts payable                                                                                                                |      |      | (7   | )      |     |        | 123  |        |       |        | 166   |  
|                                                         |                   |                                                                                                                                            | Other liabilities                                                                                                               |      |      | (203 | )      |     |        | 96   |        |       |        | 1,538 |  
|                                                         |                   |                                                                                                                                            |                                                                                                                                 |      |      |      |        |     |        |      |        |      
|Net cash provided by operating activities                |                   |                                                                                                                                            | 880                                                                                                                             |      |      |      | 2,089  |     |        |      | 3,754  |      
|                                                         |                   |                                                                                                                                            |                                                                                                                                 |      |      |      |        |     |        |      |        |      
|Cash flows from investing activities:                    |                   |                                                                                                                                            |                                                                                                                                 |      |      |      |        |     |        |      |        |      
|                                                         |                   | Net sales and maturities of (purchases of)
    marketable debt securities                                                                  |                                                                                                                                 |      | 833  |      |        |     | 39     |      |        |       | (3,003 | )    
|                                                         |                   | Net purchases of equity investments                                                                                                        |                                                                                                                                 |      | (34  | )    |        |     | (106   | )    |        |       | (82    | )    
|                                                         |                   | Acquisition of property, plant and equipment                                                                                               |                                                                                                                                 |      | (559 | )    |        |     | (1,292 | )    |        |       | (982   | )    
|                                                         |                   | Acquisition of spare parts and other assets                                                                                                |                                                                                                                                 |      | (152 | )    |        |     | (177   | )    |        |       | (69    | )    
|                                                         |                   | Payments for acquisitions, net of cash acquired                                                                                            |                                                                                                                                 |      | (49  | )    |        |     | (18    | )    |        |       | (89    | )    
|                                                         |                   |                                                                                                                                            |                                                                                                                                 |      |      |      |        |     |        |      |        |      
|Net cash provided by (used in) investing
    activities  |                   |                                                                                                                                            | 39                                                                                                                              |      |      |      | (1,554 | )   |        |      | (4,225 | )    
|                                                         |                   |                                                                                                                                            |                                                                                                                                 |      |      |      |        |     |        |      |        |      
|Cash flows from financing activities:                    |                   |                                                                                                                                            |                                                                                                                                 |      |      |      |        |     |        |      |        |      
|                                                         |                   | Acquisition of treasury stock                                                                                                              |                                                                                                                                 |      | (591 | )    |        |     | (1,321 | )    |        |       | (631   | )    
|                                                         |                   | Proceeds from issuance of common stock, net                                                                                                |                                                                                                                                 |      | 237  |      |        |     | 422    |      |        |       | 349    |      
|                                                         |                   | Principal payments on borrowings and other
    obligations                                                                                 |                                                                                                                                 |      | (13  | )    |        |     | (13    | )    |        |       | 1      |      
|                                                         |                   | Proceeds from issuance of long-term debt                                                                                                   |                                                                                                                                 |      |     |      |        |     |       |      |        |       | 1,500  |      
|                                                         |                   |                                                                                                                                            |                                                                                                                                 |      |      |      |        |     |        |      |        |      
|Net cash (used in) provided by financing
    activities  |                   |                                                                                                                                            | (367                                                                                                                            | )    |      |      | (912   | )   |        |      | 1,219  |      
|                                                         |                   |                                                                                                                                            |                                                                                                                                 |      |      |      |        |     |        |      |        |      
|Net (decrease) increase in cash and cash
    equivalents |                   |                                                                                                                                            | 552                                                                                                                             |      |      |      | (377   | )   |        |      | 748    |      
|Cash and cash equivalents, beginning of year             |                   |                                                                                                                                            | 1,472                                                                                                                           |      |      |      | 1,849  |     |        |      | 1,101  |      
|                                                         |                   |                                                                                                                                            |                                                                                                                                 |      |      |      |        |     |        |      |        |      
|Cash and cash equivalents, end of year                   |                   | $                                                                                                                                          | 2,024                                                                                                                           |      |      | $    | 1,472  |     |        | $    | 1,849  |      
|                                                         |                   |                                                                                                                                            |                                                                                                                                 |      |      |      |        |     |        |      |        |      
|Supplemental disclosures of cash flow information:       |                   |                                                                                                                                            |                                                                                                                                 |      |      |      |        |     |        |      |        |      
|                                                         |                   | Cash paid during the year for:                                                                                                             |                                                                                                                                 |      |      |      |        |     |        |      |        |       |        |      
|                                                         |                   |                                                                                                                                            | Interest                                                                                                                        |      | $    | 115  |        |     | $      | 114  |        |       | $      | 53    |  
|                                                         |                   |                                                                                                                                            | Income taxes (net of refunds of
    $329 million, $113 million and $46 million in
    fiscal 2002, 2001 and 2000, respectively) |      | $    | 93   |        |     | $      | 434  |        |       | $      | 276   |  

See accompanying notes.

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SUN MICROSYSTEMS, INC.






CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY


(in millions)


|                                                                                             |  |                 |       |                |  |                 |       |          |  |               |      |               |  |        |        |        |  |   |     |   |  |   |       |   |  |   |     |   |  |   |        |  
|-------------------------------------------------------------------------------------------- |  | --------------- | ----- | -------------- |  | --------------- | ----- | -------- |  | ------------- | ---- | ------------- |  | ------ | ------ | ------ |  | - | --- | - |  | - | ----- | - |  | - | --- | - |  | - | ------ | -
|                                                                                             |  |                 |       |                |  |                 |       |          |  |               |      |               |  |       
|                                                                                             |  | Common Stock    |       |                |  |                 |       |          |  |               |      |               |  |       
|                                                                                             |  | and             |       |                |  |                 |       |          |  |               |      | Accumulated   |  |       
|                                                                                             |  | Additional      |       |                |  |                 |       |          |  | Other         |      |              
|                                                                                             |  | Paid-in-Capital |       | Treasury Stock |  |                 |       |          |  | Comprehensive |      | Total        
|                                                                                             |  |                 |       |                |  | Unearned Equity |       | Retained |  | Income        |      | Stockholders
|                                                                                             |  | Shares          |       | Amount         |  | Shares          |       | Amount   |  | Compensation  |      | Earnings      |  | (Loss) |        | Equity
|                                                                                             |  |                 |       |                |  |                 |       |          |  |               |      |               |  |        |        |       
|Balances as of July 1, 1999                                                                  |  |                 | 3,493 |                |  | $               | 1,816 |          |  |               | (359 | )             |  | $      | (1,046 | )      |  | $ |    |   |  | $ | 4,107 |   |  | $ | (10 | ) |  | $ | 4,867  |  
|Net income                                                                                   |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   | 1,854 |   |  |   |    |   |  |   | 1,854  |  
|Change in unrealized gain (loss) on investments,
    net of taxes                            |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   |      |   |  |   | 126 |   |  |   | 126    |  
|Translation adjustments                                                                      |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   |      |   |  |   | (40 | ) |  |   | (40    | )
|                                                                                             |  |                 |       |                |  |                 |       |          |  |               |      |               |  |        |        |        |  |   |     |   |  |   |       |   |  |   |     |   |  |   |        |  
|Total comprehensive income                                                                   |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   |      |   |  |   |    |   |  |   | 1,940  |  
|Issuance of stock, net of repurchases                                                        |  |                 |      |                |  |                 | 110   |          |  |               | 81   |               |  |        | 239    |        |  |   |    |   |  |   |      |   |  |   |    |   |  |   | 349    |  
|Treasury stock purchased                                                                     |  |                 |      |                |  |                 |      |          |  |               | (23  | )             |  |        | (631   | )      |  |   |    |   |  |   |      |   |  |   |    |   |  |   | (631   | )
|Tax benefit from employee stock transactions and
    other                                   |  |                 |      |                |  |                 | 742   |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   |      |   |  |   |    |   |  |   | 742    |  
|Issuance of common stock and assumption of stock
    options in connection with acquisitions |  |                 | 1     |                |  |                 | 58    |          |  |               |     |               |  |        |       |        |  |   | (23 | ) |  |   |      |   |  |   |    |   |  |   | 35     |  
|Amortization of unearned equity compensation                                                 |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   | 8   |   |  |   |      |   |  |   |    |   |  |   | 8      |  
|Issuance of common stock dividends                                                           |  |                 |      |                |  |                 | 1     |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   | (1    | ) |  |   |    |   |  |   |       |  
|Adjustment to conform fiscal year end of pooled
    acquisition                              |  |                 | 1     |                |  |                 | 1     |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   | (1    | ) |  |   | (1  | ) |  |   | (1     | )
|                                                                                             |  |                 |       |                |  |                 |       |          |  |               |      |               |  |        |        |        |  |   |     |   |  |   |       |   |  |   |     |   |  |   |        |  
|Balances as of June 30, 2000                                                                 |  |                 | 3,495 |                |  |                 | 2,728 |          |  |               | (301 | )             |  |        | (1,438 | )      |  |   | (15 | ) |  |   | 5,959 |   |  |   | 75  |   |  |   | 7,309  |  
|Net income                                                                                   |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   | 927   |   |  |   |    |   |  |   | 927    |  
|Change in unrealized gain (loss) on investments,
    net of taxes                            |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   |      |   |  |   | (72 | ) |  |   | (72    | )
|Change in unrealized gain (loss) on derivative
    instruments                               |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   |      |   |  |   | 15  |   |  |   | 15     |  
|Translation adjustments                                                                      |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   |      |   |  |   | (47 | ) |  |   | (47    | )
|                                                                                             |  |                 |       |                |  |                 |       |          |  |               |      |               |  |        |        |        |  |   |     |   |  |   |       |   |  |   |     |   |  |   |        |  
|Total comprehensive income                                                                   |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   |      |   |  |   |    |   |  |   | 823    |  
|Issuance of stock, net of repurchases                                                        |  |                 |      |                |  |                 | 98    |          |  |               | 72   |               |  |        | 324    |        |  |   |    |   |  |   |      |   |  |   |    |   |  |   | 422    |  
|Treasury stock purchased                                                                     |  |                 |      |                |  |                 |      |          |  |               | (59  | )             |  |        | (1,321 | )      |  |   |    |   |  |   |      |   |  |   |    |   |  |   | (1,321 | )
|Tax benefit from employee stock transactions and
    other                                   |  |                 |      |                |  |                 | 839   |          |  |               |     |               |  |        |       |        |  |   | (4  | ) |  |   |      |   |  |   |    |   |  |   | 835    |  
|Issuance of common stock and assumption of stock
    options in connection with acquisitions |  |                 | 41    |                |  |                 | 2,572 |          |  |               |     |               |  |        |       |        |  |   | (75 | ) |  |   |      |   |  |   |    |   |  |   | 2,497  |  
|Amortization of unearned equity compensation                                                 |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   | 21  |   |  |   |      |   |  |   |    |   |  |   | 21     |  
|Issuance of common stock dividends                                                           |  |                 |      |                |  |                 | 1     |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   | (1    | ) |  |   |    |   |  |   |       |  
|                                                                                             |  |                 |       |                |  |                 |       |          |  |               |      |               |  |        |        |        |  |   |     |   |  |   |       |   |  |   |     |   |  |   |        |  
|Balances as of June 30, 2001                                                                 |  |                 | 3,536 |                |  |                 | 6,238 |          |  |               | (288 | )             |  |        | (2,435 | )      |  |   | (73 | ) |  |   | 6,885 |   |  |   | (29 | ) |  |   | 10,586 |  
|Net loss                                                                                     |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   | (587  | ) |  |   |    |   |  |   | (587   | )
|Change in unrealized gain (loss) on investments,
    net of taxes                            |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   |      |   |  |   | (28 | ) |  |   | (28    | )
|Change in unrealized gain (loss) on derivative
    instruments, net of taxes                 |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   |      |   |  |   | (46 | ) |  |   | (46    | )
|Translation adjustments                                                                      |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   |      |   |  |   | 72  |   |  |   | 72     |  
|                                                                                             |  |                 |       |                |  |                 |       |          |  |               |      |               |  |        |        |        |  |   |     |   |  |   |       |   |  |   |     |   |  |   |        |  
|Total comprehensive loss                                                                     |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   |      |   |  |   |    |   |  |   | (589   | )
|Issuance of stock, net of repurchases                                                        |  |                 | (1    | )              |  |                 | 116   |          |  |               | 49   |               |  |        | 121    |        |  |   |    |   |  |   |      |   |  |   |    |   |  |   | 237    |  
|Treasury stock purchased                                                                     |  |                 |      |                |  |                 |      |          |  |               | (64  | )             |  |        | (591   | )      |  |   |    |   |  |   |      |   |  |   |    |   |  |   | (591   | )
|Tax benefit from employee stock transactions and
    other                                   |  |                 |      |                |  |                 | 100   |          |  |               |     |               |  |        |       |        |  |   |    |   |  |   |      |   |  |   |    |   |  |   | 100    |  
|Issuance of common stock and assumption of stock
    options in connection with acquisitions |  |                 | 2     |                |  |                 | 31    |          |  |               |     |               |  |        |       |        |  |   | (27 | ) |  |   |      |   |  |   |    |   |  |   | 4      |  
|Amortization of unearned equity compensation                                                 |  |                 |      |                |  |                 |      |          |  |               |     |               |  |        |       |        |  |   | 54  |   |  |   |      |   |  |   |    |   |  |   | 54     |  
|                                                                                             |  |                 |       |                |  |                 |       |          |  |               |      |               |  |        |        |        |  |   |     |   |  |   |       |   |  |   |     |   |  |   |        |  
|Balances as of June 30, 2002                                                                 |  |                 | 3,537 |                |  | $               | 6,485 |          |  |               | (303 | )             |  | $      | (2,905 | )      |  | $ | (46 | ) |  | $ | 6,298 |   |  | $ | (31 | ) |  | $ | 9,801  |  
|                                                                                             |  |                 |       |                |  |                 |       |          |  |               |      |               |  |        |        |        |  |   |     |   |  |   |       |   |  |   |     |   |  |   |        |  

See accompanying notes.

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SUN MICROSYSTEMS, INC.






NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


1.     Description of
Business

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

2.     Summary of
Significant Accounting Policies

Basis of Presentation

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

In December 2000 and December 1999, Sun effected
two-for-one splits of its common stock paid in the form of stock
dividends. All share and per share data herein has been adjusted
to reflect the splits for all periods presented.

As discussed in Note 3, on October 19, 1999,
Sun completed its merger with Forte Software, Inc. (Forte). This
merger was accounted for as a pooling of interests and,
accordingly, the historical consolidated financial statements of
Sun have been restated to include the financial position,
results of operations, and cash flows of Forte for all periods
presented.

Our consolidated financial statements have been
prepared in accordance with generally accepted accounting
principles in the United States (US GAAP). The preparation
of these financial statements requires us to make estimates and
judgments that affect the reported amounts in the financial
statements and accompanying notes. These estimates form the
basis for judgments we make about the carrying values of assets
and liabilities that are not readily apparent from other
sources. We base our estimates and judgments on historical
experience and on various other assumptions that we believe are
reasonable under the circumstances. However, future events are
subject to change and the best estimates and judgments routinely
require adjustment. US GAAP requires us to make estimates
and judgments in several areas, including those related to
impairment of intangible assets and equity investments, revenue
recognition, recoverability of inventory and accounts
receivable, the fair value of derivative financial instruments,
the recording of various accruals (including our accrual for
restructuring charges), the useful lives of long lived assets
such as property and equipment, income taxes, warranty
obligations and potential losses from contingencies and
litigation, actual results in these particular areas could
differ from those estimates.

Cash Equivalents

Cash equivalents consist primarily of highly
liquid investments with insignificant interest rate risk and
original maturities of three months or less at the date of
purchase.

Bad Debt Reserves

We evaluate the collectibility of our accounts
receivable based on a combination of factors. In cases where we
are aware of circumstances that may impair a specific
customers ability to meet its financial obligations to us,
we record a specific allowance against amounts due to us, and
thereby reduce the net recognized receivable to

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the amount we reasonably believe will be
collected. For all other customers, we recognize allowances for
doubtful accounts based on the length of time the receivables
are past due, industry and geographic concentrations, the
current business environment and our historical experience. At
June 30, 2002 and 2001, our bad debt reserves were
$114 million and $111 million, respectively.


Investments

Investments consist of marketable debt
securities, marketable equity securities and other equity
securities.

Marketable Debt Securities

Investments in marketable debt securities consist
primarily of corporate notes and bonds, asset and mortgage
backed securities and U.S. government notes and bonds with
original maturities beyond three months. Short-term investments
are marketable debt securities with maturities of less than one
year from the balance sheet date (except cash equivalents),
while long-term investments represent all other marketable debt
securities. All marketable debt securities are held in
Suns name and deposited primarily with one major financial
institution. Suns policy is to protect the value of its
investment portfolio and minimize principal risk by earning
returns based on current interest rates. We only invest in
marketable debt securities with a minimum rating of
single A or above from a nationally recognized credit
rating agency. At June 30, 2002 and 2001 all of Suns
marketable debt securities were classified as available-for-sale
and were carried at fair market value.

Marketable Equity Securities

Investments in marketable equity securities
consist of equity holdings in public companies. Marketable
equity securities are initially recorded at cost upon
acquisition and are classified as available-for-sale when there
are no restrictions on Suns ability to liquidate such
securities within 12 months. Marketable equity investments
were $18 million and $62 million at June 30, 2002
and 2001, respectively. At June 30, 2002, all marketable
equity investments were classified as available-for-sale and are
included in Other non-current assets, net in the
Consolidated Balance Sheet. Changes in the fair value of these
securities are recognized in Accumulated other
comprehensive income (loss) in the Consolidated Statements
of Shareholders Equity (net of tax). Net unrealized gains,
net of tax, on marketable equity investments were none,
$10 million and $131 million at June 30, 2002,
2001 and 2000, respectively. Gross realized gains on marketable
equity securities totaled $3 million, $31 million and
$178 million in fiscal 2002, 2001 and 2000, respectively,
and are recognized in Gain (loss) on equity investments,
net in the Consolidated Statement of Operations. In
addition, we review all marketable equity securities for other
than temporary declines in fair value. Based on our evaluation,
if a security is considered to be other than temporarily
impaired an impairment charge is recognized in Gain (loss)
on equity investments, net in the Consolidated Statements
of Operations. For fiscal 2002, 2001 and 2000, $23 million,
$70 million and none were recorded as impairment charges
related to marketable equity investments, respectively.

Other Equity Securities

Investments in other equity investments consist
of equity investments in privately-held companies, developing
products, markets and services that are strategic to Sun, and
investments in venture capital funds and other joint ventures.
These equity investments were generally made in connection with
a round of financing with other third party investors. As the
investments in privately-held companies do not permit us to
exert significant influence or control over the entity in which
we are investing, the recorded amounts generally represent our
cost of the investment less any adjustments we make when we
determine that an investments net realizable value is less
than its carrying cost. These investments were $229 million
and $266 million at June 30, 2002 and 2001,
respectively, and were included in Other non-current
assets, net in the Consolidated Balance Sheets. We
periodically evaluate these investments for impairment. If we
believe that the carrying value of an investment is greater than
its fair value, an impairment charge is recognized in the
Gain (loss) on equity investments, net in the
Consolidated Statements of Operations. For the fiscal years
ended June 30, 2002, 2001 and 2000, $64 million,
$72 million and none, respectively, were recorded as
impairment charges related to our investments in privately-held
companies.

