<PAGE>   1

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

(Mark One)

  [X]     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
          EXCHANGE ACT OF 1934

                     For the quarterly period ended April 1, 2001

                                                or

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

                   For the transition period from _______ to _______

                         Commission file number: 0-15086

                                 ---------------

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

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


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

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

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

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

                    YES   [X]                   NO  [ ]

                      APPLICABLE ONLY TO CORPORATE ISSUERS:

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

             CLASS                                 OUTSTANDING AT APRIL 26, 2001
Common Stock - $0.00067 par value                           3,256,803,966



<PAGE>   2

                                      INDEX

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

  INDEX                                                                         2

  PART I - FINANCIAL INFORMATION

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

        Item 2 - Management's Discussion and Analysis of
                 Financial Condition and Results of Operations                  16

        Item 3 - Quantitative and Qualitative Disclosures About
                 Market Risk                                                    31


  PART II - OTHER INFORMATION

        Item 1 - Legal Proceedings                                              33
        Item 2 - Changes in Securities and Use of Proceeds                      33
        Item 5 - Other Information                                              33
        Item 6 - Exhibits and Reports on Form 8-K                               34

  SIGNATURES                                                                    35
</TABLE>



                                       2
<PAGE>   3

                         PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

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

<TABLE>
<CAPTION>
                                                       Three Months Ended                      Nine Months Ended
                                                   ----------------------------          -----------------------------
                                                   April 1,           March 26,          April 1,            March 26,
                                                    2001                2000               2001                2000
                                                   --------           ---------          --------            ---------
<S>                                                <C>                <C>                <C>                 <C>
Net revenues:
    Products                                       $ 3,262             $3,429            $ 11,922             $ 9,094
    Services                                           833                576               2,333               1,611
                                                   -------             ------            --------             -------
Total net revenues                                   4,095              4,005              14,255              10,705
Cost of sales:
    Cost of sales - products                         1,864              1,542               6,170               4,120
    Cost of sales - services                           539                371               1,519               1,025
                                                   -------             ------            --------             -------
Total cost of sales                                  2,403              1,913               7,689               5,145
                                                   -------             ------            --------             -------
    Gross margin                                     1,692              2,092               6,566               5,560
Operating expenses:
    Research and development                           486                417               1,473               1,172
    Selling, general and administrative                957              1,057               3,384               2,872
    Amortization of goodwill                            96                 10                 147                  30
    Purchased in-process research and
       development                                       1                  5                  72                   9
                                                   -------             ------            --------             -------
Total operating expenses                             1,540              1,489               5,076               4,083
                                                   -------             ------            --------             -------
Operating income                                       152                603               1,490               1,477
Gain (loss) on investments                             (13)               112                 (12)                112
Interest income, net                                   110                 44                 276                 105
                                                   -------             ------            --------             -------
Income before income taxes                             249                759               1,754               1,694
Provision for income taxes                             113                250                 685                 560
                                                   -------             ------            --------             -------
Net income                                         $   136             $  509            $  1,069             $ 1,134
                                                   =======             ======            ========             =======

Net income per common share - basic                $  0.04             $ 0.16            $   0.33             $  0.36
                                                   =======             ======            ========             =======
Net income per common share - diluted              $  0.04             $ 0.15            $   0.31             $  0.34
                                                   =======             ======            ========             =======
Shares used in the calculation of
    net income per common share -
       basic                                         3,256              3,170               3,230               3,142
                                                   =======             ======            ========             =======
Shares used in the calculation of
    net income per common share -
       diluted                                       3,417              3,397               3,428               3,369
                                                   =======             ======            ========             =======
</TABLE>


                             See accompanying notes.



                                       3
<PAGE>   4

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

<TABLE>
<CAPTION>
                                                                  April 1, 2001     June 30, 2000
                                                                  -------------     -------------
                                                                   (unaudited)
<S>                                                               <C>               <C>
ASSETS
Current assets:
        Cash and cash equivalents                                    $ 1,287            $ 1,849
        Short-term investments                                           942                626
        Accounts receivable, net                                       2,913              2,690
        Inventories                                                      899                557
        Deferred tax assets                                              856                673
        Prepaid expenses and other current assets                        831                482
                                                                     -------            -------
               Total current assets                                    7,728              6,877
Property, plant and equipment, net of                                  2,564              2,095
  accumulated depreciation of $1,963 and $1,597
Long-term investments                                                  5,020              4,496
Intangible assets, net                                                 1,991                205
Other assets, net                                                        608                479
                                                                     -------            -------
                                                                     $17,911            $14,152
                                                                     =======            =======

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
        Short-term borrowings                                        $     2            $     7
        Accounts payable                                               1,023                924
        Accrued payroll-related liabilities                              559                751
        Accrued liabilities and other                                  1,826              1,366
        Deferred revenues and customer deposits                        1,619              1,289
        Income taxes payable                                             139                422
                                                                     -------            -------
               Total current liabilities                               5,168              4,759
Long-term debt and other obligations                                   2,181              2,084
Total stockholders' equity                                            10,562              7,309
                                                                     -------            -------
                                                                     $17,911            $14,152
                                                                     =======            =======
</TABLE>


                             See accompanying notes.