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Investments in venture capital funds and other
joint ventures were $34 million and $37 million at
June 30, 2002 and 2001, respectively, and were accounted
for using the equity method of accounting. We recorded a loss of
$15 million and a gain of $21 million and
$30 million for fiscal 2002, 2001 and 2000, respectively,
related to our investments in venture capital funds and were
recognized in Gain (loss) on equity investments, net.

Long-lived Assets (Other than
Goodwill)

General

Sun reviews its long-lived assets (other than
goodwill) for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may
not be recoverable. We assess the recoverability of the
long-lived assets (other than goodwill) by comparing the
estimated undiscounted cashflows associated with the related
asset or group of assets against their respective carrying
amounts. The amount of an impairment, if any, is calculated
based on the excess of the carrying amount over the fair value
of those assets.

Intangible Assets Other than
Goodwill

At June 30, 2002, we had Intangible Assets
Other than Goodwill (Other Intangible Assets) with a carrying
value of approximately $215 million, net of accumulated
amortization of $429 million, as compared with
$352 million, net of accumulated amortization of
$326 million at June 30, 2001. These consisted of
Other Intangible Assets related to business combinations of
approximately $104 million, net of accumulated amortization of
$262 million, as compared with $185 million, net of
accumulated amortization of $215 million at June 30,
2001 and an Other Intangible Asset with a carrying value of
$111 million, net of accumulated amortization of
$167 million, as compared with $167 million, net of
accumulated amortization of $111 million at June 30,
2001, related to a revenue generating technology license,
acquired as part of the Strategic Alliance with AOL, see
Note 5.

During the fiscal year ended June 30, 2002,
Sun recognized acquired intangible asset impairments totaling
$6 million in selling, general and administrative expense,
as compared with $1 million in fiscal 2001 in cost of sales
and $21 million in fiscal 2000 of which $9 million was
charged to cost of sales and $12 million was charged to
selling, general and administrative expense. The entire
impairment charge for fiscal 2002 pertained to the Computer
Systems and Network Storage segment. The entire impairment
charge for fiscal 2001 pertained to the iPlanet segment. For
fiscal 2000, $12 million, $5 million and
$4 million pertained to the Computer Systems and Network
Storage segment, the iPlanet segment and the Other segment,
respectively. These charges were based on a comparison of the
fair value of the underlying intangible asset, calculated based
on the discounted cashflows expected during its remaining useful
life, to its carrying value. While our cashflow assumptions are
consistent with the plans and estimates we are using to manage
the underlying businesses, there is significant judgment in
attributing cashflows to our Other Intangible Assets over their
respective estimated useful lives.

Capitalized Software

Costs related to internally-developed software
and software purchased for internal use, which are required to
be capitalized pursuant to Statement of Position
(SOP) No. 98-1, Accounting for Costs of Computer
Software Developed or Obtained for Internal Use, are
included in property, plant and equipment under machinery and
equipment.

Concentration of Credit Risk

The majority of cash is maintained with three
major financial institutions in the United States. Deposits with
these banks exceed the amount of insurance provided on such
deposits; however, these deposits typically may be redeemed upon
demand and, therefore, bear minimal risk.

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Financial instruments that potentially subject
Sun to concentrations of credit risk consist principally of
marketable securities, foreign exchange contracts, interest rate
instruments and trade receivables. The counterparties to the
agreements relating to Suns investment securities, foreign
exchange contracts, and interest rate instruments consist of
various major corporations and financial institutions of high
credit standing. We do not believe there is significant risk of
non-performance by these counterparties because we limit the
amount of credit exposure to any one financial institution and
any one type of investment. The credit risk on receivables due
from counterparties related to foreign exchange and currency
option contracts was insignificant at June 30, 2002 and
2001. Our trade receivables are derived primarily from sales of
hardware and software products and services to end-user
customers in diversified industries, as well as various
resellers. We perform ongoing credit evaluations of our
customers financial condition and limit the amount of
credit extended when deemed necessary, but generally require no
collateral. Sun expensed amounts related to doubtful accounts of
$46 million, $25 million, and $55 million for
fiscal years 2002, 2001 and 2000, respectively.

Revenue Recognition

Sun enters into transactions to sell products
(hardware and software), services and multiple element
arrangements that may include any combination thereof. We
evaluate revenue recognition for these transactions using the
following basic criteria (collectively called the Revenue
Recognition Criteria):

Evidence of an
arrangement:We recognize revenue when
we have evidence of an agreement with the customer reflecting
the terms and conditions to deliver products or services.

Delivery:For
products, delivery is considered to occur when hardware or the
media containing software products are shipped and title and
risk of loss have been transferred or, in the case of electronic
delivery of software, the customer is given access to the
licensed software programs. For services, delivery is considered
to occur when the contracted services are performed.

Fixed or determinable
fee:We consider a fee to be fixed or
determinable if the fee is not subject to refund or adjustment.
If a portion of the arrangement fee is not fixed or
determinable, we recognize that amount as revenue when the
amount becomes fixed or determinable.

Collection is deemed
probable:At the time of the
transaction, we conduct a credit review of each customer
involved in a significant transaction with Sun to determine the
creditworthiness of the customer. Collection is deemed probable
if we expect the customer to be able to pay amounts under the
arrangement as those amounts become due. If we determine that
collection is not probable, we recognize revenue when collection
becomes probable (generally upon cash collection).

The following policies are applicable to
Suns major categories of revenue transactions:

Product Revenue

Revenue, including sales to resellers and
distributors (channel partners), is recognized when the Revenue
Recognition Criteria are met. Our sales agreements generally do
not include customer acceptance provisions. However, if there is
a customer acceptance provision, or if there is uncertainty
about customer acceptance, revenue is deferred until we have
evidence of customer acceptance. We reduce product revenue for
estimated customer returns, price protection, and other
offerings which may occur under programs we have with our
customers and Channel Partners.

In addition, we sell products to leasing
companies, that, in turn, lease these products to end-users. In
transactions where the leasing companies have no recourse or
less than significant recourse to Sun in the event of default by
the end-user, we recognize revenue on the transaction when the
Revenue Recognition Criteria are met. In arrangements where the
leasing companies have significant recourse (i.e., 10% or more
of the total sales price) to Sun in the event of default by the
end-user (defined as recourse leasing), we recognize
the product revenue (and the related cost of the product) as the
payments are made to the leasing company by the end-user
(generally ratably over the lease term). At June 30, 2002,
we had $51 million in recourse leasing

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deferred revenue ($168 million at
June 30, 2001), of which $14 million is long-term
($55 million at June 30, 2001), and $13 million
of related unamortized cost ($59 million at June 30,
2001).


Service Revenue

Service revenue is recognized when the Revenue
Recognition Criteria are met. Specifically, maintenance contract
revenue is recognized ratably over the contractual period;
educational services revenue is recognized as the services are
rendered; time and material service contract revenue is
recognized as the services are rendered; and fixed price service
contract revenue is recognized using the
percentage-of-completion method of accounting unless we are
unable to make reasonable estimates under that method, in which
case revenue is recognized on a completed contract basis. Losses
on fixed price contracts are recognized in the period in which
the loss becomes known. Our service agreements generally do not
include customer acceptance provisions. However, if there is a
customer acceptance provision, or if there is uncertainty about
customer acceptance of services rendered, revenue is deferred
until we have evidence of customer acceptance.

Multiple Element Arrangements

In certain circumstances, Sun enters into revenue
arrangements as a result of which we are obligated to deliver to
our customers multiple products and/or services (multiple
elements). In these transactions, we allocate the total revenue
to be earned under the arrangement among the various elements
based on their relative fair value; however, in the case of
software transactions, the allocation is based on Sun-specific
objective evidence of fair value. Sun-specific objective
evidence of fair value is generally the price charged when that
element is sold separately. We recognize revenue related to the
delivered products or services only if: (1) the above
Revenue Recognition Criteria are met; (2) any undelivered
products or services are not essential to the functionality of
the delivered products or services; (3) payment for the
delivered products or services is not contingent upon delivery
of the remaining products or services; (4) we have an
enforceable claim to receive the amount due in the event we do
not deliver the undelivered products or services; and
(5) as discussed above, there is evidence of the fair value
for each of the undelivered products or services.

Change in Accounting

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

Research and Development
Expenditures

Costs related to the research, design, and
development of products are charged to research and development
expenses as incurred. Software development costs are capitalized
beginning when a products technological feasibility has
been established and ending when a product is available for
general release to customers. Generally, Suns products are
released soon after technological feasibility has been
established. As a result, costs subsequent to achieving
technological feasibility have not been significant and all
software development costs have been expensed as incurred.

Shipping Costs

Suns shipping and handling costs are
included under cost of sales for all periods presented.

Advertising Costs

Advertising costs consist of development and
placement costs of our advertising campaigns and are charged to
expense when incurred. Advertising expense was
$124 million, $170 million, and $160 million for
fiscal years 2002, 2001, and 2000, respectively.

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Self-insurance

Sun is self-insured up to specific levels for
certain liabilities. Accruals are established based on
historical claim experience and include estimated amounts for
incurred but not reported claims.

Computation of Net Income (Loss) per Common
Share

Basic net income (loss) per common share is
computed using the weighted average number of common shares
outstanding during the period. Diluted net income
(loss) per common share is computed using the weighted
average number of common and dilutive common equivalent shares
outstanding during the period. Dilutive common equivalent shares
consist primarily of stock options.

The following table sets forth the computation of
basic and diluted earnings per share for each of the past three
fiscal years (in millions, except per share amounts):

|                                                                             |                                                                              |                             |       |       |   |      |      |       |   |   |       |       | 
|---------------------------------------------------------------------------- | ---------------------------------------------------------------------------- | --------------------------- | ----- | ----- | - | ---- | ---- | ----- | - | - | ----- | ----- | 
|                                                                             |                                                                              |                            
|                                                                             |                                                                              | Fiscal Years ended June 30,
|                                                                             |                                                                              |                            
|                                                                             |                                                                              | 2002                        |       | 2001  |   | 2000
|                                                                             |                                                                              |                             |       |       |   |     
|Income (loss) before cumulative effect of
    change in accounting principle |                                                                              | $                           | (587  | )     |   | $    | 981  |       |   | $ | 1,854 |      
|Cumulative effect of change in accounting
    principle, net                 |                                                                              |                             |      |       |   |      | (54  | )     |   |   |      |      
|                                                                             |                                                                              |                             |       |       |   |      |      |       |   |   |       |      
|Net income (loss)                                                            |                                                                              | $                           | (587  | )     |   | $    | 927  |       |   | $ | 1,854 |      
|                                                                             |                                                                              |                             |       |       |   |      |      |       |   |   |       |      
|Weighted average shares outstanding:                                         |                                                                              |                             |       |       |   |      |      |       |   |   |       |      
|                                                                             | Basic                                                                        |                             |       | 3,242 |   |      |      | 3,234 |   |   |       | 3,151 | 
|                                                                             | Effect of dilutive securities (primarily stock
    options)                  |                             |       |      |   |      |      | 183   |   |   |       | 228   | 
|                                                                             |                                                                              |                             |       |       |   |      |      |       |   |   |       |      
|                                                                             | Diluted                                                                      |                             |       | 3,242 |   |      |      | 3,417 |   |   |       | 3,379 | 
|                                                                             |                                                                              |                             |       |       |   |      |      |       |   |   |       |      
|Net income (loss) per common share-basic:                                    |                                                                              |                             |       |       |   |      |      |       |   |   |       |      
|                                                                             | Income (loss) before cumulative effect of
    change in accounting principle |                             | $     | (0.18 | ) |      | $    | 0.30  |   |   | $     | 0.59  | 
|                                                                             | Cumulative effect of change in accounting
    principle                      |                             |       |      |   |      |      | (0.02 | ) |   |       |      | 
|                                                                             |                                                                              |                             |       |       |   |      |      |       |   |   |       |      
|Net income (loss) per common share-basic                                     |                                                                              | $                           | (0.18 | )     |   | $    | 0.28 |       |   | $ | 0.59  |      
|                                                                             |                                                                              |                             |       |       |   |      |      |       |   |   |       |      
|Net income (loss) per common share-diluted:                                  |                                                                              |                             |       |       |   |      |      |       |   |   |       |      
|                                                                             | Income (loss) before cumulative effect of
    change in accounting principle |                             | $     | (0.18 | ) |      | $    | 0.29  |   |   | $     | 0.55  | 
|                                                                             | Cumulative effect of change in accounting
    principle                      |                             |       |      |   |      |      | (0.02 | ) |   |       |      | 
|                                                                             |                                                                              |                             |       |       |   |      |      |       |   |   |       |      
|Net income (loss) per common share-diluted                                   |                                                                              | $                           | (0.18 | )     |   | $    | 0.27 |       |   | $ | 0.55  |      
|                                                                             |                                                                              |                             |       |       |   |      |      |       |   |   |       |      

US GAAP requires all anti-dilutive securities,
including stock options, to be excluded from the diluted
earnings per share computation. For fiscal 2002, due to our net
loss, all of our outstanding options of 556 million options
were excluded from the diluted loss per share calculation
because their inclusion would have been anti-dilutive. If we
earned a profit during fiscal 2002, we would have added
97 million equivalent shares to our basic weighted average
shares outstanding to compute the diluted weighted average
shares outstanding.

Foreign Currency Translation

Sun translates most of the assets and liabilities
of international non-U.S. functional currency subsidiaries
into dollars at the current rates of exchange in effect during
each period. Revenue and expenses are translated using rates
that approximate those in effect during the period. Translation
adjustments are included in stockholders equity in the
consolidated balance sheet caption Accumulated other
comprehensive loss. Currency transaction gains or losses,
derived from monetary assets and liabilities stated in a
currency other than the functional currency, are recognized in
current operations and have not been significant to our
operating results in any period. The effect of foreign currency
rate changes on cash and cash equivalents is not material.

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Recent Pronouncements

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

In June 2002, the FASB issued SFAS 146,
Accounting for Costs Associated with Exit or Disposal
Activities, which addresses accounting for restructuring
and similar costs. SFAS 146 supersedes previous accounting
guidance, principally Emerging Issues Task Force Issue
No. 94-3 Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring).
Application of SFAS 146 is required for restructuring
activities initiated after December 31, 2002. SFAS 146
requires recognition of the liability for costs associated with
an exit or disposal activity when the liability is incurred.
Under Issue No. 94-3, a liability for an exit cost was
recognized at the date of the Companys commitment to an
exit plan. SFAS 146 also establishes that the liability should
initially be measured and recorded at fair value. Accordingly,
SFAS 146 may affect the timing of recognizing future
restructuring costs, as well as the amounts recognized.

3.     Acquisitions

On July 1, 2001, we adopted SFAS 141
Business Combinations, which eliminates the pooling
of interests method of accounting for all business combinations
initiated after July 1, 2001 and addresses the initial
recognition and measurement of goodwill and other intangible
assets acquired in a business combination.

Pooling of Interests

On October 19, 1999, Sun completed its
merger with Forte Software, Inc., a software company that
designs, develops, markets, and supports a set of products for
developing, deploying, and managing production applications in
distributed environments, including client/server and the
Internet. Under the terms of the merger agreement, Sun issued
25.4 million shares of Sun common stock (with a fair market
value of $23.52 per share on such date) in exchange for all of
Fortes common stock. In addition, Sun issued
5.4 million stock options in exchange for Fortes
previously outstanding stock options. The transaction was
accounted for as a pooling of interests and, accordingly,
Suns historical consolidated financial statements have
been restated to include Fortes financial position,
results of operations, and cash flows for all periods presented.

Prior to the merger, Fortes fiscal year
ended March 31. Suns restated consolidated financial
statements combine Suns June 30, 1999 results with
Fortes March 31, 1999 results. No adjustments were
necessary to conform accounting policies of the entities.
However, Fortes historical results have been adjusted to
reflect a decrease in income taxes due to the elimination of a
previously provided valuation allowance on its deferred tax
assets. There were no intercompany transactions requiring
elimination in any period presented. In order for both companies
to report financial results on the same fiscal year for 2000,
Fortes results of operations for the three-month period
ended June 30, 1999, which were not material to Sun, were
reflected as an adjustment to retained earnings in fiscal 2000.

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The following table summarizes Suns and
Fortes historical results for the periods prior to the
consummation of the merger of the entities (in millions):

|            |                               |                    |   |       |       | 
|----------- | ----------------------------- | ------------------ | - | ----- | ----- | 
|            |                               | Three Months Ended
|            |                               | September 26, 1999
|            |                               |                   
|            |                               | (Unaudited)       
|Revenues:   |                               |                    |   |      
|            | Sun                           |                    | $ | 3,122 |      
|            | Forte                         |                    |   | 24    |      
|            |                               |                    |   |      
|            |                               | Total              |   | $     | 3,146 | 
|            |                               |                    |   |      
|Net Income: |                               |                    |   |      
|            | Sun, as previously reported   |                    | $ | 271   |      
|            | Forte, as previously reported |                    |   | 1     |      
|            |                               |                    |   |      
|            |                               | Total              |   | $     | 272   | 
|            |                               |                    |   |      

Purchase Acquisitions

During the three fiscal years ended June 30,
2002, Sun completed 15 acquisitions, which were accounted
for under the purchase method of accounting. Pro forma results
of operations have not been presented for any of the
acquisitions because the effects of these acquisitions were not
material to Sun on either an individual or an aggregate basis.
The results of operations of each purchase acquisition are
included in Suns consolidated statements of operations
from the date of each acquisition.

The amounts allocated to purchased in-process
research and development (IPRD) were determined
through established valuation techniques in the high-technology
computer industry and were expensed upon acquisition because
technological feasibility had not been established and no future
alternative uses existed. Research and development costs to
bring the products from the acquired companies to technological
feasibility are not expected to have a material impact on
Suns future results of operations or cash flows.
Intangible assets subject to amortization are being amortized on
a straight-line basis over periods not exceeding five years.

The amounts allocated to unearned equity
compensation were determined in accordance with the method
prescribed in FASB Interpretation No. 44 Accounting
for Certain Transactions Involving Stock Compensation.
Under this method, unearned equity compensation related to
unearned equity instruments assumed in acquisitions (generally
restricted stock and stock options) is calculated as the
pro-rata portion of the intrinsic value (the difference between
the fair value and the exercise price) of the unearned equity
instrument as of the date of acquisition. Subsequent to the
acquisition, this amount is recognized as compensation expense
as earned, generally classified under either research and
development expense or selling, general and administrative
expense.

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A summary of Suns purchase transactions for
the three fiscal years ended June 30, 2002, is included in
the following table (in millions, except share amounts):

|                                                                                                |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |                                                      
|----------------------------------------------------------------------------------------------- |  | ----------------- | --------- | ------------- | ---- | -------- | ------- | --------------------- | --- | ------------ | ------- | ---- | ---- | --------------- | ---- | - | ---- | - | ----- | - | - | - | ---- | ---------------------------------------------------- |  | -----------------------------------------------------
|                                                                                               
|                                                                                               
|                                                                                                |  | Other Net Assets  |           |              
|                                                                                                |  | (Liabilities) and |           |              
|Entity Name and Description of                                                                  |  | Developed         |           | Unearned      |      |          |         | Form of Consideration
|Business Acquired                                                                               |  | Date              |           | Consideration |      | Goodwill |         | Technology            |     | Compensation |         | IPRD |      | and Other Notes
|                                                                                               
|                                                                                               
|Fiscal 2002 Acquisitions                                                                        |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |                                                      
|                                                                                               
|Isopia, Inc.                                                                                    |  |                   | 07/01     |               |      | $        | 66.8    |                       |     | $            | 39.0    |      |      | $               | 3.7  |   |      | $ | 20.9  |   |   | $ | 3.2  |                                                      |  |  $ 28.0 1,840,000
    exchangeable shares issued    
|On-Line Training and E-Learning Software                                                        |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 1.3 Fair value of
    1,400,000 options assumed  
|                                                                                                |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 37.5 cash paid (including
    acquisition costs) 
|                                                                                               
|Two immaterial acquisitions                                                                     |  | 09/0102/02        |           | $             | 14.5 |          |         | $                     | 4.7 |              |         | $    | 13.6 |                 |      | $ | (3.8 | ) |       |   |  |   |      |  $ 14.5 cash paid (including
    acquisition costs)
|                                                                                               
|Fiscal 2001 Acquisitions                                                                        |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |                                                      
|                                                                                               
|LSC, Incorporated                                                                               |  |                   | 5/01      |               |      | $        | 68.0    |                       |     | $            | 55.7    |      |      | $               | 6.9  |   |      | $ | 5.1   |   |   | $ | 0.3  |                                                      |  |  $ 52.2 1,779,000 shares
    common stock issued    
|Intelligent file system software                                                                |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 12.8 Fair value of
    564,000 options assumed   
|                                                                                                |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 2.7 cash paid for
    acquisition costs          
|                                                                                                |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 0.3 Fair value of 13,000
    warrants assumed    
|                                                                                               
|HighGround Systems, Inc.                                                                        |  |                   | 4/01      |               |      | $        | 413.7   |                       |     | $            | 387.8   |      |      | $               | 24.9 |   |      | $ | (3.8  | ) |   | $ | 4.8  |                                                      |  |  $ 331.6 8,039,000 shares
    common stock issued   
|Storage Resource Management software                                                            |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 78.5 Fair value of
    2,142,000 options assumed 
|                                                                                                |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 3.6 cash, including
    acquisition costs        
|                                                                                               
|Cobalt Networks, Inc.                                                                           |  |                   | 12/00     |               |      | $        | 2,061.0 |                       |     | $            | 1,779.1 |      |      | $               | 93.5 |   |      | $ | 117.6 |   |   | $ | 70.8 |                                                      |  |  $1,775.7 30,456,000 shares
    common stock issued 
|Server appliances                                                                               |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 283.3 Fair value of
    5,565,000 options assumed
|                                                                                                |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 2.0 cash paid for
    acquisition costs          
|                                                                                               
|Gridware, Inc.                                                                                  |  |                   | 7/00      |               |      | $        | 19.8    |                       |     | $            | 13.6    |      |      | $               | 10.6 |   |      | $ | (4.4  | ) |   |   |     |                                                      |  |  $ 18.5 378,000 shares
    common stock issued      
|Workload management software                                                                    |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 0.7 16,000 vested options
    assumed            
|                                                                                                |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 0.6 liabilities assumed                          
|                                                                                               
|Dolphin Interconnect Solutions, Inc. and Dolphin
    Interconnect Solutions North America, Inc. |  |                   | 7/00      |               |      | $        | 19.0    |                       |     | $            | 19.0    |      |      |                 |     |   |      |   |      |   |   |   |     |                                                      |  |  $ 19.0 cash, including
    acquisition costs       
|Infiniband interconnect architecture                                                            |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |                                                      
|                                                                                               
|Two immaterial acquisitions                                                                     |  |                   | 3/0111/00 |               |      | $        | 17.9    |                       |     | $            | 12.6    |      |      | $               | 1.0  |   |      | $ | 2.8   |   |   | $ | 1.5  |                                                      |  |  $ 6.8 332,000 shares common
    stock issued       
|                                                                                                |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 1.1 Fair value of 63,000
    options assumed     
|                                                                                                |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 10.0 cash, including
    acquisition costs       
|                                                                                               
|Fiscal 2000 Acquisitions                                                                        |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |                                                      
|                                                                                               
|Innosoft International, Inc.                                                                    |  |                   | 3/00      |               |      | $        | 42.4    |                       |     | $            | 34.8    |      |      | $               | 5.6  |   |      | $ | (1.1  | ) |   | $ | 3.1  |                                                      |  |  $ 34.9 813,000 shares
    common stock issued      
|Internet mail, directory and messaging services                                                 |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 4.1 cash, including
    acquisition costs        
|                                                                                                |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 3.4 76,000 vested options
    assumed            
|                                                                                               
|Trustbase, Limited and JCP Computer Services,
    Limited                                       |  |                   | 1/00      |               |      | $        | 20.5    |                       |     | $            | 8.5     |      |      | $               | 5.0  |   |      | $ | 2.1   |   |   | $ | 4.9  |                                                      |  |  $ 9.1 cash                                         
|Financial e-commerce applications                                                               |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 5.9 note payable                                 
|                                                                                                |  |                   |           |               |      |          |         |                       |     |              |         |      |      |                 |      |   |      |   |       |   |   |   |      |                                                      |  |  $ 5.5 liabilities assumed                          
|                                                                                               

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|                                                                                        |  |                   |          |               |  |          |      |                       |  |              |      |      |  |                 |     |  |  |   |      |   |  |   |     |  |  |                                               
|--------------------------------------------------------------------------------------- |  | ----------------- | -------- | ------------- |  | -------- | ---- | --------------------- |  | ------------ | ---- | ---- |  | --------------- | --- |  |  | - | ---- | - |  | - | --- |  |  | ----------------------------------------------
|                                                                                       
|                                                                                       
|                                                                                        |  | Other Net Assets  |          |              
|                                                                                        |  | (Liabilities) and |          |              
|Entity Name and Description of                                                          |  | Developed         |          | Unearned      |  |          |      | Form of Consideration
|Business
Acquired                                                                       |  | Date              |          | Consideration |  | Goodwill |      | Technology            |  | Compensation |      | IPRD |  | and Other Notes
|                                                                                       
|                                                                                       
|Star Division Corporation and Star Division
    Software Entwicklung und Vertriebs GmbH |  |                   | 8/99     |               |  | $        | 75.5 |                       |  | $            | 70.1 |      |  | $               | 3.3 |  |  | $ | (1.4 | ) |  | $ | 3.5 |  |  |  $ 66.3 cash                                 
|Office productivity applications                                                        |  |                   |          |               |  |          |      |                       |  |              |      |      |  |                 |     |  |  |   |      |   |  |   |     |  |  |  $ 8.5 liabilities assumed                   
|                                                                                        |  |                   |          |               |  |          |      |                       |  |              |      |      |  |                 |     |  |  |   |      |   |  |   |     |  |  |  $ 0.7 96,000 vested options
    assumed     
|                                                                                       
|Two immaterial acquisitions                                                             |  |                   | 6/010/99 |               |  | $        | 19.3 |                       |  | $            | 18.0 |      |  | $               | 0.7 |  |  | $ | 0.6  |   |  |   |    |  |  |  $ 7.9 197,000 shares common
    stock issued
|                                                                                        |  |                   |          |               |  |          |      |                       |  |              |      |      |  |                 |     |  |  |   |      |   |  |   |     |  |  |  $ 11.2 cash including
    acquisition costs 
|                                                                                        |  |                   |          |               |  |          |      |                       |  |              |      |      |  |                 |     |  |  |   |      |   |  |   |     |  |  |  $ 0.1 liabilities assumed                   
|                                                                                        |  |                   |          |               |  |          |      |                       |  |              |      |      |  |                 |     |  |  |   |      |   |  |   |     |  |  |  $ 0.1 6,000 vested options
    assumed      
|                                                                                       

As compared with previous years, goodwill has
been updated in accordance with SFAS 142, in order to
reflect the reclassification of assembled workforce and the tax
impact of acquired assets and liabilities under SFAS 109.

We completed three acquisitions in fiscal 2002.
Suns acquisition of ISOPIA, Inc. (Isopia) on July 26,
2001 is described below (the aggregate purchase price of the
other two acquisitions was less than $15 million and,
accordingly, are not considered significant to Suns
financial statements).

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

4.     Goodwill and
Other Acquisition-Related Intangible Assets

As of July 1, 2001, Sun adopted
SFAS 142, Goodwill and Other Intangible Assets,
which addresses the financial accounting and reporting standards
for goodwill and other intangible assets subsequent to their
acquisition. This standard requires that goodwill no longer be
amortized, and instead, be tested for impairment on a periodic
basis. We completed both our transitional and annual goodwill
impairment tests as of July 1, 2001 and April 1, 2002,
respectively, and found no impairment. At June 30, 2002, we
had goodwill with a carrying value of approximately
$2.2 billion. Reporting units in our Computer Systems and
Network Storage segment accounted for more than 95% of the
carrying value of our goodwill at June 30, 2002.

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

|                            |                                       |                             |      |       |   |      |       |      |    |   |       |      |    |  
|--------------------------- | ------------------------------------- | --------------------------- | ---- | ----- | - | ---- | ----- | ---- | -- | - | ----- | ---- | -- | -
|                            |                                       |                            
|                            |                                       | Fiscal Years Ended June 30,
|                            |                                       |                            
|                            |                                       | 2002                        |      | 2001  |   | 2000
|                            |                                       |                             |      |       |   |     
|Reported net income (loss)  |                                       | $                           | (587 | )     |   | $    | 927   |      |    | $ | 1,854 |     
|                            | Add: Goodwill amortization            |                             |      |      |   |      |       | 285  |    |   |       | 72   |   
|                            |                                       | Workforce amortization      |      |       |  |      |       |      | 8  |   |       |      | 5  |  
|                            |                                       | Tax impact                  |      |       |  |      |       |      | (3 | ) |       |      | (3 | )
|                            |                                       |                             |      |       |   |      |       |      |    |   |       |     
|Adjusted net income (loss)  |                                       | $                           | (587 | )     |   | $    | 1,217 |      |    | $ | 1,928 |     
|                            |                                       |                             |      |       |   |      |       |      |    |   |       |     
|Basic earnings per share:   |                                       |                             |      |       |   |      |       |      |    |   |       |     
|                            | Reported earnings per share  basic   |                             | $    | (0.18 | ) |      | $     | 0.28 |    |   | $     | 0.59 |   
|                            | Add: Goodwill amortization            |                             |      |      |   |      |       | 0.09 |    |   |       | 0.02 |   
|                            |                                       | Workforce amortization      |      |       |  |      |       |      |   |   |       |      |   |  
|                            |                                       | Tax impact                  |      |       |  |      |       |      |   |   |       |      |   |  
|                            |                                       |                             |      |       |   |      |       |      |    |   |       |     
|                            | Adjusted earnings per share  basic   |                             | $    | (0.18 | ) |      | $     | 0.37 |    |   | $     | 0.61 |   
|                            |                                       |                             |      |       |   |      |       |      |    |   |       |     
|Diluted earnings per share: |                                       |                             |      |       |   |      |       |      |    |   |       |     
|                            | Reported earnings per share  diluted |                             | $    | (0.18 | ) |      | $     | 0.27 |    |   | $     | 0.55 |   
|                            | Add: Goodwill amortization            |                             |      |      |   |      |       | 0.08 |    |   |       | 0.02 |   
|                            |                                       | Workforce amortization      |      |       |  |      |       |      |   |   |       |      |   |  
|                            |                                       | Tax impact                  |      |       |  |      |       |      |   |   |       |      |   |  
|                            |                                       |                             |      |       |   |      |       |      |    |   |       |     
|                            | Adjusted earnings per share  diluted |                             | $    | (0.18 | ) |      | $     | 0.35 |    |   | $     | 0.57 |   
|                            |                                       |                             |      |       |   |      |       |      |    |   |       |     

Changes in the carrying amount of goodwill for
the years ended June 30, 2002 and 2001, by reportable
segment, are as follows (in millions):

|                            |                                         |             |       |            |   |         |    |       |   |       |    |     |   |   |    |     |   |   |       |       |  
|--------------------------- | --------------------------------------- | ----------- | ----- | ---------- | - | ------- | -- | ----- | - | ----- | -- | --- | - | - | -- | --- | - | - | ----- | ----- | -
|                            |                                         | Computer    |       |            |   |         |    |       |   |      
|                            |                                         | Systems and |       |            |   |         |    |       |   |      
|                            |                                         | Network     |       | Enterprise |   |         |    |       |   |      
|                            |                                         | Storage     |       | Services   |   | iPlanet |    | Other |   | Total
|                            |                                         |             |       |            |   |         |    |       |   |      
|Balance as of July 1, 2000  |                                         | $           | 44    |            |   | $       | 8  |       |   | $     | 50 |     |   | $ | 65 |     |   | $ | 167   |      
|                            | Goodwill acquired during the period     |             |       | 2,232      |   |         |    |      |   |       |    | 8   |   |   |    | 4   |   |   |       | 2,244 |  
|                            | Goodwill amortized during the period    |             |       | (253       | ) |         |    | (2    | ) |       |    | (14 | ) |   |    | (16 | ) |   |       | (285  | )
|                            |                                         |             |       |            |   |         |    |       |   |       |    |     |   |   |    |     |   |   |       |      
|Balance as of June 30, 2001 |                                         | $           | 2,023 |            |   | $       | 6  |       |   |       | 44 |     |   | $ | 53 |     |   | $ | 2,126 |      
|                            | Goodwill reclassified on July 1, 2001   |             |       | 48         |   |         |    | 3     |   |       |    | 1   |   |   |    | (52 | ) |   |       |      |  
|                            | Workforce reclassified as goodwill      |             |       | 10         |   |         |    | 1     |   |       |    | 1   |   |   |    |    |   |   |       | 12    |  
|                            | Goodwill acquired during the period     |             |       | 3          |   |         |    | 39    |   |       |    | 2   |   |   |    |    |   |   |       | 44    |  
|                            | Goodwill reclassified during the period |             |       |           |   |         |    | 17    |   |       |    | (17 | ) |   |    |    |   |   |       |      |  
|                            |                                         |             |       |            |   |         |    |       |   |       |    |     |   |   |    |     |   |   |       |      
|Balance as of June 30, 2002 |                                         | $           | 2,084 |            |   | $       | 66 |       |   | $     | 31 |     |   | $ | 1  |     |   | $ | 2,182 |      
|                            |                                         |             |       |            |   |         |    |       |   |       |    |     |   |   |    |     |   |   |       |      

Upon adoption of SFAS 142 at July 1,
2001, goodwill previously assigned to the Other
operating segment was allocated to the Computer Systems and
Network Storage operating segment and to the Enterprise Services
and iPlanet operating segments because these operating segments
receive substantially all of the benefits of this acquired
goodwill.

During fiscal 2002, a significant portion of the
iPlanets service and support business was transferred to
Enterprise Services. The amount of goodwill transferred to
Enterprise Services was determined based on the

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relative fair value of the business transferred
as compared with the estimated total fair value of the iPlanet
business prior to the transfer.


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

|                     |  |                |     |               |  |     |      |                |  |              |     |     |  |   |     |  |  |   |      |   |  |   |     | 
|-------------------- |  | -------------- | --- | ------------- |  | --- | ---- | -------------- |  | ------------ | --- | --- |  | - | --- |  |  | - | ---- | - |  | - | --- | 
|                     |  |                |     |              
|                     |  | June 30, 2002  |     | June 30, 2001
|                     |  |                |     |              
|                     |  | Gross Carrying |     | Accumulated   |  |     |      | Gross Carrying |  | Accumulated  |     |    
|                     |  | Amount         |     | Amortization  |  | Net |      | Amount         |  | Amortization |     | Net
|                     |  |                |     |               |  |     |      |                |  |              |     |    
|Developed technology |  | $              | 308 |               |  | $   | (224 | )              |  | $            | 84  |     |  | $ | 290 |  |  | $ | (169 | ) |  | $ | 121 | 
|Customer base        |  |                | 51  |               |  |     | (34  | )              |  |              | 17  |     |  |   | 57  |  |  |   | (19  | ) |  |   | 38  | 
|Other                |  |                | 7   |               |  |     | (4   | )              |  |              | 3   |     |  |   | 53  |  |  |   | (27  | ) |  |   | 26  | 
|                     |  |                |     |               |  |     |      |                |  |              |     |     |  |   |     |  |  |   |      |   |  |   |     | 
|                     |  | $              | 366 |               |  | $   | (262 | )              |  | $            | 104 |     |  | $ | 400 |  |  | $ | (215 | ) |  | $ | 185 | 
|                     |  |                |     |               |  |     |      |                |  |              |     |     |  |   |     |  |  |   |      |   |  |   |     | 

Amortization expense of other acquisition-related
intangible assets was $72 million, $55 million and
$48 million for the years ended June 30, 2002, 2001
and 2000, respectively.

The weighted average amortization period of the
intangible assets acquired through business combinations during
fiscal 2002 is three years.

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

|     |  |   |     | 
|---- |  | - | --- | 
|2003 |  | $ | 69  | 
|2004 |  |   | 32  | 
|2005 |  |   | 3   | 
|     |  |   |     | 
|     |  | $ | 104 | 
|     |  |   |     | 

5.     Strategic
Alliance with America Online, Inc.

On November 23, 1998, Sun and America
Online, Inc., which is now AOL Time Warner Inc.
(AOL) entered into a strategic alliance consisting of
several agreements between the parties (the Strategic
Alliance). The Strategic Alliance commenced on
March 17, 1999 and expired March 17, 2002. A summary
of the significant terms of the Strategic Alliance is discussed
below.

Under the Strategic Alliance, Sun and AOL agreed
to collaboratively develop, market, and sell client and server
software, and collaboratively develop an AOL-specific Java
technology-based environment that would enable AOL services to
be accessed through a variety of hardware devices. The Strategic
Alliance provided that, over its term, AOL and Sun would develop
and market client software and network application and server
software based, in part, on Netscape code, on Sun code and
technology, and certain AOL service features to business
enterprises. In addition, AOL and Sun agreed to coordinate their
sales efforts with respect to designated AOL, Netscape, Sun and
collaboratively developed client server and network application
and server software and associated services.

Under the terms of the Strategic Alliance, Sun
committed that the total amount collected by or on behalf of AOL
from the sale or license of certain AOL, Netscape and
collaboratively developed software products would not be less
than approximately $975 million over the three year term of
the Strategic Alliance.

In addition, the terms of the Strategic Alliance
required Sun to pay $278 million for related intellectual
property rights and licenses granted to Sun by AOL. This
software license is being amortized in cost of sales over its
five year estimated useful life. Sun also committed to purchase
approximately $90 million in marketing and advertising during
the term of the Strategic Alliance. Finally, AOL committed to
purchase approximately $300 million (up to approximately
$500 million at list price) in Sun equipment and services,
net of discounts of up to 40% of list price.

Subsequently, Sun and AOL amended the agreements
comprising the Strategic Alliance. The first amendment, in June
2000, increased AOLs commitment to purchase Sun equipment
by approximately $250 million (up to approximately
$420 million at list price), net of discounts of up to 40%.
In September

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2001, in order to ensure an effective transition
upon expiration, the terms were modified to give Sun operational
control of the Strategic Alliance during the remaining six month
term. This second amendment also fixed and accelerated the
payment obligations that were otherwise due by the parties
through March 2002.