                                       4
<PAGE>   5

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

<TABLE>
<CAPTION>
                                                                               Nine Months Ended
                                                                         -----------------------------
                                                                         April 1,            March 26,
                                                                           2001                2000
                                                                         --------            ---------
<S>                                                                      <C>                 <C>
Cash flows from operating activities:
  Net income                                                             $ 1,069             $ 1,134
  Adjustments to reconcile net income to net cash provided by
    operating activities:
     Depreciation and amortization                                           818                 536
     Tax benefits from employee stock plans                                  692                 522
     Purchased in-process research and development                            72                   9
     Loss (gain) on investments                                               12                (112)
     Changes in operating assets and liabilities:
          Accounts receivable, net                                          (215)               (215)
          Inventories                                                       (340)               (250)
          Other current and long-term assets                                (448)               (252)
          Accounts payable                                                    97                  95
          Other current and long-term liabilities                            266                 535
                                                                         -------             -------
Net cash provided by operating activities                                  2,023               2,002
                                                                         -------             -------

Cash flows from investing activities:
  Purchases of investments                                                (9,749)             (6,216)
  Proceeds from sales and maturities of investments                        8,834               4,123
  Acquisition of property, plant and equipment                              (942)               (647)
  Acquisition of spare parts and other assets                               (164)                (49)
  Payments for acquisitions, net of cash acquired                            (23)                (84)
                                                                         -------             -------
Net cash used in investing activities                                     (2,044)             (2,873)
                                                                         -------             -------

Cash flows from financing activities:
  Proceeds from issuance of long-term debt                                    --               1,500
  Net (decrease) increase in borrowings and other obligations                (15)                  4
  Proceeds from issuance of common stock, net                                278                 219
  Acquisition of treasury stock                                             (804)               (489)
                                                                         -------             -------
Net cash (used in) provided by financing activities                         (541)              1,234
                                                                         -------             -------

Net (decrease) increase in cash and cash equivalents                        (562)                363
Cash and cash equivalents, beginning of period                             1,849               1,101
                                                                         -------             -------
Cash and cash equivalents, end of period                                 $ 1,287             $ 1,464
                                                                         =======             =======

Supplemental disclosures of cash flow information:
 Cash paid during the period for:
        Interest                                                         $   114             $    53
                                                                         =======             =======
        Income taxes                                                     $   385             $   276
                                                                         =======             =======
</TABLE>


                             See accompanying notes.



                                       5
<PAGE>   6

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

<TABLE>
<CAPTION>
                                                                        Nine Months Ended
                                                                   ---------------------------
                                                                   April 1,          March 26,
                                                                    2001               2000
                                                                   --------          ---------
<S>                                                                <C>               <C>
Supplemental schedule of non-cash investing activities:
  In conjunction with the Company's acquisitions,
    liabilities were assumed as follows:
      Fair value of net assets acquired                            $ 2,061             $ 103
      Cash paid for assets, net                                        (29)              (84)
      Stock issued and vested options assumed                       (2,029)               (1)
                                                                   -------             -----
      Liabilities assumed                                          $     3             $  18
                                                                   =======             =====
</TABLE>


                             See accompanying notes.



                                       6
<PAGE>   7

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

1. DESCRIPTION OF BUSINESS

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


2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Fiscal Year

Sun's first three quarters in fiscal 2001 ended on October 1, December 31 and
April 1 (in fiscal 2000 the quarters ended on September 26, December 26 and
March 26). The fourth quarter ends on June 30.

Basis of Presentation

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

On December 5, 2000, the Company effected a two-for-one split of its common
stock paid in the form of a stock dividend. All share and per share data herein
has been adjusted to reflect the split for all periods presented.

While the quarterly financial information is unaudited, the financial statements
included in this report reflect all adjustments (consisting of normal recurring
adjustments) that the Company considers necessary for a fair presentation of the
results of operations for the interim periods covered and of the financial
condition of the Company at the date of the interim balance sheet. The results
for the interim periods are not necessarily indicative of the results for the
entire year. The condensed consolidated balance sheet as of June 30, 2000 has
been derived from the audited consolidated balance sheet as of that date. The
information included in this report should be read in conjunction with the
Company's Annual Report on Form 10-K for fiscal 2000.