Following expiration of the Strategic Alliance on
March 17, 2002, Sun retained rights equivalent to ownership
of intellectual property developed by the Strategic Alliance,
subject to AOLs license rights; Sun retained broad
licensing rights to intellectual property that existed prior to
the formation of the Strategic Alliance; and Sun retained
limited licensing rights to certain third party intellectual
property. As of June 30, 2002, Sun had no financial
obligations to AOL under the Strategic Alliance.

AOL is considered a related party because
James L. Barksdale, the former President and Chief
Executive Officer of Netscape Communications Corporation is a
member of the Board of Directors of both Sun and AOL.

6.     Restructuring
Charges

We committed to a restructuring plan in fiscal
2002 (Fiscal 2002 Restructuring Plan) and a facility exit plan
in fiscal 2001 (Fiscal 2001 Facility Exit Plan). We recorded
initial restructuring charges in fiscal 2002 and 2001 based on
assumptions and related estimates that were deemed appropriate
for the economic environment that existed at the time these
estimates were made. However, due to the continued deterioration
of the commercial real estate market, primarily in the U.S., and
the final settlement of certain lease obligations, we made the
appropriate adjustments to the initial restructuring charges
recorded in fiscal 2002 and 2001. During fiscal 2001, we
recorded a charge of $75 million for the Fiscal 2001
Facility Exit Plan. During fiscal 2002, we recorded a net charge
of $517 million, $26 million of additional charges
related to our Fiscal 2001 Facility Exit Plan and the remaining
net charges of $491 million related to our Fiscal 2002
Restructuring Plan. At June 30, 2002, we had an accrued
liability of $241 million with respect to Fiscal 2002
Restructuring Plan and Fiscal 2001 Facility Exit Plan. Details
about each of these plans are discussed below.

Our accrued liability of $241 million at
June 30, 2002, is net of $207 million of estimated
sublease income. Our ability to generate this amount of sublease
income, as well as our ability to terminate lease obligations at
the amounts we have estimated, is highly dependent upon the
economic conditions, particularly lease market conditions in
certain geographies, at the time we negotiate the lease
termination and sublease arrangements with third parties. While
the amount we have accrued is our best estimate, estimates are
subject to change and may require routine adjustment as
conditions and facts change through the implementation period.
If macroeconomic conditions, particularly as they pertain to the
commercial real estate market, continue to be negative, we maybe
required to increase our estimated cost to exit certain
facilities.

Fiscal 2002 Restructuring Plan

In response to the continuing global economic
slowdown, Sun implemented a workforce reduction and facility
exit plan in the second quarter of fiscal 2002. This
restructuring resulted in a charge of $511 million
(consisting of a $146 million workforce reduction charge
and a $365 million excess facility charge as discussed
below) in the second quarter of fiscal 2002. The goal of the
restructuring was to reduce costs and improve operating
efficiencies in order to adjust to the current business
environment. Specifically, we reduced our headcount by
approximately 9% (or 3,400 employees and
500 contractors) and eliminated excess facilities in light
of revised facility requirements.

Worldwide
Workforce Reduction

As part of the restructuring, we recorded a
workforce reduction charge of $146 million related to
severance and fringe benefits for terminated employees. The
restructuring resulted in the termination of approximately
3,400 employees across all employee levels, business
functions, operating units, and geographic regions.

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Consolidation of
Excess Facilities

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



|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | $282 million of estimated future obligations
    for non-cancelable lease payments or termination fees generated
    by exiting excess leased facilities. We estimated the cost of
    exiting and terminating the facility leases based on the
    contractual terms of the agreements and then current real estate
    market conditions. In addition, we intend to sublease certain
    leased facilities and estimated the sublease income based on
    then current real estate market conditions or, where applicable,
    amounts being negotiated;
| 
| | $66 million for the impairment of in-process
    construction costs related to the termination of certain
    building construction projects; and                                                                                                                                                                                                                                                                                                                                                                                                         
| 
| | $17 million for the impairment of property
    and equipment (primarily leasehold improvements) that were no
    longer in use. The property and equipment impairment was
    determined based on the difference between the assets
    estimated fair value and their carrying value.                                                                                                                                                                                                                                                                   

We expect to exit the facilities relating to the
amounts accrued under the restructuring by no later than
December 31, 2002.

During the second half of fiscal 2002, we reduced
our estimate of the total cost of $511 million associated
with this restructuring activity and recorded an adjustment of
$20 million. This adjustment primarily reflects the
settlement of certain lease obligations. As of June 30,
2002, the revised total estimated cost for the Fiscal 2002
Restructuring Plan of $491 million was net of approximately
$180 million of estimated sublease income.

Fiscal 2001 Facility Exit Plan

In the fourth quarter of fiscal 2001, we elected
to exit certain building leases and building projects. We
charged approximately $75 million for facility exit costs
associated with this decision, of which $46 million was
reflected as an accrual as of June 30, 2001. As a result of
the continued deterioration of certain commercial real estate
markets, we reduced our sublease income assumptions and,
accordingly, recorded an additional $26 million charge in
fiscal 2002 to reflect this change in estimates. As of
June 30, 2002, the revised total estimated facility exit
cost of $101 million was net of approximately
$27 million in estimated sublease income.

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The following table sets forth an analysis of the
restructuring accrual activity for the fiscal years ending
June 30, 2001 and 2002 (in millions):

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

The remaining cash expenditures relating to
workforce reductions and the termination of lease agreements are
expected to be paid by the second quarter of fiscal 2003. The
current estimates accrued for abandoned leases (net of
anticipated sublease proceeds) will be paid over their
respective lease terms through fiscal 2018. As of June 30,
2002, $90 million of the $241 million accrual was
classified as current and the remaining $151 million was
classified as non-current.

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

7.     Balance Sheet
and Statement of Cash Flow Information

Inventories

At June 30, Inventoriesconsisted of
the following (in millions):

|                |  |      |     |      |  |   |       | 
|--------------- |  | ---- | --- | ---- |  | - | ----- | 
|                |  | 2002 |     | 2001
|                |  |      |     |     
|Raw materials   |  | $    | 168 |      |  | $ | 600   | 
|Work in process |  |      | 125 |      |  |   | 137   | 
|Finished goods  |  |      | 298 |      |  |   | 312   | 
|                |  |      |     |      |  |   |       | 
|                |  | $    | 591 |      |  | $ | 1,049 | 
|                |  |      |     |      |  |   |       | 

Inventories are stated at the lower of cost
(first in, first out) or market (net realizable value).
Inventory in-transit (included in finished goods) consists of
products shipped but not recognized as revenue because they did
not meet the revenue recognition criteria. As of June 30,
2002, inventory in-transit was $161 million as compared
with $154 million at June 30, 2001. We evaluate our
ending inventories for estimated excess quantities and
obsolescence. This evaluation includes analyses of sales levels
by product and projections of future demand within specific time
horizons (generally six months or less). Inventories in excess
of future demand, as defined, are reserved. In addition, we
assess the impact of changing technology on our

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inventory-on-hand and we write-off inventories
that are considered obsolete. At June 30, 2002 and 2001,
our inventory balances were net of write-downs of approximately
$90 million and $99 million, respectively.


Prepaid Expenses and Other Current
Assets

At June 30, Prepaid expenses and other
current assetsconsisted of the following (in millions):

|                                                |  |      |     |      |  |   |     | 
|----------------------------------------------- |  | ---- | --- | ---- |  | - | --- | 
|                                                |  | 2002 |     | 2001
|                                                |  |      |     |     
|Refundable income taxes                         |  | $    | 412 |      |  | $ | 260 | 
|Other prepaid expenses and other current assets |  |      | 435 |      |  |   | 709 | 
|                                                |  |      |     |      |  |   |     | 
|                                                |  | $    | 847 |      |  | $ | 969 | 
|                                                |  |      |     |      |  |   |     | 

Property, Plant and Equipment, net

At June 30, Property, plant, and
equipment, net, consisted of the following (in millions):

|                                               |  |      |        |      |  |   |        |  
|---------------------------------------------- |  | ---- | ------ | ---- |  | - | ------ | -
|                                               |  | 2002 |        | 2001
|                                               |  |      |        |     
|Machinery and equipment                        |  | $    | 2,851  |      |  | $ | 2,726  |  
|Land, buildings, and building improvements     |  |      | 1,386  |      |  |   | 1,313  |  
|Leasehold improvements                         |  |      | 484    |      |  |   | 452    |  
|Furniture and fixtures                         |  |      | 272    |      |  |   | 270    |  
|                                               |  |      |        |      |  |   |        |  
|                                               |  |      | 4,993  |      |  |   | 4,761  |  
|Less accumulated depreciation and amortization |  |      | (2,540 | )    |  |   | (2,064 | )
|                                               |  |      |        |      |  |   |        |  
|                                               |  | $    | 2,453  |      |  | $ | 2,697  |  
|                                               |  |      |        |      |  |   |        |  

Property, plant and equipment are stated at cost.
Depreciation is provided principally on the straight-line method
over the estimated useful lives of the assets. The useful lives
for machinery and equipment range from one to five years,
buildings and building improvements range from seven to
25 years, leasehold improvement range from the shorter of
five years or applicable lease term and furniture and fixtures
have a useful life of five years. Land is not depreciated.

Depreciation expense was $790 million,
$620 million, and $460 million for fiscal years 2002,
2001 and 2000, respectively.

Other Non-Current Assets, net

At June 30, Other non-current assets,
net, consisted of the following (in millions):

|                                                             |  |      |       |      |  |   |     | 
|------------------------------------------------------------ |  | ---- | ----- | ---- |  | - | --- | 
|                                                             |  | 2002 |       | 2001
|                                                             |  |      |       |     
|Marketable equity securities and other equity
    securities |  | $    | 281   |      |  | $ | 365 | 
|Spares, net                                                  |  |      | 223   |      |  |   | 200 | 
|Long-term deferred tax assets                                |  |      | 155   |      |  |   |    | 
|Interest-rate swap agreements                                |  |      | 152   |      |  |   | 69  | 
|Other                                                        |  |      | 216   |      |  |   | 293 | 
|                                                             |  |      |       |      |  |   |     | 
|                                                             |  | $    | 1,027 |      |  | $ | 927 | 
|                                                             |  |      |       |      |  |   |     | 

Spare parts are amortized using the straight-line
method over their useful lives of three years. Amortization
expense for fiscal 2002, 2001, and 2000 was $128 million,
$113 million, and $85 million, respectively. In
addition, Other non-current assets also includes certain trading
assets we maintain to generate returns that offset changes in
certain liabilities related to deferred compensation
arrangements. The trading assets consist of marketable equity
securities and are stated at fair value. Both realized and
unrealized gains and losses,

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which have not been material, are included in
income and expense and generally offset the change in the
deferred compensation liability.


For further discussion on interest-rate swaps
agreements, see Notes 8 and 9.

Deferred Revenues

At June 30, Deferred revenuesconsisted of the following (in millions):

|                          |  |      |       |      |  |   |       | 
|------------------------- |  | ---- | ----- | ---- |  | - | ----- | 
|                          |  | 2002 |       | 2001
|                          |  |      |       |     
|Deferred service revenues |  | $    | 1,284 |      |  | $ | 1,223 | 
|Other deferred revenues   |  |      | 501   |      |  |   | 604   | 
|                          |  |      |       |      |  |   |       | 
|                          |  | $    | 1,785 |      |  | $ | 1,827 | 
|                          |  |      |       |      |  |   |       | 

Deferred service revenues consist primarily of
prepayments by our customers related to: (1) maintenance
contract revenue, which is recognized ratably over the
contractual period; (2) educational services revenue, which
is recognized as the services are rendered; (3) time and
material professional service contract revenue, which is
recognized as the services are rendered; and (4) fixed
price service contract revenue, which is recognized using the
percentage-of-completion method.

Other deferred revenue primarily comprised
revenue deferred in connection with product installations and
customer deposits.

Accumulated Other Comprehensive Income
(Loss)

At June 30, the components of Accumulated
other comprehensive income (loss), reflected in the
Consolidated Statements of Stockholders Equity,net
of related taxes, consisted of the following (in millions):

|                                                          |  |      |     |      |  |      |     |   |  |   |     |  
|--------------------------------------------------------- |  | ---- | --- | ---- |  | ---- | --- | - |  | - | --- | -
|                                                          |  | 2002 |     | 2001 |  | 2000
|                                                          |  |      |     |      |  |     
|Unrealized gain on investments, net                       |  | $    | 25  |      |  | $    | 53  |   |  | $ | 125 |  
|Unrealized gain (loss) on derivative
    instruments, net |  |      | (31 | )    |  |      | 15  |   |  |   |    |  
|Cumulative translation adjustments                        |  |      | (25 | )    |  |      | (97 | ) |  |   | (50 | )
|                                                          |  |      |     |      |  |      |     |   |  |   |     |  
|                                                          |  | $    | (31 | )    |  | $    | (29 | ) |  | $ | 75  |  
|                                                          |  |      |     |      |  |      |     |   |  |   |     |  

At June 30, the net change in unrealized
gains (losses) on available-for-sale securities,net
of related taxes, consisted of the following (in millions):

|                                                                                                                                                        |  |      |     |      |  |      |     |   |  |   |     | 
|------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | --- | ---- |  | ---- | --- | - |  | - | --- | 
|                                                                                                                                                        |  | 2002 |     | 2001 |  | 2000
|                                                                                                                                                        |  |      |     |      |  |     
|Net unrealized gains arising during the period,
    net of tax expense of $37, $17, and $172 in 2002, 2001, and
    2000, respectively                  |  | $    | 56  |      |  | $    | 26  |   |  | $ | 263 | 
|Less net gains included in net income for the
    period, net of tax expense of $46, $37, and $89 in 2002, 2001,
    and 2000, respectively             |  |      | 70  |      |  |      | 56  |   |  |   | 137 | 
|Add adjustment for unrealized loss written off
    due to impairment, net of tax benefit of $9, $28, and none in
    2002, 2001, and 2000, respectively |  |      | (14 | )    |  |      | (42 | ) |  |   |    | 
|                                                                                                                                                        |  |      |     |      |  |      |     |   |  |   |     | 
|Net change in unrealized gains (losses) on
    available for sale securities                                                                            |  | $    | (28 | )    |  | $    | (72 | ) |  | $ | 126 | 
|                                                                                                                                                        |  |      |     |      |  |      |     |   |  |   |     | 

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Statement of Cash Flow Information

At June 30, net sales and maturities of
(purchases of) marketable debt securities consisted of the
following (in millions):

|                                                                     |  |      |         |      |  |      |         |   |  |   |        |  
|-------------------------------------------------------------------- |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------ | -
|                                                                     |  | 2002 |         | 2001 |  | 2000
|                                                                     |  |      |         |      |  |     
|Purchases of marketable debt securities                              |  | $    | (14,921 | )    |  | $    | (14,068 | ) |  | $ | (9,507 | )
|Proceeds from sales and maturities of marketable
    debt securities |  |      | 15,754  |      |  |      | 14,107  |   |  |   | 6,504  |  
|                                                                     |  |      |         |      |  |      |         |   |  |   |        |  
|                                                                     |  | $    | 833     |      |  | $    | 39      |   |  | $ | (3,003 | )
|                                                                     |  |      |         |      |  |      |         |   |  |   |        |  

At June 30, net purchases of equity
investments consisted of the following (in millions):

|                                          |  |      |     |      |  |      |      |   |  |   |      |  
|----------------------------------------- |  | ---- | --- | ---- |  | ---- | ---- | - |  | - | ---- | -
|                                          |  | 2002 |     | 2001 |  | 2000
|                                          |  |      |     |      |  |     
|Purchases of equity investments           |  | $    | (41 | )    |  | $    | (182 | ) |  | $ | (301 | )
|Proceeds from sales of equity investments |  |      | 7   |      |  |      | 76   |   |  |   | 219  |  
|                                          |  |      |     |      |  |      |      |   |  |   |      |  
|                                          |  | $    | (34 | )    |  | $    | (106 | ) |  | $ | (82  | )
|                                          |  |      |     |      |  |      |      |   |  |   |      |  

At June 30, in conjunction with our
acquisitions, liabilities were assumed as follows (in millions):

|                                        |  |      |     |      |  |      |        |   |  |   |     |  
|--------------------------------------- |  | ---- | --- | ---- |  | ---- | ------ | - |  | - | --- | -
|                                        |  | 2002 |     | 2001 |  | 2000
|                                        |  |      |     |      |  |     
|Fair value of assets acquired           |  | $    | 68  |      |  | $    | 2,535  |   |  | $ | 139 |  
|Cash paid for assets                    |  |      | (52 | )    |  |      | (37    | ) |  |   | (90 | )
|Stock issued and vested options assumed |  |      | (4  | )    |  |      | (2,497 | ) |  |   | (35 | )
|                                        |  |      |     |      |  |      |        |   |  |   |     |  
|Liabilities assumed                     |  | $    | 12  |      |  | $    | 1      |   |  | $ | 14  |  
|                                        |  |      |     |      |  |      |        |   |  |   |     |  

8.     Fair Value of
Financial Instruments

Cash equivalents are carried at cost as this
approximates fair value due to the short period of time to
maturity. The fair value of long-term debt was estimated based
on current interest rates available to Sun for debt instruments
with similar terms, degrees of risk, and remaining maturities.
The estimated fair value of forward foreign currency exchange
contracts is based on the estimated amount at which they could
be settled based on market exchange rates. The fair value of
foreign currency option contracts and the interest-rate swap
agreements is obtained from dealer quotes and represents the
estimated amount we would receive or pay to terminate the
agreements. However, considerable judgment is required in
interpreting market data to develop the estimates of fair value.
Accordingly, the estimates presented herein are not necessarily
indicative of the amounts that we could realize in a current
market exchange.