Derivative Financial Instruments

The Company uses derivatives to moderate the financial market risks of its
business operations. Derivative products, such as forward and option contracts,
are used to hedge the foreign currency market exposures underlying certain
assets and liabilities and forecasted transactions with customers and vendors.
The Company also enters into interest rate swap agreements to modify the
interest characteristics of its outstanding long-term debt. The Company's
accounting policies for these instruments are based on its designation of such
instruments as hedging transactions. An instrument is designated as a hedge
based in part on its effectiveness in risk reduction and one-to-one matching of
derivative instruments to underlying transactions. The Company records all
derivatives on the balance sheet at fair value.



                                       7
<PAGE>   8

For derivative instruments that are designated and qualify as a fair value hedge
(i.e., hedging the exposure to changes in the fair value of an asset or a
liability or an identified portion thereof that is attributable to a particular
risk), the gain or loss on the derivative instrument as well as the offsetting
gain or loss on the hedged item attributable to the hedged risk are recognized
in earnings in the current period. For derivative instruments that are
designated and qualify as a cash flow hedge (i.e., hedging the exposure of
variability in expected future cash flows that is attributable to a particular
risk), the effective portion of the gain or loss on the derivative instrument is
reported as a component of Other Comprehensive Income (OCI) in stockholders'
equity and reclassified into earnings in the same period or periods during which
the hedged transaction affects earnings. The remaining gain or loss on the
derivative instrument in excess of the cumulative change in the present value of
the future cash flows of the hedged item, if any, is recognized in current
earnings during the period of change. For derivative instruments not designated
as hedging instruments, changes in their fair values are recognized in earnings
in the current period.

For currency forward contracts, effectiveness is measured by using the
forward-to-forward rate compared to the underlying economic exposure. For
currency option contracts, effectiveness is measured on an intrinsic basis using
only the current forward rate and the strike price for both the currency option
contract (either put or call option) and the underlying transaction. All time
value and volatility changes are deemed ineffective and are immediately
recognized in earnings. For interest rate swap agreements, the Company assumes
no ineffectiveness as each interest rate swap meets the short-cut method
conditions required under Statement of Financial Accounting Standards No. 133
(SFAS 133), "Accounting for Derivative Instruments and Hedging Activities" (see
Note 5, "Derivative Financial Instruments").

Computation of Net Income Per Common Share

Basic net income per common share is computed using the weighted average number
of common shares outstanding during the period. Diluted net income 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.

Recent Pronouncements

In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements". SAB 101 summarizes certain of the SEC's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
In October 2000, the SEC issued additional written guidance to further
supplement SAB 101. The Company is required to adopt SAB 101 for its fiscal year
ended June 30, 2001 in the fourth quarter of fiscal 2001. At this time,
management does not expect the adoption of SAB 101 to have a material effect on
the Company's financial position or results of operations as of and for the year
ended June 30, 2001.



                                       8
<PAGE>   9

3. BUSINESS COMBINATIONS

The Company completed several acquisitions in fiscal 2001 that were accounted
for under the purchase method of accounting. See the Company's Form 10-Q for the
quarterly periods ended on October 1, 2000 and December 31, 2000 for information
on acquisitions completed during the first six months of fiscal 2001. The
Company completed one acquisition in the third quarter of fiscal 2001, as
discussed below. The consolidated financial statements include the operating
results of each business from the date of acquisition. Pro forma results of
operations have not been presented because the effects of these acquisitions
were not material on either an individual or a year-to-date aggregate basis.

The Company calculates amounts allocated to in-process research and development
(IPRD) using established valuation techniques in the high-technology industry
and expenses such amounts in the quarter that the related acquisition was
consummated if technological feasibility of the in-process technology has not
been achieved and no alternate future uses have been established. Research and
development costs to bring the products from the acquired companies to
technological feasibility are not expected to have a material impact on the
Company's future results of operations or cash flows. The Company computes IPRD
using a discounted cash flow analysis on the anticipated income stream to be
generated by the IPRD with consideration given to the in-process technology's
stage of completion.

The excess purchase price over the estimated value of the net tangible assets
and IPRD is allocated to various intangible assets, consisting primarily of
developed technology and goodwill, as well as other intangible assets, such as
customer base, trade name or trademark, and assembled workforce. The value of
developed technology is based upon future discounted cash flows related to the
existing products' projected income streams. The value of the customer base is
based upon the value of existing relationships and the expected revenue streams.
The value of the assembled workforce is based upon the cost to replace that
workforce. Intangible assets, including goodwill, are amortized on a straight
line basis over periods not exceeding five years.