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At June 30, the fair values of Suns
short-term and long-term marketable debt securities were as
follows (in millions):

|                                           |  |          |       |            |  |            |    |            |  |   |    |   |  |   |       | 
|------------------------------------------ |  | -------- | ----- | ---------- |  | ---------- | -- | ---------- |  | - | -- | - |  | - | ----- | 
|                                           |  |          |       |           
|                                           |  |          |       | 2001      
|                                           |  |          |       |           
|                                           |  |          |       | Gross      |  | Gross      |    |           
|                                           |  | Adjusted |       | Unrealized |  | Unrealized |    |           
|                                           |  | Cost     |       | Gains      |  | Losses     |    | Fair Value
|                                           |  |          |       |            |  |            |    |           
|Corporate notes and bonds                  |  | $        | 1,663 |            |  | $          | 22 |            |  | $ | (1 | ) |  | $ | 1,684 | 
|Asset and mortgage-based securities        |  |          | 1,493 |            |  |            | 25 |            |  |   | (1 | ) |  |   | 1,517 | 
|U.S. government notes and bonds            |  |          | 1,487 |            |  |            | 14 |            |  |   | (3 | ) |  |   | 1,498 | 
|Money market funds                         |  |          | 806   |            |  |            |   |            |  |   |   |   |  |   | 806   | 
|                                           |  |          |       |            |  |            |    |            |  |   |    |   |  |   |       | 
|Total marketable securities                |  | $        | 5,449 |            |  | $          | 61 |            |  | $ | (5 | ) |  | $ | 5,505 | 
|                                           |  |          |       |            |  |            |    |            |  |   |    |   |  |   |       | 
|Less cash equivalents                      |  |          | (806  | )         
|                                           |  |          |       |           
|Total marketable debt securities           |  |          | 4,699 |           
|Less short-term portion                    |  |          | (387  | )         
|                                           |  |          |       |           
|Total long-term marketable debt securities |  | $        | 4,312 |           
|                                           |  |          |       |           

|                                           |  |          |        |            |  |            |    |            |  |   |    |   |  |   |       | 
|------------------------------------------ |  | -------- | ------ | ---------- |  | ---------- | -- | ---------- |  | - | -- | - |  | - | ----- | 
|                                           |  |          |        |           
|                                           |  |          |        | 2002      
|                                           |  |          |        |           
|                                           |  |          |        | Gross      |  | Gross      |    |           
|                                           |  | Adjusted |        | Unrealized |  | Unrealized |    |           
|                                           |  | Cost     |        | Gains      |  | Losses     |    | Fair Value
|                                           |  |          |        |            |  |            |    |           
|Corporate notes and bonds                  |  | $        | 975    |            |  | $          | 8  |            |  | $ |   |   |  | $ | 983   | 
|Asset and mortgage-based securities        |  |          | 1,806  |            |  |            | 14 |            |  |   | (1 | ) |  |   | 1,819 | 
|U.S. government notes and bonds            |  |          | 1,594  |            |  |            | 9  |            |  |   |   |   |  |   | 1,603 | 
|Money market funds                         |  |          | 735    |            |  |            |   |            |  |   |   |   |  |   | 735   | 
|                                           |  |          |        |            |  |            |    |            |  |   |    |   |  |   |       | 
|Total marketable securities                |  | $        | 5,110  |            |  | $          | 31 |            |  | $ | (1 | ) |  | $ | 5,140 | 
|                                           |  |          |        |            |  |            |    |            |  |   |    |   |  |   |       | 
|Less cash equivalents                      |  |          | (1,300 | )         
|                                           |  |          |        |           
|Total marketable debt securities           |  |          | 3,840  |           
|Less short-term portion                    |  |          | (861   | )         
|                                           |  |          |        |           
|Total long-term marketable debt securities |  | $        | 2,979  |           
|                                           |  |          |        |           

We only invest in debt securities with a minimum
rating of single A or above from a nationally recognized credit
rating agency. At June 30, 2002, we had investments in debt
instruments of three issuers exceeding 5% of the fair market
value of our marketable debt securities of $5,140 million.
At June 30, 2002, investment concentration by issuer was as
follows (dollars in millions):

|                                      |  |               |       |               |  |  |     |  
|------------------------------------- |  | ------------- | ----- | ------------- |  |  | --- | -
|Issuer                                |  | Fair Value($) |       | Fair Value(%)
|                                      |  |               |       |              
|Federal Home Loan Bank                |  | $             | 962   |               |  |  | 19  | %
|Federal National Mortgage Association |  | $             | 552   |               |  |  | 11  | %
|US Treasuries                         |  | $             | 359   |               |  |  | 7   | %
|All others1                           |  | $             | 3,267 |               |  |  | 63  | %
|                                      |  |               |       |               |  |  |     |  
|                                      |  | $             | 5,140 |               |  |  | 100 | %
|                                      |  |               |       |               |  |  |     |  



---



|    |                                                                                                                                                                            
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Investments in all other issuers were,
    individually, less than $100 million or 2% of the fair
    market value of our marketable debt securities of
    $5,140 million.

Realized gains (before taxes) on marketable debt
securities totaled $114 million, $58 million and
$4 million in fiscal year 2002, 2001 and 2000,
respectively. There were no realized losses in fiscal years
2002, 2001 and 2000. The cost of securities sold was determined
based on the specific identification method.

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At June 30, 2002, the cost and estimated
fair values of short-term and long-term marketable debt
securities (excluding cash equivalents) by contractual maturity
were as follows (in millions):

|                     |  |      |       |            |  |   |       | 
|-------------------- |  | ---- | ----- | ---------- |  | - | ----- | 
|                     |  | Cost |       | Fair Value
|                     |  |      |       |           
|Less than one year   |  | $    | 857   |            |  | $ | 861   | 
|Mature in 1-2 years  |  |      | 938   |            |  |   | 944   | 
|Mature in 2-5 years  |  |      | 1,238 |            |  |   | 1,251 | 
|Mature after 5 years |  |      | 777   |            |  |   | 784   | 
|                     |  |      |       |            |  |   |       | 
|Total                |  | $    | 3,810 |            |  | $ | 3,840 | 
|                     |  |      |       |            |  |   |       | 

Mortgage-backed assets were allocated based on
their contractual maturity.

At June 30, the fair value of Suns
borrowing arrangements and other financial instruments was as
follows (in millions):

|                                                                                                                                  |  |                   |        |                   |  |          |        |            |  |   |        |   |  |   |        |  
|--------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------ | ----------------- |  | -------- | ------ | ---------- |  | - | ------ | - |  | - | ------ | -
|                                                                                                                                  |  |                   |        |                  
|                                                                                                                                  |  | 2002              |        | 2001             
|                                                                                                                                  |  | Asset (Liability) |        | Asset (Liability)
|                                                                                                                                  |  |                   |        |                  
|                                                                                                                                  |  | Carrying          |        |                   |  | Carrying |        |           
|                                                                                                                                  |  | Amount            |        | Fair Value        |  | Amount   |        | Fair Value
|                                                                                                                                  |  |                   |        |                   |  |          |        |           
|Current portion of long-term debt and short-term
    borrowings                                                                   |  | $                 | (205   | )                 |  | $        | (201   | )          |  | $ | (3     | ) |  | $ | (3     | )
|7.0-7.65% Senior Debt                                                                                                             |  |                   | (1,449 | )                 |  |          | (1,339 | )          |  |   | (1,565 | ) |  |   | (1,526 | )
|Forward foreign exchange contracts                                                                                                |  |                   | (24    | )                 |  |          | (24    | )          |  |   | (8     | ) |  |   | (8     | )
|Foreign currency option contracts                                                                                                 |  |                   | 2      |                   |  |          | 2      |            |  |   |       |   |  |   |       |  
|Interest-rate swap agreements (non-current
    portion of $152 million and $69 million in fiscal 2002
    and 2001, respectively) |  |                   | 157    |                   |  |          | 157    |            |  |   | 69     |   |  |   | 69     |  

9.     Derivative
Financial Instruments

On July 1, 2000, we adopted Statement of
Financial Accounting Standards No. 133 (SFAS 133),
Accounting for Derivatives and Hedging Activities
and related pronouncements. SFAS 133 established accounting
and reporting standards for derivative instruments, and requires
that all derivative instruments be recorded on the balance sheet
at fair value.

We have interest rate swaps that are designated
and qualify as fair value hedges. The gains or losses on the
derivative instruments as well as the offsetting gains or losses
on the hedged items attributable to the hedged risk are
recognized in earnings in the current period.

We enter into foreign exchange forward and option
contracts that are designated and qualify as cash flow hedges
under SFAS 133. Changes in the fair value of the effective
portion of these outstanding forward and option contracts are
recognized in Other Comprehensive Income (OCI). These amounts
are reclassified from OCI and recognized in earnings when either
the forecasted transaction occurs or it becomes probable that
the forecasted transaction will not occur. Gains or losses
resulting from changes in forecast probability were not material
during fiscal years 2001 and 2002.

Changes in the ineffective portion of a
derivative instrument are recognized in earnings (classified in
selling, general and administrative expense) in the current
period. Effectiveness for forward cash flow hedge contracts is
measured by comparing the fair value of the forward contract to
the change in the forward value of the anticipated transaction.

In November 2001, we began applying SFAS 133
Implementation Issue G20 (Issue G20), Assessing
and Measuring the Effectiveness of a Purchased Option Used in a
Cash Flow Hedge, which allows an entity to document its
assessment of effectiveness on currency option contracts based
on total possible changes in cash flows (i.e., entire fair
value). Subsequent to this adoption, we have included the
volatility of the option in our effectiveness testing. Under
Issue G20, the fair market value of the hedged exposure is
presumed to be the market value of the hedge instrument when
critical terms match.

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Prior to the application of Issue G20,
effectiveness for option contracts was measured by calculating
the change in the intrinsic value of the derivative instrument
(i.e., the difference between the options exercise price
and its current market price), compared with the change in the
fair value of the underlying anticipated transaction. All
volatility changes were excluded from effectiveness testing and
were immediately recognized in earnings. Ineffectiveness in 2001
and 2002 was not significant.

We do not use derivative financial instruments
for speculative or trading purposes, nor do we hold or issue
leveraged derivative financial instruments.

Foreign Exchange Exposure Management.We have significant international
sales and purchase transactions denominated in foreign
currencies. As a result, we purchase currency option and forward
contracts as cash flow hedges to reduce or eliminate certain
foreign currency exposures that can be identified and
quantified. These contracts generally expire within
12 months.

Our hedging contracts are primarily intended to
protect against changes in the value of the U.S. dollar.
Accordingly, for forecasted transactions, U.S. dollar
functional subsidiaries hedge foreign currency revenues and
non-U.S. dollar functional subsidiaries selling in foreign
currencies hedge U.S. dollar inventory purchases. OCI
associated with hedges of foreign currency sales is reclassified
into revenue upon shipment and OCI related to inventory
purchases is reclassified into cost of sales in the period that
inventory is sold. All values reported in OCI at June 30,
2002 will be reclassified to earnings within 12 months.

We also enter into foreign currency forward
contracts to hedge against changes in the fair value of monetary
assets and liabilities denominated in a non-functional currency.
These derivative instruments are not designated as hedging
instruments; therefore, changes in the fair value of these
contracts are recognized immediately in selling, general and
administrative expense as an offset to the changes in the fair
value of the monetary assets or liabilities being hedged.

Interest Rate Risk Management.We are exposed to interest rate risk
from both investments and debt. We have hedged against the risk
of changes in fair value associated with our fixed rate Senior
Notes (Note 10) by entering into 12 fixed-to-variable
interest rate swap agreements, designated as fair value hedges,
with a total notional amount of $1.5 billion as of
June 30, 2002. We assume no ineffectiveness as each
interest rate swap meets the short-cut method requirements under
SFAS 133 for fair value hedges of debt instruments. As a
result, changes in the fair value of the interest rate swaps are
offset by changes in the fair value of the debt, both reported
in interest expense, and no net gain or loss is recognized in
earnings.

Accumulated Derivative Gains or Losses.The following table summarizes
activity in OCI, net of related taxes, related to foreign
exchange derivatives held by Sun during the fiscal year ended
June 30, 2002 (in millions):

|                                                                             |               |      |     |      |   |   |     |     |  
|---------------------------------------------------------------------------- | ------------- | ---- | --- | ---- | - | - | --- | --- | -
|                                                                             |               | 2002 |     | 2001
|                                                                             |               |      |     |     
|Unrealized gain, net, on derivative instruments,
    at beginning of period  |               | $    | 15  |      |   | $ |    |    
|Increase (decrease) in fair value of
    derivatives, net of taxes           |               |      | (66 | )    |   |   | 106 |    
|(Gains)/ losses reclassified from OCI:                                       |               |      |     |      |   |   |     |    
|                                                                             | Revenues      |      |     | 23   |   |   |     | (63 | )
|                                                                             | Cost of sales |      |     | (3   | ) |   |     | (28 | )
|                                                                             |               |      |     |      |   |   |     |    
|Unrealized gain (loss), net, on derivative
    instruments, at end of period |               | $    | (31 | )    |   | $ | 15  |    
|                                                                             |               |      |     |      |   |   |     |    

10.     Borrowing
Arrangements

In August 1997, we negotiated a $500 million
unsecured revolving Credit Agreement with an international group
of 20 banks. Any borrowings under this agreement bear interest
at a floating rate based on prime, certificate of deposit, or
Eurodollar rates, at our option. Under the agreement, we are
required to maintain various financial ratios. The agreement
expired on August 28, 2002.

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At June 30, 2002 and 2001, Sun and its
subsidiaries had uncommitted lines of credit aggregating
approximately $594 million and $590 million,
respectively. No amounts were drawn from these lines of credit
as of June 30, 2002 and 2001. Interest rates and other
terms of borrowing under these lines of credit vary from country
to country depending on local market conditions at the time of
borrowing. There is no guarantee that the banks would approve
our request for funds under these uncommitted lines of credit.

In August 1999, we issued $1.5 billion of
unsecured senior debt securities in four tranches (the
Senior Notes). The Senior Notes consist of the
following notes: $200 million (due and paid by
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 is payable semi-annually. We 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 in addition to an amount determined by a quotation
agent, representing the present value of the remaining scheduled
payments. As discussed in Note 9, we also entered into various
interest-rate swap agreements to modify the interest
characteristics of the Senior Notes so that the interest
associated with the Senior Notes effectively becomes variable.
In addition, we currently have effective shelf registration
statements on file with the Securities and Exchange Commission
that permit us to offer an additional $2.5 billion of debt
securities and common and preferred stock in one or more
separate series, in amounts, at prices, and on terms to be set
forth in the prospectus contained in these registration
statements and in one or more supplements to the prospectus.
However, there is no guarantee that we will be able to raise
money under these shelf registration statements.

Interest expense on Suns borrowings was
$58 million in fiscal 2002, $100 million in fiscal
2001, and $84 million in fiscal 2000.

11.     Income
taxes

Income tax expense is based on pretax financial
accounting income. Deferred tax assets and liabilities are
determined based on the difference between the US GAAP
financial statements and tax basis of assets and liabilities
using enacted tax rates in effect for the year in which the
differences are expected to reverse.

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In the years ended June 30, income (loss)
before income taxes and the provision (benefit) for income taxes
consisted of the following (in millions):

|                                      |                       |                                         |      |        |        |      |     |       |       |   |     |       |       |  
|------------------------------------- | --------------------- | --------------------------------------- | ---- | ------ | ------ | ---- | --- | ----- | ----- | - | --- | ----- | ----- | -
|                                      |                       | 2002                                    |      | 2001   |        | 2000
|                                      |                       |                                         |      |        |        |     
|Income (loss) before income taxes:    |                       |                                         |      |        |        |      |     |       |       |   |     |      
|                                      | United States         |                                         | $    | (1,078 | )      |      | $   | 388   |       |   | $   | 1,647 |      
|                                      | Foreign               |                                         |      | 30     |        |      |     | 1,196 |       |   |     | 1,124 |      
|                                      |                       |                                         |      |        |        |      |     |       |       |   |     |      
|                                      |                       | Total income (loss) before income taxes |      | $      | (1,048 | )    |     | $     | 1,584 |   |     | $     | 2,771 |  
|                                      |                       |                                         |      |        |        |      |     |       |       |   |     |      
|Provision (benefit) for income taxes: |                       |                                         |      |        |        |      |     |       |       |   |     |      
|Current                               |                       |                                         |      |        |        |      |     |       |       |   |     |      
|                                      | United States federal |                                         | $    | 81     |        |      | $   | 438   |       |   | $   | 684   |      
|                                      | State                 |                                         |      | 5      |        |      |     | 56    |       |   |     | 85    |      
|                                      | Foreign               |                                         |      | 126    |        |      |     | 295   |       |   |     | 234   |      
|                                      |                       |                                         |      |        |        |      |     |       |       |   |     |      
|                                      |                       | Total current income taxes              |      |        | 212    |      |     |       | 789   |   |     |       | 1,003 |  
|                                      |                       |                                         |      |        |        |      |     |       |       |   |     |      
|Deferred:                             |                       |                                         |      |        |        |      |     |       |       |   |     |      
|                                      | United States federal |                                         |      | (529   | )      |      |     | (204  | )     |   |     | (20   | )    
|                                      | State                 |                                         |      | (137   | )      |      |     | 7     |       |   |     | 12    |      
|                                      | Foreign               |                                         |      | (7     | )      |      |     | 11    |       |   |     | (78   | )    
|                                      |                       |                                         |      |        |        |      |     |       |       |   |     |      
|                                      |                       | Total deferred income taxes             |      |        | (673   | )    |     |       | (186  | ) |     |       | (86   | )
|                                      |                       |                                         |      |        |        |      |     |       |       |   |     |      
|Provision (benefit) for income taxes  |                       | $                                       | (461 | )      |        | $    | 603 |       |       | $ | 917 |      
|                                      |                       |                                         |      |        |        |      |     |       |       |   |     |      

Deferred income taxes reflect the net tax effects
of temporary differences between the carrying amounts of assets
and liabilities for financial reporting purposes and the amount
used for income tax purposes.

Significant components of our deferred tax
liabilities and assets, at June 30, were as follows (in
millions):

|                               |                                           |      |       |      |   |   |      |      |  
|------------------------------ | ----------------------------------------- | ---- | ----- | ---- | - | - | ---- | ---- | -
|                               |                                           | 2002 |       | 2001
|                               |                                           |      |       |     
|Deferred tax assets:           |                                           |      |       |      |   |   |      |     
|                               | Inventory valuation                       |      | $     | 133  |   |   | $    | 91   |  
|                               | Reserves and other accrued expenses       |      |       | 364  |   |   |      | 328  |  
|                               | Compensation not currently deductible     |      |       | 82   |   |   |      | 78   |  
|                               | State net operating loss carryforwards    |      |       | 51   |   |   |      |     |  
|                               | Deferred revenue                          |      |       | 5    |   |   |      | 35   |  
|                               | Tax credits carryforward                  |      |       | 462  |   |   |      | 230  |  
|                               | Investment impairments                    |      |       | 77   |   |   |      | 43   |  
|                               | Restructuring reserves                    |      |       | 141  |   |   |      |     |  
|                               | Other                                     |      |       | 249  |   |   |      | 129  |  
|                               |                                           |      |       |      |   |   |      |     
|Gross deferred tax assets      |                                           |      | 1,564 |      |   |   | 934  |     
|                               |                                           |      |       |      |   |   |      |     
|Deferred tax liabilities:      |                                           |      |       |      |   |   |      |     
|                               | Net undistributed profits of subsidiaries |      |       | (129 | ) |   |      | (130 | )
|                               | Unrealized gain on investments            |      |       | (6   | ) |   |      | (22  | )
|                               | Acquisition-related intangibles           |      |       | (72  | ) |   |      | (99  | )
|                               | Other                                     |      |       | (38  | ) |   |      | (30  | )
|                               |                                           |      |       |      |   |   |      |     
|Gross deferred tax liabilities |                                           |      | (245  | )    |   |   | (281 | )   
|                               |                                           |      |       |      |   |   |      |     
|Net deferred tax assets        |                                           | $    | 1,319 |      |   | $ | 653  |     
|                               |                                           |      |       |      |   |   |      |     

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The provision for income taxes differs from the
amount computed by applying the statutory federal income tax
rate to income before income taxes. The sources and tax effects
of the difference, for fiscal years ended June 30, were as
follows (in millions):

|                                                                  |  |      |      |      |  |      |     |   |  |   |      |  
|----------------------------------------------------------------- |  | ---- | ---- | ---- |  | ---- | --- | - |  | - | ---- | -
|                                                                  |  | 2002 |      | 2001 |  | 2000
|                                                                  |  |      |      |      |  |     
|Expected tax rate at 35%                                          |  | $    | (366 | )    |  | $    | 554 |   |  | $ | 970  |  
|State income taxes, net of federal tax benefit                    |  |      | (87  | )    |  |      | 41  |   |  |   | 63   |  
|Foreign earnings permanently reinvested in
    foreign operations |  |      | 39   |      |  |      | (80 | ) |  |   | (118 | )
|Goodwill amortization                                             |  |      |     |      |  |      | 96  |   |  |   | 26   |  
|Acquired in-process research and development                      |  |      |     |      |  |      | 27  |   |  |   | 3    |  
|R&D credit                                                        |  |      | (53  | )    |  |      | (42 | ) |  |   | (23  | )
|Other                                                             |  |      | 6    |      |  |      | 7   |   |  |   | (4   | )
|                                                                  |  |      |      |      |  |      |     |   |  |   |      |  
|Provision for income taxes                                        |  | $    | (461 | )    |  | $    | 603 |   |  | $ | 917  |  
|                                                                  |  |      |      |      |  |      |     |   |  |   |      |  

As of June 30, 2002, Sun had unrecognized
deferred tax liabilities of approximately $451 million
related to approximately $1,463 million of cumulative net
undistributed earnings of foreign subsidiaries. These earnings
are considered to be permanently invested in operations outside
the United States.