On March 14, 2001, the Company acquired InfraSearch, Inc. (InfraSearch) in a
stock-for-stock merger. InfraSearch is a privately-held company focusing on
distributed search technology. Under the terms of the merger agreement, Sun
issued approximately 332,000 shares at a value of $20.66 per share in exchange
for all of InfraSearch's outstanding stock, assumed all of InfraSearch's
outstanding options (equivalent to approximately 63,000 Sun options) at a fair
value of $1.1 million, and incurred $0.6 million in acquisition costs, resulting
in an aggregate purchase price of approximately $8.5 million. This merger was
accounted for as a purchase, with the excess of the purchase price over the
estimated fair value of the net tangible assets ($0.2 million) being allocated
to various intangible assets, including goodwill ($3.6 million), assembled
workforce ($0.8 million) and in-process research and development ($1.0 million).
Also included in the purchase price is $2.9 million allocated to deferred
compensation, which represents the pro-rata portion of the intrinsic value of:
(1) certain restricted stock issued to InfraSearch founders; and (2)
InfraSearch's options assumed but not vested at the date of the acquisition.



                                       9
<PAGE>   10

4. BALANCE SHEET DETAILS

Inventories are comprised of the following (in millions):

<TABLE>
<CAPTION>
                                                   April 1, 2001     June 30, 2000
                                                   -------------     -------------
           <S>                                     <C>               <C>
           Raw materials                               $  429            $  169
           Work in process                                117                82
           Finished goods                                 353               306
                                                       ------            ------
                                                         $899              $557
                                                       ======            ======
</TABLE>

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

<TABLE>
<CAPTION>
                                                   April 1, 2001     June 30, 2000
                                                   -------------     -------------
           <S>                                     <C>               <C>
           Long-term investments:
               Marketable securities                   $4,638            $3,961
               Strategic equity investments               382               535
                                                       ------            ------
                        Total                          $5,020            $4,496
                                                       ======            ======
</TABLE>


Marketable securities consist primarily of corporate bonds, floating-rate notes,
and asset-backed and mortgage-backed securities with original maturities greater
than one year from the balance sheet date. Strategic equity investments consist
of marketable strategic equity securities and preferred stock and other
strategic equity holdings. Marketable strategic equity securities represent
equity holdings in public companies. Preferred stock and other strategic equity
holdings represent equity holdings in nonpublic companies and investments in
venture capital funds.

Marketable securities and marketable strategic equity securities are considered
available-for-sale and are reported at fair value with changes in unrealized
gains and losses, net of applicable taxes, recorded in stockholders' equity.
Gross unrealized losses related to the marketable strategic equity securities
were $34 million as of April 1, 2001 (gross unrealized gains of $210 million as
of June 30, 2000). Preferred stock and other strategic equity holdings are
carried at the lower of cost or net realizable value due to their illiquid
nature. Realized gains and losses for all investments are calculated based on
the specific identification method.

Statement of Financial Accounting Standards No. 115 (SFAS 115), "Accounting for
Certain Investments in Debt and Equity Securities", requires companies to
determine whether a decline in fair value below the amortized cost basis is
other than temporary. If a decline in fair value is determined to be other than
temporary, SFAS 115 requires the carrying value of the debt or equity security
to be written down to its fair value. Accordingly, the Company recognized an
other-than-temporary impairment loss of $36 million (which is included under the
caption "Gain (loss) on investments" in the Condensed Consolidated Statements of
Income for the three and nine months ended April 1, 2001). No
other-than-temporary impairment losses were recognized in fiscal 2000.



                                       10
<PAGE>   11

5. DERIVATIVE FINANCIAL INSTRUMENTS

On July 1, 2000, the Company adopted SFAS 133 which requires that all
derivatives be recorded on the balance sheet at fair value. Changes in the fair
value of derivatives that do not qualify for hedge treatment, as well as the
ineffective portion of a particular hedge, must be recognized currently in
earnings. Upon adoption on July 1, 2000, the cumulative transition adjustment
was insignificant.

Foreign Exchange Exposure Management. The Company has significant international
sales and purchase transactions in foreign currencies and continues its policy
of hedging forecasted and actual foreign currency risk with purchased currency
options and forward contracts that expire within 12 months. These derivative
instruments are employed to eliminate or minimize certain foreign currency
exposures that can be confidently identified and quantified. In accordance with
SFAS 133, hedges related to anticipated transactions are designated and
documented at the inception of the respective hedge as cash flow hedges and
evaluated for effectiveness quarterly. As the terms of the forward contract and
the underlying transaction are matched at inception, forward contract
effectiveness is calculated by comparing the fair value of the contract to the
change in the forward value of the anticipated transaction, with the effective
portion of the gain or loss on the derivative instrument reported as a component
of OCI in stockholders' equity and reclassified into earnings in the same period
or periods during which the hedged transaction affects earnings. Option contract
effectiveness is calculated by comparing the intrinsic value of the instrument
to any degradation of the anticipated transaction against the strike price with
the effective portion of changes in fair value accumulated in OCI. Any residual
change in fair value of the instruments, including option time value or other
ineffectiveness are recognized immediately in Selling, general and
administrative expense. Ineffectiveness in the first nine months of fiscal 2001
is not significant.