As of June 30, 2002, Sun had aggregate state
net operating loss carryforwards of $1,458 million. If not
utilized, these carryforwards will expire in fiscal years 2006
through 2021.

As of June 30, 2002, Sun had aggregate
foreign net operating loss carryforwards of $93 million. If
not utilized, these carryforwards will expire in fiscal years
2005 through 2012.

As of June 30, 2002, Sun had federal and
state tax credit carryforwards for income tax purposes of
$324 million and $213 million, respectively. If not
utilized, the federal credits will expire in fiscal years 2006
through 2022. State tax credit carryforwards of
$46 million, if unused, will expire in fiscal years 2009
and 2010. The remaining state tax credit carryforwards of
$167 million have an indefinite life.

We believe it is more likely than not that all
deferred tax assets will be realized in the foreseeable future.
Realization of our net deferred tax assets is dependent upon our
generation of sufficient taxable income in future years in
appropriate tax jurisdictions to obtain benefit from the
reversal of temporary differences, net operating loss
carryfowards, and from tax credit carryforwards. The amount of
deferred tax assets considered realizable is subject to
adjustment in future periods if estimates of future taxable
income are reduced.

The federal and state provisions do not reflect
the tax savings resulting from deductions associated with our
various stock option plans. These savings were $98 million,
$816 million, and $708 million in fiscal 2002, 2001,
and 2000, respectively.

The Internal Revenue Service completed its
examination of fiscal years ended June 30, 1995 and 1996 in
fiscal 2002. The results of the examination are included in
fiscal 2002 financial statements and did not have a material
impact upon them.

Our United States income tax returns for fiscal
years ended June 30, 1997 through June 30, 2000 are
currently under examination and the Internal Revenue Service has
proposed certain adjustments. We believe that adequate amounts
have been provided for any adjustments that may ultimately
result from these examinations.

12.     Commitments
and Contingencies

We lease certain facilities and equipment under
noncancelable operating leases. During fiscal 2002 and 2001, we
elected to exit certain building leases and building projects,
but still have obligations on these particular facilities. See
Note 6 for further discussion.

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At June 30, 2002, the future minimum annual
lease payments were approximately:

|            |  |                     |       | 
|----------- |  | ------------------- | ----- | 
|            |  | Total Noncancelable
|            |  | Operating Leases   
|            |  |                    
|Fiscal 2003 |  | $                   | 282   | 
|Fiscal 2004 |  |                     | 249   | 
|Fiscal 2005 |  |                     | 203   | 
|Fiscal 2006 |  |                     | 170   | 
|Fiscal 2007 |  |                     | 141   | 
|Thereafter  |  |                     | 505   | 
|            |  |                     |       | 
|            |  | $                   | 1,550 | 
|            |  |                     |       | 

Rent expense under the noncancelable operating
leases was $269 million in 2002, $261 million in 2001,
and $187 million in 2000.

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

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

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

13.     Stockholders
Equity

Stockholders Rights Plan

We have adopted a share purchase rights plan to
protect stockholders rights in the event of a proposed
takeover not approved by our Board of Directors. Under the plan,
a preferred share purchase right (a Right) is
associated with each share of our common stock (a Common
Share). Upon becoming exercisable, each Right will entitle
its holder to purchase 1/10,000th of a share of Series A
participating preferred stock of Sun, a designated series of
preferred stock for which each 1/10,000th of a share has
economic attributes and voting rights equivalent to one Common
Share at an exercise price of $250, subject to adjustment. The
Rights are not exercisable or transferable apart from the Common
Shares until the earlier of (1) the tenth day or a later
date as determined by the Board after a public announcement that
a person or group (an Acquiring Person) has acquired
or obtained the right to acquire 10% or more (20% or more for an
Acquiring Person who has filed a Schedule 13G in accordance
with the Securities Act of 1934 a 13G Filer) of
our outstanding Common Shares or (2) the tenth business day
(or a later date as determined by the Board) after a person or
group publicly announces a tender or exchange offer for 10% or
more of the outstanding Common Shares. Unless the Rights are
redeemed, for example, in the event that an Acquiring Person
acquires 10% or more (20% or more if the Acquiring Person is a
13G Filer) of our outstanding Common Shares, each Right not
held by the Acquiring Person will entitle the holder to purchase
for the exercise price that number of our Common Shares having
market value equal to two times the exercise price. In the event
that; (1) Sun is acquired in a merger or business
combination in which we are not the surviving corporation or in
which the Common Shares are exchanged for stock or assets of
another entity; or (2) 50% or more of our consolidated
assets or earning power is sold, each Right not held by an
Acquiring Person will entitle the holder to purchase for the
exercise price that number of shares of common stock of the
acquiring company having a market value equal to two times the
exercise price. The Rights are redeemable, in whole but not in
part, at Suns option, at $0.00125 per Right at any time on
or before the fifth day (or such later day as determined by the
Board) after an acquiring person has acquired or obtained the
right to acquire 10% or more (20% or more if the Acquiring
Person is a 13G Filer of our outstanding Common Shares. Sun
may, as its option, at any time after an Acquiring Person has
acquired or obtained the right to acquire 10% or more (20% or
more if the Acquiring Person is a 13G Filer) of our Common
Shares but before such Acquiring Person acquires or obtains the
right to acquire 50% or more of our Common Shares, exchange each
Right (other than Rights held by an Acquiring Person) for one
Common Share. The Rights expire on July 25, 2012.

Common stock repurchase programs

In December 1990, the Board of Directors approved
a systematic common stock repurchase program related to the 1990
Employee Stock Purchase Plan. In fiscal 2002, Sun repurchased
2 million shares at a cost of

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approximately $37 million under this
program, as compared with 7 million shares at a cost of
approximately $198 million in 2001 and 5 million
shares at a cost of approximately $126 million in 2000.


In August 1996, the Board of Directors approved a
systematic common stock repurchase program related to the 1990
Long-Term Equity Incentive Plan. In June 1999, the Board renewed
this repurchase plan for an additional three years. In fiscal
2002, we repurchased 50 million shares at a cost of
approximately $407 million under this program, as compared
with 18 million shares at a cost of approximately
$501 million in 2001 and 18 million shares at a cost
of approximately $505 million in 2000. This Plan expired in
June 2002.

In February 2001, the Board of Directors
authorized a new opportunistic stock repurchase program to
acquire shares in the open market at any time. In fiscal 2002,
we repurchased 12 million shares at a cost of approximately
$148 million under this program, as compared with
34 million shares at a cost of approximately
$622 million in 2001.

When treasury shares are reissued, any excess
proceeds over the average acquisition cost of the shares are
recorded as additional paid-in-capital. Any excess of the
average acquisition cost of the shares over the proceeds from
reissuance is charged to additional paid-in-capital to the
extent of previous credits on similar transactions, with any
remaining amounts charged to retained earnings.

14.     Employee
Benefit Plans

Stock option and incentive plans

Suns 1990 Long-Term Equity Incentive Plan
and 1986 Equity Compensation Acquisition Plan provide the Board
of Directors broad discretion in creating employee equity
incentives. These plans authorize the grant of incentive stock
options, in the case of the 1990 Incentive Plan, and
non-statutory stock options, in the case of both plans, as well
as certain other awards. In addition, these plans provide for
issuance of non-statutory stock options to eligible employees to
purchase common stock, at or below fair market value, at the
date of grant, subject to certain limitations set forth in the
plans. Options expire up to ten years from the date of grant or
up to three months following termination of employment,
whichever occurs earlier, and are exercisable at specified times
prior to such expiration. Under the plans, common stock may also
be issued pursuant to stock purchase agreements that grant Sun
certain rights to repurchase the shares at their original issue
price in the event that the employment of the employee is
terminated prior to certain pre-determined vesting dates. In
addition, shares of common stock may be sold at less than fair
market value, which results in compensation expense equal to the
difference between the market value on the date of grant and the
purchase price. This expense is recognized over the vesting
period of the shares. Suns 1988 Directors Stock
Option Plan provides for the automatic grant of stock options to
non-employee directors on the date such person initially becomes
a director, and on the date of each annual meeting of
stockholders to directors who are elected and who have served as
a member of our board of directors for at least six months.
These options are granted at fair market value on the date of
grant, expire five years from the date of grant or three months
following termination of service on the Board, whichever occurs
earlier, and are exercisable at specified times prior to such
expiration.

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Information with respect to stock option and
stock purchase rights activity is as follows (in millions,
except per share amounts):

|                           |  |           |      |                     |  |                |     |   |  |   |       | 
|-------------------------- |  | --------- | ---- | ------------------- |  | -------------- | --- | - |  | - | ----- | 
|                           |  |           |      |                    
|                           |  |           |      | Outstanding Options
|                           |  | Shares    |      |                    
|                           |  | Available |      |                     |  | Weighted      
|                           |  | for       |      | Number of           |  | Average       
|                           |  | Grant     |      | Shares              |  | Exercise Price
|                           |  |           |      |                     |  |               
|Balance at June 30, 1999   |  |           | 293  |                     |  |                | 417 |   |  | $ | 4.49  | 
|Additional shares reserved |  |           | 167  |                     |  |                |    |   |  |   |      | 
|Grants and assumptions     |  |           | (132 | )                   |  |                | 132 |   |  |   | 32.82 | 
|Exercises                  |  |           |     |                     |  |                | (70 | ) |  |   | 2.48  | 
|Cancellations              |  |           | 22   |                     |  |                | (22 | ) |  |   | 8.94  | 
|                           |  |           |      |                     |  |                |     |   |  |   |       | 
|Balance at June 30, 2000   |  |           | 350  |                     |  |                | 457 |   |  |   | 12.79 | 
|Additional shares reserved |  |           | 34   |                     |  |                |    |   |  |   |      | 
|Grants and assumptions     |  |           | (124 | )                   |  |                | 124 |   |  |   | 27.03 | 
|Exercises                  |  |           |     |                     |  |                | (63 | ) |  |   | 3.20  | 
|Cancellations              |  |           | 18   |                     |  |                | (18 | ) |  |   | 18.91 | 
|                           |  |           |      |                     |  |                |     |   |  |   |       | 
|Balance at June 30, 2001   |  |           | 278  |                     |  |                | 500 |   |  |   | 17.31 | 
|Additional shares reserved |  |           | 50   |                     |  |                |    |   |  |   |      | 
|Grants and assumptions     |  |           | (119 | )                   |  |                | 119 |   |  |   | 9.18  | 
|Exercises                  |  |           |     |                     |  |                | (28 | ) |  |   | 2.80  | 
|Cancellations              |  |           | 35   |                     |  |                | (35 | ) |  |   | 23.93 | 
|                           |  |           |      |                     |  |                |     |   |  |   |       | 
|Balance at June 30, 2002   |  |           | 244  |                     |  |                | 556 |   |  | $ | 15.86 | 
|                           |  |           |      |                     |  |                |     |   |  |   |       | 

The following table summarizes significant ranges
of outstanding and exercisable options at June 30, 2002
(shares and aggregate intrinsic value in millions):

|                         |  |                     |     |                     |  |          |     |           |  |           |       |          |  |          |     |           |  |           |       |  |  |  |     |  |  |   |       |  |  |   |     |  |  |  |      | 
|------------------------ |  | ------------------- | --- | ------------------- |  | -------- | --- | --------- |  | --------- | ----- | -------- |  | -------- | --- | --------- |  | --------- | ----- |  |  |  | --- |  |  | - | ----- |  |  | - | --- |  |  |  | ---- | 
|                         |  |                     |     |                    
|                         |  | Outstanding Options |     | Options Exercisable
|                         |  |                     |     |                    
|                         |  |                     |     | Weighted            |  |          |     |          
|                         |  |                     |     | Average             |  | Weighted |     |           |  |           |       | Weighted |  |         
|                         |  |                     |     | Remaining           |  | Average  |     | Aggregate |  |           |       |          |  | Average  |     | Aggregate |  |          
|                         |  |                     |     | Life                |  | Exercise |     | Intrinsic |  | Potential |       |          |  | Exercise |     | Intrinsic |  | Potential
|Range of Exercise Prices |  | Shares              |     | in Years            |  | Price    |     | Value     |  | Dilution  |       | Shares   |  | Price    |     | Value     |  | Dilution 
|                         |  |                     |     |                     |  |          |     |           |  |           |       |          |  |          |     |           |  |          
|$0.01 - $3.50            |  |                     | 91  |                     |  |          | 2.3 |           |  | $         | 2.34  |          |  | $        | 243 |           |  |           | 2.8%  |  |  |  | 90  |  |  | $ | 2.33  |  |  | $ | 240 |  |  |  | 2.8% | 
|$3.51 - $5.01            |  |                     | 27  |                     |  |          | 3.5 |           |  |           | 4.06  |          |  |          | 26  |           |  |           | 0.8%  |  |  |  | 24  |  |  |   | 4.03  |  |  |   | 23  |  |  |  | 0.7% | 
|$5.02 - $10.00           |  |                     | 175 |                     |  |          | 6.1 |           |  |           | 7.32  |          |  |          |    |           |  |           | 5.4%  |  |  |  | 54  |  |  |   | 5.70  |  |  |   |    |  |  |  | 1.7% | 
|$10.01 - $15.00          |  |                     | 56  |                     |  |          | 6.0 |           |  |           | 12.63 |          |  |          |    |           |  |           | 1.7%  |  |  |  | 21  |  |  |   | 12.71 |  |  |   |    |  |  |  | 0.7% | 
|$15.01 - $20.00          |  |                     | 96  |                     |  |          | 6.5 |           |  |           | 17.96 |          |  |          |    |           |  |           | 3.0%  |  |  |  | 24  |  |  |   | 17.75 |  |  |   |    |  |  |  | 0.7% | 
|$20.01 - $40.00          |  |                     | 59  |                     |  |          | 6.0 |           |  |           | 37.37 |          |  |          |    |           |  |           | 1.8%  |  |  |  | 23  |  |  |   | 37.55 |  |  |   |    |  |  |  | 0.7% | 
|$40.00 - $108.30         |  |                     | 52  |                     |  |          | 6.1 |           |  |           | 49.90 |          |  |          |    |           |  |           | 1.6%  |  |  |  | 15  |  |  |   | 48.61 |  |  |   |    |  |  |  | 0.5% | 
|                         |  |                     |     |                     |  |          |     |           |  |           |       |          |  |          |     |           |  |           |       |  |  |  |     |  |  |   |       |  |  |   |     |  |  |  |      | 
|                         |  |                     | 556 |                     |  |          | 5.4 |           |  | $         | 15.86 |          |  | $        | 269 |           |  |           | 17.1% |  |  |  | 251 |  |  | $ | 11.61 |  |  | $ | 263 |  |  |  | 7.8% | 
|                         |  |                     |     |                     |  |          |     |           |  |           |       |          |  |          |     |           |  |           |       |  |  |  |     |  |  |   |       |  |  |   |     |  |  |  |      | 

The aggregate intrinsic value in the table above
represents the total pretax intrinsic value (i.e., the
difference between Suns closing stock price of $5.01 at
June 30, 2002, and the exercise price, times the number of
shares) that would have been received by the option holder had
all option holders exercised their options on June 30,
2002. This amount changes based on the fair market value of
Suns stock.

At June 30, 2001, options to purchase
195 million shares were exercisable at a weighted average
exercise price of $7.62 (at June 30, 2000, options to
purchase 159 million shares were exercisable at a weighted
average exercise price of $3.21). At June 30, 2002, Sun
retained repurchase rights to 1.4 million shares issued
pursuant to stock purchase agreements and other stock plans at a
weighted average price of approximately $0.01.

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Potential dilution is computed by dividing the
options in the related range of exercise prices by the shares of
common stock issued, adjusted by treasury stock, as of
June 30, 2002 (3,234 million shares).

The 556 million options outstanding will
vest as follows (in millions):

|                  |  |                |     |      |  |      |    |      |  |      |    |      |  |       |    |  |  |  |    |  |  |  |    |  |  |  |     | 
|----------------- |  | -------------- | --- | ---- |  | ---- | -- | ---- |  | ---- | -- | ---- |  | ----- | -- |  |  |  | -- |  |  |  | -- |  |  |  | --- | 
|                  |  | 2002 and prior |     | 2003 |  | 2004 |    | 2005 |  | 2006 |    | 2007 |  | Total
|                  |  |                |     |      |  |      |    |      |  |      |    |      |  |      
|Number of Options |  |                | 251 |      |  |      | 97 |      |  |      | 79 |      |  |       | 65 |  |  |  | 42 |  |  |  | 22 |  |  |  | 556 | 
|                  |  |                |     |      |  |      |    |      |  |      |    |      |  |       |    |  |  |  |    |  |  |  |    |  |  |  |     | 

As of June 30, 2002, Sun had approximately
800 million shares of common stock reserved for future
issuance under its stock plans.

Employee stock purchase plan

To provide employees with an opportunity to
purchase Sun common stock through payroll deductions, Sun
established the 1990 Employee Stock Purchase Plan (ESPP). Under
the ESPP, Sun employees, subject to certain restrictions, may
purchase shares of common stock at 85% of the fair market value
at either the date of enrollment or the date of purchase,
whichever is less. Sun issued approximately 20.7 million,
10.2 million, and 10.1 million shares of common stock
in fiscal 2002, 2001, and 2000, respectively, under the ESPP. At
June 30, 2002, approximately 94.8 million shares
remained available for future issuance.

Employee 401(k) plan

Sun has a 401(k) plan known as the Sun
Microsystems, Inc. Tax Deferred Retirement Savings Plan (Plan).
The Plan is available to all regular employees on Suns
U.S. Payroll and provides employees with tax deferred
salary deductions and alternative investment options. The Plan
does not provide employees with the option to invest in
Suns common stock. Employees may contribute up to 16% of
their salary, subject to certain limitations. Sun matches
employees contributions to the Plan at a maximum of 4% of
eligible compensation up to the annual maximum of $6,800. We
expensed $83 million, $93 million, and
$71 million in the fiscal years ended June 30, 2002,
2001, and 2000, respectively, for our contributions to the Plan.
Suns contributions to the Plan vest 100% upon contribution.