To meet SFAS 133 entity hedging requirements and to protect U.S. dollar margins,
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
recognized in Revenue upon shipment and OCI related to inventory purchases is
recognized in Cost of sales upon shipment. All values reported in OCI at April
1, 2001 will be reclassified to earnings within 12 months.

Additionally, the Company enters into foreign currency forward contracts to
hedge the gains and losses generated by the remeasurement of monetary assets and
liabilities in a non-functional currency. These hedges are not SFAS 133
designated hedges, and thus are recognized in Selling, general and
administrative expense immediately as an offset to the changes in the fair value
of the assets or liability being hedged.

Interest Rate Risk Management. The Company is exposed to interest rate risk from
both investments and debt. The Company offsets the risk in variable rate
interest earnings from investments by converting the existing fixed rate debt
(with maturities of 3 years, 5 years, 7 years, and 10 years) of $1.5 billion
into variable rate debt with 12 fixed-to-variable interest rate swaps. The
Company assumes no ineffectiveness as each interest rate swap meets the
short-cut method conditions required under SFAS 133 for fair value hedges of
debt instruments. Accordingly, no gains or losses were recorded in income
relative to the Company's underlying interest rate swaps.



                                       11
<PAGE>   12

Accumulated Derivative Gains or Losses. The following table summarizes activity
in OCI related to derivatives held by Sun during the period from July 1, 2000
through April 1, 2001 (in millions):

<TABLE>
<S>                                                   <C>
Cumulative effect of adopting SFAS 133                $ --
Increase in fair value of derivatives                   99
Gains reclassified from OCI, net, into:
     Revenues                                          (34)
     Cost of sales                                     (21)
                                                      ----
Accumulated derivative gain, April 1, 2001            $ 44
                                                      ====
</TABLE>


6. COMPREHENSIVE INCOME

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

<TABLE>
<CAPTION>
                                                 Three Months Ended                    Nine Months Ended
                                             --------------------------           ----------------------------
                                             April 1,         March 26,           April 1,           March 26,
                                               2001             2000                2001               2000
                                             --------         ---------           --------           ---------
<S>                                          <C>              <C>                 <C>                <C>
Net income                                    $ 136             $ 509             $ 1,069             $ 1,134
Change in unrealized value of
  investments, net                              (11)             (122)                (87)                268
Change in unrealized fair value of
  derivative instruments                         37                --                  44                  --
Translation adjustments                          23               (14)                  4                 (19)
                                              -----             -----             -------             -------
Comprehensive income                          $ 185             $ 373             $ 1,030             $ 1,383
                                              =====             =====             =======             =======
</TABLE>

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

<TABLE>
<CAPTION>
                                                     April 1, 2001     June 30, 2000
                                                     -------------     -------------
<S>                                                  <C>               <C>
Unrealized gains on investments, net                      $ 38             $ 125
Unrealized gains on derivative instruments                  44                --
Cumulative translation adjustments                         (46)              (50)
                                                          ----             -----
Accumulated other comprehensive income                    $ 36             $  75
                                                          ====             =====
</TABLE>



                                       12
<PAGE>   13

7. NET INCOME PER COMMON SHARE

The following table presents the calculation of basic and diluted earnings per
share (in millions, except per share amounts):

<TABLE>
<CAPTION>
                                              Three Months Ended                  Nine Months Ended
                                          --------------------------          --------------------------
                                          April 1,         March 26,          April 1,         March 26,
                                          --------         ---------          --------         ---------
                                            2001              2000              2001              2000
                                          -------            -------          -------            -------
<S>                                       <C>                <C>              <C>                <C>
Net income                                 $  136            $  509            $1,069            $1,134
                                           ======            ======            ======            ======
Denominator:
  Weighted average common
   shares - basic                           3,256             3,170             3,230             3,142
  Effect of dilutive securities
   (primarily stock options)                  161               227               198               227
                                           ------            ------            ------            ------
  Weighted average common
   shares - diluted                         3,417             3,397             3,428             3,369
                                           ======            ======            ======            ======
Net income per common share -
basic                                      $ 0.04            $ 0.16            $ 0.33            $ 0.36
                                           ======            ======            ======            ======

Net income per common share -
diluted                                    $ 0.04            $ 0.15            $ 0.31            $ 0.34
                                           ======            ======            ======            ======
</TABLE>


8. OPERATING SEGMENTS

Sun designs, manufactures, markets, and services network computing systems and
software solutions that feature networked desktops and servers. The Company is
organized by various product groups. The following product groups are the only
reportable segments under the criteria of Statement of Financial Accounting
Standards No. 131 (SFAS 131), "Disclosures About Segments of an Enterprise and
Related Information": (1) System Products and Network Storage and (2) Enterprise
Services. Products in the System Products and Network Storage segment include a
broad range of desktop systems, servers, storage, and network switches,
incorporating the UltraSPARC(TM) processors and Solaris(TM) Operating
Environment. In the Enterprise Services segment, the Company provides a full
range of services and support to existing and new customers, including
education, professional services, and systems integration. Effective July 1,
2000, Sun consolidated its sales and manufacturing functions into organizations
known as the Global Sales Operations (GSO) and Worldwide Operations (WWOPS),
respectively. The GSO manages most of the Company's field sales organizations
and all field marketing organizations. Sales generated through the sales and
marketing efforts of the 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.



                                       13
<PAGE>   14

The following table presents revenues, interdivision revenues, and operating
income (loss) for the Company's segments. The Other segment consists of certain
operating product groups, which did not meet the requirements for a reportable
segment as defined by SFAS 131, such as Sun's Software Systems Group and
iPlanet, and other miscellaneous functions, such as Corporate and the GSO.

Three Months Ended:

<TABLE>
<CAPTION>
                               System Products and      Enterprise
                                 Network Storage         Services            Other               Total
                               -------------------      ----------          -------             -------
<S>                            <C>                      <C>                <C>              <C>
APRIL 1, 2001
  Revenues                           $  2,861             $  833            $   401             $ 4,095
  Interdivision revenues                 (118)                63                 55                  --
  Operating income (loss)                 762                182               (792)                152

MARCH 26, 2000
  Revenues                           $  3,083             $  576            $   346             $ 4,005
  Interdivision revenues                  (96)                45                 51                  --
  Operating income (loss)               1,270                113               (780)                603
</TABLE>

Nine Months Ended:

<TABLE>
<CAPTION>
                               System Products and      Enterprise
                                 Network Storage         Services            Other               Total
                               -------------------      ----------          -------             -------
<S>                            <C>                      <C>                 <C>                 <C>
APRIL 1, 2001
  Revenues                           $ 10,640             $2,333            $ 1,282             $14,255
  Interdivision revenues                 (344)               179                165                  --
  Operating income (loss)               3,786                477             (2,773)              1,490

MARCH 26, 2000
  Revenues                           $  8,349             $1,611            $   745             $10,705
  Interdivision  revenues                (273)               129                144                  --
  Operating income (loss)               3,338                311             (2,172)              1,477
</TABLE>


9. STOCK REPURCHASE PROGRAMS

On February 14, 2001, the Company's Board of Directors authorized a new stock
repurchase program to acquire its outstanding common stock in the open market.
Sun's management currently intends to buy back up to $1.5 billion of its
outstanding common stock. This new repurchase program is in addition to Sun's
other on-going stock repurchase programs. During the nine months ended April 1,
2001, the Company repurchased $804 million of common stock under all repurchase
programs.



                                       14
<PAGE>   15

10. SUBSEQUENT EVENTS

On April 2, 2001, the Company acquired HighGround Systems, Inc. (HighGround) in
a stock-for-stock merger. HighGround, a privately-held company, is a leading
developer of storage resource management software for open systems. Under the
terms of the merger agreement, the Company issued approximately 8.0 million
shares of its common stock and assumed options and warrants exercisable for
approximately 2.2 million shares of Sun common stock (after giving effect to the
two-for-one stock split effected December 5, 2000) in exchange for all of
HighGround's outstanding capital stock, options and warrants, resulting in an
aggregate purchase price valued at approximately $400 million. This merger was
accounted for as a purchase and the purchase price will be allocated to tangible
assets and identified intangible assets, with any excess being allocated to
goodwill.

On May 2, 2001, the Company acquired LSC, Incorporated (LSC) in a
stock-for-stock merger. LSC is a privately-held company which designs, develops,
and supports high performance file systems and data storage software. Under the
terms of the merger agreement, the Company issued approximately 1.7 million
shares of its common stock and assumed options and warrants exercisable for
approximately 0.7 million shares of Sun common stock in exchange for all of
LSC's outstanding capital stock, options and warrants, resulting in an aggregate
purchase price valued at approximately $74 million. The merger was accounted for
as a purchase and the purchase price will be allocated to tangible assets and
identified intangible assets, with any excess being allocated to goodwill.