Stock-based compensation

SFAS No. 123, Accounting for
Stock-Based Compensation, permits companies to measure
compensation cost of stock-based awards based on their estimated
fair value at the date of grant and recognize that amount over
the related service period. We believe the existing stock option
valuation models do not necessarily provide a reliable
transparent measure of the fair value of stock-based awards.
Therefore, as permitted, we apply the existing accounting rules
under APB 25 and provide pro forma net income and pro forma
net income per common share disclosures for stock-based awards
made during the year as if the fair-value-based method defined
in SFAS 123 had been applied.

The fair value of the following stock-based
awards was estimated using the Black-Scholes model with the
following weighted-average assumptions for fiscal years ended
June 30:

|                         |  |         |       |                              |  |      |       |      |  |      |       |      |  |  |       |   |  |  |       |   |  |  |       |  
|------------------------ |  | ------- | ----- | ---------------------------- |  | ---- | ----- | ---- |  | ---- | ----- | ---- |  |  | ----- | - |  |  | ----- | - |  |  | ----- | -
|                         |  |         |       |                             
|                         |  | Options |       | Employee Stock Purchase Plan
|                         |  |         |       |                             
|                         |  | 2002    |       | 2001                         |  | 2000 |       | 2002 |  | 2001 |       | 2000
|                         |  |         |       |                              |  |      |       |      |  |      |       |     
|Expected life (in years) |  |         | 6.8   |                              |  |      | 5.8   |      |  |      | 5.8   |      |  |  | 0.5   |   |  |  | 0.5   |   |  |  | 0.5   |  
|Interest rate            |  |         | 4.53  | %                            |  |      | 5.16  | %    |  |      | 5.96  | %    |  |  | 2.66  | % |  |  | 6.31  | % |  |  | 4.75  | %
|Volatility               |  |         | 63.08 | %                            |  |      | 61.41 | %    |  |      | 52.05 | %    |  |  | 66.87 | % |  |  | 93.82 | % |  |  | 53.03 | %
|Dividend yield           |  |         |      |                              |  |      |      |      |  |      |      |      |  |  |      |   |  |  |      |   |  |  |      |  

The estimated weighted-average fair value at the
grant date for options granted under Suns various stock
option plans during fiscal years 2002, 2001, and 2000 was $5.92,
$18.27, and $19.55 per option, respectively. The estimated
weighted-average fair value at the date of grant for options
granted under the Employee Stock Purchase Plan during fiscal
years 2002, 2001 and 2000 was $4.37, $2.73, and $6.37 per
option, respectively.

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If the fair values of the options granted during
a fiscal year had been recognized as compensation expense on a
straight-line basis over the vesting period of the grant,
stock-based compensation costs would have impacted our pretax
income (loss), after tax income (loss) and earnings per
common share for the fiscal years ended at June 30, as
follows (in millions, except per share amounts):

|                                                                                                             |  |      |        |      |  |      |       |   |  |   |       |  
|------------------------------------------------------------------------------------------------------------ |  | ---- | ------ | ---- |  | ---- | ----- | - |  | - | ----- | -
|                                                                                                             |  | 2002 |        | 2001 |  | 2000
|                                                                                                             |  |      |        |      |  |     
|Pro forma net income (loss):                                                                                 |  |      |        |      |  |      |       |   |  |   |       |  
|Net income (loss) after tax                                                                                  |  |      | (587   | )    |  |      | 927   |   |  |   | 1,854 |  
|Stock-based compensation costs (net of tax
    expense of $423, $263 and $156, respectively) under SFAS 123. |  |      | (647   | )    |  |      | (533  | ) |  |   | (317  | )
|                                                                                                             |  |      |        |      |  |      |       |   |  |   |       |  
|Pro forma net income (loss) after tax                                                                        |  | $    | (1,234 | )    |  | $    | 394   |   |  | $ | 1,537 |  
|                                                                                                             |  |      |        |      |  |      |       |   |  |   |       |  
|Pro forma basic net income (loss) per common
    share:                                                      |  |      |        |      |  |      |       |   |  |   |       |  
|Pro forma shares used in the calculation of pro
    forma net income (loss) per common share-basic           |  |      | 3,242  |      |  |      | 3,234 |   |  |   | 3,151 |  
|Pro forma net income (loss) per common
    share-basic                                                       |  | $    | (0.38  | )    |  | $    | 0.12  |   |  | $ | 0.49  |  
|Reported net income (loss) per common
    share-basic                                                        |  | $    | (0.18  | )    |  | $    | 0.28  |   |  | $ | 0.59  |  
|Pro forma diluted net income (loss) per
    common share:                                                    |  |      |        |      |  |      |       |   |  |   |       |  
|Pro forma shares used in the calculation of pro
    forma net income (loss) per common share-diluted         |  |      | 3,242  |      |  |      | 3,327 |   |  |   | 3,332 |  
|Pro forma net income (loss) per common
    share-diluted                                                     |  | $    | (0.38  | )    |  | $    | 0.12  |   |  | $ | 0.46  |  
|Reported net income (loss) per common
    share-diluted                                                      |  | $    | (0.18  | )    |  | $    | 0.27  |   |  | $ | 0.55  |  

15.     Industry
Segment, Geographic, and Customer Information

Sun designs, manufactures, markets, and services
network computing systems and software solutions that feature
networked desktops and servers. We are organized by various
product groups. Each product group has an executive vice
president who reports to the President of Sun. The President of
Sun has been identified as the Chief Operating Decision Maker
(CODM) as defined by SFAS 131, Disclosures About
Segments of an Enterprise and Related Information. The
CODM allocates resources to each of the product groups using
information regarding their respective revenues and operating
income.

The following product groups are the only
reportable segments under the criteria of SFAS 131:
(1) Computer Systems and Network Storage,
(2) Enterprise Services and (3) iPlanet. Products in
the Computer Systems and Network Storage segment include a broad
range of desktop systems, servers, storage, and network
switches, incorporating the UltraSPARC processors and Solaris
Operating Environment. The iPlanet segment includes products
that enable enterprises to leverage their information and
applications into services offered on intranets and on the
Internet. In the Enterprise Services segment, we provide a full
range of services and support to existing and new customers,
including professional services, systems integration, and
education. Total assets of these three reportable
segments are primarily comprised of property, plant and
equipment, other current assets (such as prepaid expenses) and
intangible assets related to the acquisition of companies that
were incorporated into their groups. Whenever a reorganization
occurred, historical balance sheet amounts were reclassified to
conform with current balance sheet classifications wherever
practical.

Effective July 1, 2000, Sun consolidated its
sales and manufacturing functions into organizations known as
Global Sales Operations (GSO) and Worldwide Operations (WWOPS).
GSO manages most of Suns field sales organizations and all
field marketing organizations. Sales generated through the sales
and marketing efforts of GSO are recorded as revenues by the
various product groups. Operating expenses (primarily sales and
marketing) related to the GSO are not allocated to the product
groups and, accordingly, are included under the Other segment.
WWOPS manages all operations, supply chain and purchasing
functions. WWOPS manufacturing costs are allocated as cost of
sales to the various product groups. GSO and WWOPS manage the
majority of Suns accounts receivable and inventory,
respectively, and as such these amounts are reflected under the
Other segment reported below.

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The following table presents revenues,
interdivision revenues, operating income (loss) and total assets
for our segments for the three years ended June 30, 2002.
The Other segment consists of certain operating product groups
that did not meet the requirements for a reportable segment as
defined by SFAS 131, such as Software Systems Group, and
other miscellaneous functions, such as Corporate and GSO (in
millions):

|                        |  |                  |        |            |  |         |       |       |  |       |      |     |  |   |        |   |  |   |        |  
|----------------------- |  | ---------------- | ------ | ---------- |  | ------- | ----- | ----- |  | ----- | ---- | --- |  | - | ------ | - |  | - | ------ | -
|                        |  | Computer Systems |        |            |  |         |       |       |  |      
|                        |  | and Network      |        | Enterprise |  |         |       |       |  |      
|                        |  | Storage          |        | Services   |  | iPlanet |       | Other |  | Total
|                        |  |                  |        |            |  |         |       |       |  |      
|2002                    |  |                  |        |            |  |         |       |       |  |       |      |     |  |   |        |   |  |   |        |  
|Revenues                |  | $                | 8,574  |            |  | $       | 3,403 |       |  | $     | 254  |     |  | $ | 265    |   |  | $ | 12,496 |  
|Interdivision revenues  |  |                  |       |            |  |         | 481   |       |  |       | 24   |     |  |   | (505   | ) |  |   |       |  
|Operating income (loss) |  |                  | 1,230  |            |  |         | 896   |       |  |       | (314 | ) 1 |  |   | (3,060 | ) |  |   | (1,248 | )
|Total assets            |  |                  | 2,372  |            |  |         | 402   |       |  |       | 174  |     |  |   | 13,574 |   |  |   | 16,522 |  
|2001                    |  |                  |        |            |  |         |       |       |  |       |      |     |  |   |        |   |  |   |        |  
|Revenues                |  |                  | 14,196 |            |  |         | 3,235 |       |  |       | 406  |     |  |   | 413    |   |  |   | 18,250 |  
|Interdivision revenues  |  |                  | 2      |            |  |         | 472   |       |  |       | 23   |     |  |   | (497   | ) |  |   |       |  
|Operating income (loss) |  |                  | 4,289  |            |  |         | 711   |       |  |       | (409 | ) 1 |  |   | (3,280 | ) |  |   | 1,311  |  
|Total assets            |  |                  | 2,452  |            |  |         | 369   |       |  |       | 320  |     |  |   | 15,040 |   |  |   | 18,181 |  
|2000                    |  |                  |        |            |  |         |       |       |  |       |      |     |  |   |        |   |  |   |        |  
|Revenues                |  |                  | 12,841 |            |  |         | 2,300 |       |  |       | 289  |     |  |   | 291    |   |  |   | 15,721 |  
|Interdivision revenues  |  |                  | 2      |            |  |         | 368   |       |  |       | 22   |     |  |   | (392   | ) |  |   |       |  
|Operating income (loss) |  |                  | 4,951  |            |  |         | 472   |       |  |       | (335 | ) 1 |  |   | (2,695 | ) |  |   | 2,393  |  
|Total assets            |  |                  | 1,067  |            |  |         | 340   |       |  |       | 408  |     |  |   | 12,337 |   |  |   | 14,152 |  



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | For fiscal 2002, 2001 and 2000, the iPlanet
    segment operating losses included $221 million,
    $356 million and $247 million, respectively, in costs
    charged to earnings, as a result of the Strategic Alliance with
    AOL, which expired in March 2002. Each of these amounts included
    approximately $56 million in amortization costs for the
    technology license acquired from AOL for approximately
    $278 million. See Note 5.

Effective July 1, 2002, we reorganized the
Company. The effects of the changes to our business organization
will be included in our operating segments disclosure in the
first quarter of fiscal 2003.

Sales to General Electric Company (GE) and
its subsidiaries in the aggregate accounted for approximately
12%, 13% and 19% of our fiscal 2002, 2001 and 2000 net revenues,
respectively. Our Chairman of the Board of Directors, President
and Chief Executive Officer, Scott McNealy, is a member of
GEs Board of Directors. More than 90% of the revenue
attributed to GE was generated through GE subsidiaries
acting as either a reseller or financier of our products. Sales
through MRA Systems, Inc., a master reseller and a GE
subsidiary, consisted of 8%, 10% and 16% of net revenues in
2002, 2001 and 2000, respectively, and sales to GE Capital,
a finance/leasing company and a GE subsidiary, consisted of 2%,
2%, and 3% of net revenues in fiscal 2002, 2001 and 2000,
respectively. As a master reseller, MRA Systems, Inc. acts as a
distributor of our products to resellers who in turn sell those
products to end-users. Revenue is generated from GE Capital
whenever our customers elect to lease equipment through GE
Capital; in such cases, we sell the equipment to GE Capital,
which in turn, leases that equipment to customers. No other
customer accounted for more than 10% of revenues. The revenues
from GE are primarily generated in the Computer Systems and
Network Storage and Enterprise Services segments.

Suns significant operations outside the
United States include manufacturing facilities, design centers,
and sales offices in Europe, Middle East, and Africa (EMEA), as
well as the Asia Pacific (APAC) and Americas-Other (Canada
and Latin America) regions. Intercompany transfers between
operating segments and geographic areas are primarily accounted
for at prices that approximate arms length transactions.
In fiscal

85



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years 2002, 2001, and 2000, sales between
segments are recorded at standard cost. Information regarding
geographic areas at June 30, and for each of the years then
ended, was as follows (in millions):


|                                                                      |  |        |       |            |  |            |     |      |  |      |       |       |  |   |       |  |  |   |       |  |  |   |        | 
|--------------------------------------------------------------------- |  | ------ | ----- | ---------- |  | ---------- | --- | ---- |  | ---- | ----- | ----- |  | - | ----- |  |  | - | ----- |  |  | - | ------ | 
|                                                                      |  | United |       | Americas  |  | Americas  |     |      |  |      |       |      
|                                                                      |  | States |       | Other      |  | Total      |     | EMEA |  | APAC |       | Total
|                                                                      |  |        |       |            |  |            |     |      |  |      |       |      
|2002                                                                  |  |        |       |            |  |            |     |      |  |      |       |       |  |   |       |  |  |   |       |  |  |   |        | 
|Sales to unaffiliated customers                                       |  | $      | 5,812 |            |  | $          | 663 |      |  | $    | 6,475 |       |  | $ | 3,844 |  |  | $ | 2,177 |  |  | $ | 12,496 | 
|Long-lived assets (excluding investments and
    deferred tax assets) |  |        | 4,638 |            |  |            | 34  |      |  |      | 4,672 |       |  |   | 533   |  |  |   | 125   |  |  |   | 5,330  | 
|Net assets                                                            |  |        | 3,315 |            |  |            | 57  |      |  |      | 3,372 |       |  |   | 5,464 |  |  |   | 965   |  |  |   | 9,801  | 
|                                                                     
|2001                                                                  |  |        |       |            |  |            |     |      |  |      |       |       |  |   |       |  |  |   |       |  |  |   |        | 
|Sales to unaffiliated customers                                       |  |        | 8,647 |            |  |            | 955 |      |  |      | 9,602 |       |  |   | 5,515 |  |  |   | 3,133 |  |  |   | 18,250 | 
|Long-lived assets (excluding investments and
    deferred tax assets) |  |        | 4,890 |            |  |            | 36  |      |  |      | 4,926 |       |  |   | 512   |  |  |   | 132   |  |  |   | 5,570  | 
|Net assets                                                            |  |        | 3,446 |            |  |            | 76  |      |  |      | 3,522 |       |  |   | 6,053 |  |  |   | 1,011 |  |  |   | 10,586 | 
|                                                                     
|2000                                                                  |  |        |       |            |  |            |     |      |  |      |       |       |  |   |       |  |  |   |       |  |  |   |        | 
|Sales to unaffiliated customers                                       |  |        | 8,134 |            |  |            | 688 |      |  |      | 8,822 |       |  |   | 4,498 |  |  |   | 2,401 |  |  |   | 15,721 | 
|Long-lived assets (excluding investments and
    deferred tax assets) |  |        | 2,251 |            |  |            | 39  |      |  |      | 2,290 |       |  |   | 384   |  |  |   | 105   |  |  |   | 2,779  | 
|Net assets                                                            |  | $      | 514   |            |  | $          | 57  |      |  | $    | 571   |       |  | $ | 5,754 |  |  | $ | 984   |  |  | $ | 7,309  | 

16.     Quarterly
Financial Data (unaudited)

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

The following tables contain selected unaudited
Consolidated Statement of Operations data for each quarter of
fiscal years 2002 and 2001 (in millions, except per share
amounts).

|                                         |         |                           |       |          |  |             |       |              |   |   |       |       |   |   |       |       |  
|---------------------------------------- | ------- | ------------------------- | ----- | -------- |  | ----------- | ----- | ------------ | - | - | ----- | ----- | - | - | ----- | ----- | -
|                                         |         |                          
|                                         |         | Fiscal 2002 Quarter Ended
|                                         |         |                          
|                                         |         | June 30                   |       | March 31 |  | December 30 |       | September 30
|                                         |         |                           |       |          |  |             |       |             
|Net revenues                             |         | $                         | 3,420 |          |  | $           | 3,107 |              |   | $ | 3,108 |       |   | $ | 2,861 |      
|Gross margin                             |         |                           | 1,414 |          |  |             | 1,307 |              |   |   | 1,139 |       |   |   | 1,056 |      
|Operating income (loss)                  |         |                           | 61    |          |  |             | (148  | )            |   |   | (766  | )     |   |   | (395  | )    
|Net income (loss)                        |         |                           | 61    |          |  |             | (37   | )            |   |   | (431  | )     |   |   | (180  | )    
|Earnings (loss) per common
    share(1): |         |                           |       |          |  |             |       |              |   |   |       |       |   |   |       |      
|                                         | Basic   |                           | $     | 0.02     |  |             | $     | (0.01        | ) |   | $     | (0.13 | ) |   | $     | (0.06 | )
|                                         | Diluted |                           | $     | 0.02     |  |             | $     | (0.01        | ) |   | $     | (0.13 | ) |   | $     | (0.06 | )
|Weighted average shares outstanding:     |         |                           |       |          |  |             |       |              |   |   |       |       |   |   |       |      
|                                         | Basic   |                           |       | 3,245    |  |             |       | 3,245        |   |   |       | 3,239 |   |   |       | 3,240 |  
|                                         | Diluted |                           |       | 3,309    |  |             |       | 3,245        |   |   |       | 3,239 |   |   |       | 3,240 |  

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|                                                                                 |                                                                 |                              |       |         |       |             |       |           |       |   |       |   |       |   |       |   |       | 
|-------------------------------------------------------------------------------- | --------------------------------------------------------------- | ---------------------------- | ----- | ------- | ----- | ----------- | ----- | --------- | ----- | - | ----- | - | ----- | - | ----- | - | ----- | 
|                                                                                 |                                                                 |                             
|                                                                                 |                                                                 | Fiscal 2001 Quarter Ended(2)
|                                                                                 |                                                                 |                             
|                                                                                 |                                                                 | June 30                      |       | April 1 |       | December 31 |       | October 1
|                                                                                 |                                                                 |                              |       |         |       |             |       |          
|Net revenues                                                                     |                                                                 | $                            | 3,995 |         |       | $           | 4,095 |           |       | $ | 5,115 |   |       | $ | 5,045 |  
|Gross margin                                                                     |                                                                 |                              | 1,643 |         |       |             | 1,692 |           |       |   | 2,444 |   |       |   | 2,430 |  
|Operating income (loss)                                                          |                                                                 |                              | (179  | )       |       |             | 152   |           |       |   | 640   |   |       |   | 698   |  
|Net income (loss) before cumulative effect
    of change in accounting principle |                                                                 |                              | (88   | )       |       |             | 136   |           |       |   | 423   |   |       |   | 510   |  
|Net income (loss)                                                                |                                                                 |                              | (88   | )       |       |             | 136   |           |       |   | 423   |   |       |   | 456   |  
|Earnings (loss) per common
    share(1):                                         |                                                                 |                              |       |         |       |             |       |           |       |   |       |   |       |   |       |  
|                                                                                 | Before cumulative effect of change in accounting
    principle: |                              |       |         |       |             |       |           |       |   |       |   |       |   |       |   |      
|                                                                                 |                                                                 | Basic                        |       | $       | (0.03 | )           |       | $         | 0.04  |   |       | $ | 0.13  |   |       | $ | 0.16  | 
|                                                                                 |                                                                 | Diluted                      |       | $       | (0.03 | )           |       | $         | 0.04  |   |       | $ | 0.12  |   |       | $ | 0.15  | 
|                                                                                 | After cumulative effect of change in accounting
    principle:  |                              |       |         |       |             |       |           |       |   |       |   |       |   |       |   |      
|                                                                                 |                                                                 | Basic                        |       | $       | (0.03 | )           |       | $         | 0.04  |   |       | $ | 0.13  |   |       | $ | 0.14  | 
|                                                                                 |                                                                 | Diluted                      |       | $       | (0.03 | )           |       | $         | 0.04  |   |       | $ | 0.12  |   |       | $ | 0.13  | 
|Weighted average shares outstanding:                                             |                                                                 |                              |       |         |       |             |       |           |       |   |       |   |       |   |       |  
|                                                                                 |                                                                 | Basic                        |       |         | 3,248 |             |       |           | 3,256 |   |       |   | 3,229 |   |       |   | 3,204 | 
|                                                                                 |                                                                 | Diluted                      |       |         | 3,248 |             |       |           | 3,417 |   |       |   | 3,430 |   |       |   | 3,436 | 



---



|    |                                                                                                                                                                                                                                                                                                                
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Earnings per common share are computed
    independently for each of the quarters presented. Therefore, the
    sum of the quarterly per common share information may not equal
    the annual earnings per common share.                                                                                      
|   
|(2) | Reflects the adoption of SAB 101 as discussed in
    Note 2. The cumulative effect of this change was
    $54 million, net of taxes. Other than the cumulative
    effect, this accounting change had no material effect on
    Suns previously reported revenue or quarterly earnings
    during fiscal 2001.