                                       15
<PAGE>   16

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


This quarterly report, including the following sections, contains
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements include statements relating to
our expectations as to product demand in the fourth quarter of fiscal 2001, our
expectations regarding product mix trends, our expectations that products gross
margins will continue to be affected by volume of products, component costs,
product mix and market conditions, our products and services gross margin
expectations for the fourth quarter of fiscal 2001, our expectations to continue
to invest in our services business, our continuous evaluation of the
competitiveness of our product and service offerings and any possible related
repricing actions, our plans to increase research and development spending on a
dollar basis during the fourth quarter of fiscal 2001, our expectations relating
to selling, general and administrative expenses on a dollar basis during the
fourth quarter of fiscal 2001 and our continual focus on efforts to achieve
additional operating efficiencies and review and improvement of our business
processes and our continued focus on our cost structure, our expectations as to
average balances of cash and marketable securities and related interest income,
net as a result of stock repurchase activity in the fourth quarter of fiscal
2001, our expected effective income tax rate for the remainder of fiscal 2001,
our expectations to continue leveraging our operating EBITDA on our cost
structure, our intentions as to stock repurchase activity, our belief that we
have sufficient capital to meet our requirements for at least the next twelve
months, and as set forth in the section entitled "Purchased in-process research
and development expenses": statements regarding our belief regarding realization
of expected economic return from acquired in-process technology and resulting or
related products and our ability to continue making substantial progress in the
development and commercialization of acquired technologies.

These forward-looking statements involve risks and uncertainties. The cautionary
statements set forth below and those contained in "Risk Factors," identify
important factors that could cause actual results to differ materially from
those predicted in any such forward-looking statements. Such factors include,
but are not limited to, increased competition, continued adverse changes in
general economic conditions in the U.S. and internationally, including adverse
changes in the specific markets for our products, adverse business conditions,
adverse changes in customer order patterns, lack of acceptance of new products,
pricing pressures, lack of success in technological advancements, risks
associated with foreign operations, failure to reduce costs or improve operating
efficiencies, our ability to attract, hire and retain key and qualified
employees, and risks associated with acquiring companies.

With respect to risks related to purchased in-process research and development,
we cannot assure you that any new technologies will be developed into products,
that such products will achieve either technological or commercial success, or
that we will receive any economic benefit from such products as a result of
delays in the development of the technology or release of such products into the
market, the complexity of the technology, our ability to successfully manage
product introductions, lack of customer acceptance, competition and changes in
technological trends, and fluctuations in market or general economic conditions.



                                       16
<PAGE>   17

RESULTS OF OPERATIONS

NET REVENUES
(dollars in millions)

<TABLE>
<CAPTION>
                                              Three Months Ended                             Nine Months Ended
                                           -------------------------                      -------------------------
                                           April 1,        March 26,                      April 1,         March 26,
                                             2001            2000              Change       2001              2000            Change
                                           --------        ---------           ------     --------         ---------          ------
<S>                                        <C>             <C>                 <C>        <C>              <C>                <C>
Products net revenue                       $ 3,262          $ 3,429             -4.9%      $11,922          $ 9,094            31.1%
  Percentage of total net revenues            79.7%            85.6%                          83.6%            85.0%
Services net revenue                       $   833          $   576             44.6%      $ 2,333          $ 1,611            44.8%
  Percentage of total net revenues            20.3%            14.4%                          16.4%            15.0%

Total net revenues                         $ 4,095          $ 4,005              2.2%      $14,255          $10,705            33.2%
</TABLE>

Products net revenue

Products net revenue is comprised of revenue generated from the sales of our
scalable computer systems and storage, high-speed microprocessors, and our line
of high-performance software for operating network computing equipment. While we
experienced significant growth in our enterprise and workgroup server product
lines as well as storage products for the first nine months of fiscal 2001,
there was a significant decrease in these same product lines for the third
quarter of fiscal 2001, as compared with the corresponding periods in fiscal
2000.

For the third quarter of fiscal 2001, products net revenue decreased by $167
million, or 4.9% to $3,262 million, over the corresponding period of fiscal
2000. The decrease in products net revenue for the third quarter of fiscal 2001,
as compared with fiscal 2000, was primarily due to decreased demand for our
products in the United States (as further discussed below in the section "Net
revenues by geographic area"). We believe this decrease substantially resulted
from the weakness in the U.S. economy, in general, and the reduction in
information technology spending, in particular. Decreases in our enterprise and
workgroup server product lines as well as storage products accounted for more
than 70% of the total decrease in products net revenue in the third quarter of
fiscal 2001. These decreases were partially offset by increased revenues
generated from our network service provider and iPlanet offerings. Unless there
are changes in the current macroeconomic conditions, we expect the decreased
demand experienced in the third quarter of fiscal 2001 to continue in the fourth
quarter of fiscal 2001.