17.     Subsequent
Events

Acquisition of Afara Websystems,
Inc.

On July 22, 2002, Sun acquired Afara
Websystems, Inc. (Afara), a corporation located in San Jose,
California, by means of a merger pursuant to which all of the
outstanding shares of capital stock of Afara were exchanged for
the right to receive shares of Suns common stock. In
addition, all outstanding options and warrants to purchase Afara
capital stock were exchanged and converted into options to
purchase shares of Suns common stock. Afara develops
processor technology. The total consideration of approximately
$28 million was comprised of approximately $27 million
in stock and assumed options and $1 million in transaction
costs. This transaction will be accounted for as a purchase of
net assets, not as a business combination under SFAS 141,
and the purchase price will be allocated to acquired assets and
liabilities, including assembled workforce. The amount of
purchase price in excess of the fair values of the acquired
assets and liabilities will be allocated to non-monetary,
non-current assets including the acquired workforce.

Acquisition of Pirus Networks, Inc.
(unaudited)

On September 17, 2002, we entered into an
agreement to acquire Pirus Networks, Inc. (Pirus), a corporation
based in Acton, Massachusetts, in a stock-for-stock merger at a
purchase price of approximately $160 million. Pirus
develops intelligent storage networking systems that enable the
delivery of advanced storage services within multi-protocol
environments from a single, centrally managed platform. This
acquisition will be accounted for as a purchase and is expected
to be completed during our second quarter of fiscal 2003, which
ends December 29, 2002. The closing of the acquisition is
subject to customary closing conditions including Pirus
shareholders approval.

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Report of Ernst & Young LLP, Independent
Auditors

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

We have audited the accompanying consolidated
balance sheets of Sun Microsystems, Inc. as of June 30,
2002 and 2001, and the related consolidated statements of
operations, stockholders equity, and cash flows for each
of the three years in the period ended June 30, 2002. Our
audits also included the financial statement schedule listed in
the Index at Item 14(a). These financial statements and
schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of Sun Microsystems, Inc. at
June 30, 2002 and 2001, and the consolidated results of
their operations and their cash flows for each of the three
years in the period ended June 30, 2002, in conformity with
accounting principles generally accepted in the United States.
Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements
taken as a whole, presents fairly in all material respects the
information set forth therein.

As discussed in Note 2 to the consolidated
financial statements, effective July 1, 2000, the Company
changed their method of accounting for revenue recognition in
accordance with guidance provided in SEC Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial
Statements. Also, as discussed in Note 4 to the
consolidated financial statements, effective July 1, 2001,
the Company adopted Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets.



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

San Jose, California

September 16, 2002


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|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH
    ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.




PART III




ITEM
10.     DIRECTORS AND EXECUTIVE
OFFICERS OF THE REGISTRANT

Information regarding our directors is
incorporated by reference from the information contained under
the caption Proposal  Election of
Directors in our 2002 Proxy Statement for the 2002 Annual
Meeting of Stockholders. Information regarding current executive
officers found under the caption Executive Officers of the
Registrant in Part I hereof is also incorporated by
reference into this Item 10. Information regarding
Section 16 reporting compliance is incorporated by
reference from information contained under the caption
Executive Compensation-Section 16(a) beneficial
ownership reporting compliance in our 2002 Proxy Statement.




ITEM
11.     EXECUTIVE
COMPENSATION

The information required by this item is
incorporated by reference from the information contained under
the captions Proposal 1  Election of
Directors  Director compensation,
Proposal 1  Election of Directors 
Stock option plan for non-employee directors and
Executive Compensation in our 2002 Proxy Statement.






|         |                                                                   
|-------- | ------------------------------------------------------------------
|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
    OWNERS AND MANAGEMENT

The information required by this item is
incorporated by reference from the information contained under
the captions Security Ownership of Certain Beneficial
Owners and Management and
Proposal 2  Amendment to 1990 Long-Term
Equity Incentive Plan  Securities authorized for
issuance under equity compensation plans in our 2002 Proxy
Statement.






|         |                                                   
|-------- | --------------------------------------------------
|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED
    TRANSACTIONS

The information required by this item is
incorporated by reference from the information contained under
the captions Proposal 1  Election of
Directors  Compensation committee interlocks any
insider participation, Executive
Compensation  Summary Compensation Table,
 Executive Officer employment contracts,
 Executive Officer change-in-control
arrangements,  Deferred compensation
arrangements and  Certain transactions
with officers and members of the Board, in our 2002 Proxy
Statement.






|         |                        
|-------- | -----------------------
|ITEM 14. | CONTROLS AND PROCEDURES

Not applicable.




PART IV






|         |                                                                     
|-------- | --------------------------------------------------------------------
|ITEM 15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
    AND REPORTS ON FORM 8-K

(a) The following documents are filed as
part of this report:



| |    |                                                                                                                     
| | -- | --------------------------------------------------------------------------------------------------------------------
| | 1. | Financial Statements: See Index to Consolidated
    Financial Statements under Item 8 on Page 50 of this
    report.
|
| | 2. | Financial Statement schedule: See
    Schedule II on Page 93 of this report.                                        
|
| | 3. | Exhibits: See Index to Exhibits on Pages 94 to 95
    hereof.                                                       

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(b) Reports on Forms 8-K



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | We filed a report on Form 8-K with the
    Securities and Exchange Commission on May 3, 2002,
    announcing: (1) on April 25, 2002, the resignation of
    Michael E. Lehman, Executive Vice President, Corporate
    Resources and Chief Financial Officer and the appointment of
    Stephen T. McGowan as Executive Vice President, Corporate
    Resources and Chief Financial Officer effective as of
    July 1, 2002; and (2) on May 1, 2002, the
    resignation of Edward J. Zander, President and Chief
    Operating Officer, and the appointment of Scott G. McNealy,
    Chairman of the Board and Chief Executive Officer, as Chairman
    of the Board, Chief Executive Officer and President, effective
    July 1, 2002.
|   
|(2) | We filed a report on Form 8-K with the SEC
    on August 9, 2002, disclosing loans made and/or outstanding
    during fiscal year 2002 and fiscal year 2003 to the following
    members of the Board of Directors and Executive Officers,
    including former Executive Officers, of the Company:
    Mark A. Canepa; Eva Sage-Gavin; Masood A. Jabbar;
    Robert L. Long; Jonathan I. Schwartz; and
    Patricia C. Sueltz.                                                                                                                                                                                                                                                                                                           

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SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) 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.

|                   |  |                                       |  |                                                                                                                                                                                  
|------------------ |  | ------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|September 30, 2002 |  | SUN MICROSYSTEMS, INC.
    Registrant
|                   |  | By:                                   |  | /s/ STEPHEN T. MCGOWAN
    ------------------------------------------------
    (Stephen T. McGowan)Chief Financial Officer and Executive
    Vice President, Corporate Resources

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the
capacities and on the dates indicated.

|                                           |  |                                                                                                                 |  |                    |  | 
|------------------------------------------ |  | --------------------------------------------------------------------------------------------------------------- |  | ------------------ |  | 
|                                           |  |                                                                                                                 |  |                   
|Signature                                  |  | Title                                                                                                           |  | Date              
|                                           |  |                                                                                                                 |  |                   
|                                          
|/s/ SCOTT G. MCNEALY(Scott G. McNealy)     |  | Chairman of the Board of Directors, President and
    Chief Executive Officer
    (Principal Executive Officer) |  | September 30, 2002
|                                          
|/s/ STEPHEN T. MCGOWAN(Stephen T. McGowan) |  | Chief Financial Officer and Executive Vice
    President, Corporate Resources
    (Principal Financial Officer) |  | September 30, 2002
|                                          
|/s/ MICHAEL L. POPOV(Michael L. Popov)     |  | Vice President and Corporate Controller
    (Principal Accounting Officer)                                      |  | September 30, 2002
|                                          
|/s/ JAMES L. BARKSDALE(James L. Barksdale) |  | Director                                                                                                        |  | September 30, 2002
|                                          
|/s/ L. JOHN DOERR(L. John Doerr)           |  | Director                                                                                                        |  | September 30, 2002
|                                          
|/s/ JUDITH L. ESTRIN(Judith L. Estrin)     |  | Director                                                                                                        |  | September 30, 2002
|                                          
|/s/ ROBERT J. FISHER(Robert J. Fisher)     |  | Director                                                                                                        |  | September 30, 2002
|                                          
|/s/ ROBERT L. LONG(Robert L. Long)         |  | Director                                                                                                        |  | September 30, 2002
|                                          
|/s/ M. KENNETH OSHMAN(M. Kenneth Oshman)   |  | Director                                                                                                        |  | September 30, 2002
|                                          
|/s/ NAOMI O. SELIGMAN(Naomi O. Seligman)   |  | Director                                                                                                        |  | September 30, 2002

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I, Scott G. McNealy, certify that:

1.     I have reviewed
this annual report on Form 10-K of Sun Microsystems, Inc.;

2.     Based on my
knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;

3.     Based on my
knowledge, the financial statements, and other financial
information included in this annual report, fairly present in
all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the
periods presented in this annual report.

Date: September 30, 2002



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

* Provide a separate certification for each
principal executive officer and principal financial officer of
the registrant. See Rules 13a-14 and 15d-14. The required
certification must be in the exact form set forth above.

I, Stephen T. McGowan, certify that:

1.     I have reviewed
this annual report on Form 10-K of Sun Microsystems, Inc.;

2.     Based on my
knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;

3.     Based on my
knowledge, the financial statements, and other financial
information included in this annual report, fairly present in
all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the
periods presented in this annual report.

Date: September 30, 2002



| |                        
| | -----------------------
| | /s/ STEPHEN T. MCGOWAN 
| |                        
| | Stephen T. McGowan     
| | Chief Financial Officer

* Provide a separate certification for each
principal executive officer and principal financial officer of
the registrant. See Rules 13a-14 and 15d-14. The required
certification must be in the exact form set forth above.

92



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SCHEDULE II

SUN MICROSYSTEMS, INC.

VALUATION AND QUALIFYING ACCOUNTS

|                                 |  |               |     |            |  |           |    |                |  |   |    |  |  |   |     | 
|-------------------------------- |  | ------------- | --- | ---------- |  | --------- | -- | -------------- |  | - | -- |  |  | - | --- | 
|                                 |  | Balance at    |     | Charged to |  |           |    |               
|                                 |  | Beginning of  |     | Costs and  |  |           |    | Balance at End
|Description                      |  | Year          |     | Expenses   |  | Write-off |    | of Year       
|                                 |  |               |     |            |  |           |    |               
|                                 |  |              
|                                 |  | (In millions)
|Fiscal year ended June 30, 2000: |  |               |     |            |  |           |    |                |  |   |    |  |  |   |     | 
|Bad debt reserves                |  | $             | 158 |            |  | $         | 55 |                |  | $ | 83 |  |  | $ | 130 | 
|                                 |  |               |     |            |  |           |    |                |  |   |    |  |  |   |     | 
|Fiscal year ended June 30, 2001: |  |               |     |            |  |           |    |                |  |   |    |  |  |   |     | 
|Bad debt reserves                |  | $             | 130 |            |  | $         | 25 |                |  | $ | 44 |  |  | $ | 111 | 
|                                 |  |               |     |            |  |           |    |                |  |   |    |  |  |   |     | 
|Fiscal year ended June 30, 2002: |  |               |     |            |  |           |    |                |  |   |    |  |  |   |     | 
|Bad debt reserves                |  | $             | 111 |            |  | $         | 46 |                |  | $ | 43 |  |  | $ | 114 | 
|                                 |  |               |     |            |  |           |    |                |  |   |    |  |  |   |     | 

93



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INDEX TO EXHIBITS

|          |  |                                                                                                                                                                                                                                                                                                              
|--------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit   |  |                                                                                                                                                                                                                                                                                                              
|Number    |  | Description                                                                                                                                                                                                                                                                                                  
|          |  |                                                                                                                                                                                                                                                                                                              
|3.1(1)    |  | Registrants Restated Certificate of
    Incorporation.                                                                                                                                                                                                                                                      
|3.2(2)    |  | Certificate of Amendment of the Restated
    Certificate of Incorporation of Registrant dated
    November 8, 2000.                                                                                                                                                                                          
|3.3(3)    |  | Amended and Restated Certificate of Designations
    dated December 13, 2000.                                                                                                                                                                                                                                
|3.4       |  | Bylaws of the Registrant, as amended
    September 17, 2002.                                                                                                                                                                                                                                                 
|4.8(4)    |  | Third Amended and Restated Shares Rights
    Agreement dated July 25, 2002.                                                                                                                                                                                                                                  
|4.10(5)   |  | Indenture, dated August 1, 1999 (the
    Indenture) between Registrant and The Bank of New
    York, as Trustee.                                                                                                                                                                                           
|4.11(5)   |  | Form of Subordinated Indenture.                                                                                                                                                                                                                                                                              
|4.12(5)   |  | Officers Certificate Pursuant to
    Section 301 of the Indenture, without exhibits,
    establishing the terms of Registrants Senior Notes.                                                                                                                                                               
|4.13(5)   |  | Form of Senior Note.                                                                                                                                                                                                                                                                                         
|10.64(6)  |  | Registrants 1988 Directors Stock
    Option Plan, as amended on August 11, 1999.                                                                                                                                                                                                                           
|10.65(7)  |  | Registrants 1990 Employee Stock Purchase
    Plan, as amended on August 13, 1997.                                                                                                                                                                                                                           
|10.66(8)  |  | Registrants 1990 Long-Term Equity Incentive
    Plan, as amended on August 15, 2001.                                                                                                                                                                                                                        
|10.66A(9) |  | Representative form of agreement to
    Registrants 1990 Long-Term Equity Incentive Plan (LTEIP).                                                                                                                                                                                                           
|10.66B(9) |  | French Sub-Plan to 1990 Long Term Equity
    Incentive Plan.                                                                                                                                                                                                                                                 
|10.84(10) |  | Registrants Non-Qualified Deferred
    Compensation Plan, as amended June 30, 2002.                                                                                                                                                                                                                         
|10.85(11) |  | Registrants Section 162(m) Executive
    Officer Performance-Based Bonus Plan, as amended and restated
    July 1, 2001.                                                                                                                                                                                    
|10.87     |  | Registrants Equity Compensation Acquisition
    Plan, as amended on July 25, 2002.                                                                                                                                                                                                                          
|10.89(12) |  | Form of Change of Control Agreement executed by
    each executive officer of Registrant.                                                                                                                                                                                                                    
|10.90(12) |  | Form of Change of Control Agreement executed by
    Chief Executive Officer of Registrant.                                                                                                                                                                                                                   
|10.94(10) |  | Promissory Notes issued by Robert L. Long on
    November 12, 2001 and January 10, 2002 and related
    documents.                                                                                                                                                                                           
|10.95(10) |  | Promissory Notes issued by Masood A. Jabbar
    on November 7, 2001 and related documents.                                                                                                                                                                                                                   
|10.96(13) |  | Promissory Notes issued by Jonathan I.
    Schwartz dated October 29, 2001 (Note 1),
    Promissory Note issued by Jonathan I. Schwartz dated
    June 28, 2002 (Note 2), cancellation of
    Notes 1 and 2 dated July 18, 2002, and Promissory Note
    issued by Jonathan I. Schwartz on July 19, 2002.
|10.97     |  | Retirement Transition Agreement dated
    April 30, 2002, and Resignation dated September 17,
    2002, between the Registrant and Michael Lehman.                                                                                                                                                           

94



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##### Table of Contents



|        |  |                                                                                                                  
|------- |  | -----------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                  
|Number  |  | Description                                                                                                      
|        |  |                                                                                                                  
|10.98   |  | Retirement Transition Agreement dated
    April 30, 2002 between the Registrant and Edward Zander.               
|10.99   |  | Retirement Transition Agreement dated
    July 18, 2002 between the Registrant and Masood Jabbar.                
|10.100  |  | Retirement Transition Agreement dated
    July 25, 2002 between the Registrant and John Shoemaker.               
|10.101  |  | Employment Agreement dated January 3, 2001
    between the Registrant and David Yen, as amended May 17,
    2001.
|10.102  |  | Retention Bonus Agreement dated September 5,
    2002 between the Registrant and Patricia Sueltz.                
|10.103  |  | Retention Bonus Agreement dated September 5,
    2002 between the Registrant and Eva Sage-Gavin.                 
|10.104  |  | Form of Indemnification Agreement executed by
    each executive officer of Registrant.                          
|21.0    |  | Subsidiaries of Registrant.                                                                                      
|23.1    |  | Consent of Ernst & Young LLP,
    Independent Auditors.                                                          
|99.1    |  | Certification of Chief Executive Officer, Scott
    G. McNealy.                                                  
|99.2    |  | Certification of Chief Financial Officer, Stephen
    T. McGowan.                                                



---



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



|     |                                                                                                                             
|---- | ----------------------------------------------------------------------------------------------------------------------------
|(10) | Incorporated by reference to Registrants
    Quarterly Report on Form 10-Q for fiscal quarter ended
    March 31, 2002.    
|    
|(11) | Incorporated by reference to Registrants
    Quarterly Report on Form 10-Q for fiscal quarter ended
    September 30, 2001.
|    
|(12) | Incorporated by reference to Registrants
    Quarterly Report on Form 10-Q for fiscal quarter ended
    December 29, 1996. 
|    
|(13) | Incorporated by reference to Registrants
    Current Report on Form 8-K filed on August 9, 2002.                           

95