For the first nine months of fiscal 2001, products net revenue increased by
$2,828 million, or 31.1% to $11,922 million, over the corresponding period of
fiscal 2000. Growth in enterprise and workgroup server product lines as well as
storage products accounted for more than 70% of the total increase in products
net revenue in the first nine months of fiscal 2001. In addition, increased
revenues generated by our network service provider and iPlanet offerings also
contributed to the increase in products net revenue. As a result of the
historically strong demand for our servers, desktop system revenue as a
percentage of products net revenue declined for the nine months ended April 1,
2001, as compared with the corresponding period of fiscal 2000.



                                       17
<PAGE>   18

We expect our current product mix trends of: (1) increasing enterprise and
workgroup server product lines as well as storage products as a percentage of
products net revenue; and (2) gradually decreasing desktop systems as a
percentage of products net revenue, to continue for the fourth quarter of fiscal
2001.

Services net revenue

Services net revenue is comprised of revenue generated from the sale of a full
range of services, including support, education, and professional services. For
the third quarter of fiscal 2001, services net revenue increased by $257
million, or 44.6% to $833 million, over the corresponding period of fiscal 2000.
For the first nine months of fiscal 2001, services net revenue increased by $722
million, or 44.8% to $2,333 million, over the corresponding period of fiscal
2000. The increase in services net revenue 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 expectations to higher levels of support; (2) a larger base of product
units related to the increase in product unit sales; and (3) an increase in
revenues associated with our educational and professional services.

Net revenues by geographic area
(dollars in millions)
<TABLE>
<CAPTION>
                                              Three Months Ended                          Nine Months Ended
                                           -------------------------                   -------------------------
                                           April 1,        March 26,                   April 1,         March 26,
                                             2001            2000           Change       2001              2000        Change
                                           --------        ---------        ------     --------         ---------      ------
<S>                                        <C>             <C>              <C>        <C>              <C>            <C>
Domestic                                    $ 1,639          $ 1,920        -14.6%     $ 6,776          $ 5,426        24.9%
  Percentage of net revenues                   40.0%            47.9%                     47.5%            50.7%
International                               $ 2,456          $ 2,085         17.8%     $ 7,479          $ 5,279        41.7%
  Percentage of net revenues                   60.0%            52.1%                     52.5%            49.3%
Total net revenues                          $ 4,095          $ 4,005          2.2%     $14,255          $10,705        33.2%
</TABLE>

Domestic net revenues decreased by 14.6% and increased by 24.9% for the third
quarter and the first nine months of fiscal 2001, respectively, over the
corresponding periods of fiscal 2000. Beginning in December 2000, we experienced
an unexpected and significant decline in U.S. demand primarily for our products.
There is no assurance that this decline in U.S. demand will not continue to
affect future operating results. In U.S. dollars, international net revenues
increased by 17.8% and 41.7% for the third quarter and first nine months of
fiscal 2001, respectively, over the corresponding periods of fiscal 2000. The
revenue growth in international net revenues was primarily due to continued
strong demand for our network computing products and services. To a lesser
degree, the increase in international revenues was also impacted by our expanded
presence in numerous emerging countries. We experienced revenue growth in the
majority of the countries within the European, Middle Eastern, African (EMEA)
region (such as, the United Kingdom, Germany, France, Switzerland, Italy and
Spain) and the rest of world (ROW) region (such as, Japan, China and Taiwan)
during the third quarter and first nine months of fiscal 2001, as compared with
the corresponding periods of fiscal 2000. Net revenues in the United Kingdom,
Germany, Japan and China accounted for more than 50% of the total increase in
international net revenues for the third quarter and first nine months of fiscal
2001. Although we have experienced U.S. dollar revenue growth in the
international marketplaces on a year-over-year basis, we cannot assure you that
such trends will continue. In fact, we have begun to see some signs of a
moderation of demand in our non-U.S.markets. If capital spending declines in
certain countries, or any such countries experience changes in their economic
environment, our results of operations and cash flows could suffer.


Fluctuations in exchange rates reduced total net revenue in the third quarter of
fiscal 2001 by approximately 4-5%. This reduction was principally driven by
weakness in the Euro, the British pound, the Japanese yen and, to a lesser
extent, the Australian dollar.



                                       18
<PAGE>   19
GROSS MARGIN
(dollars in millions)

<TABLE>
<CAPTION>
                                         Three Months Ended                                 Nine Months Ended
                                      ---------------------------                       -------------------------
                                      April 1,          March 26,                       April 1,         March 26,
                                        2001              2000              Change        2001              2000        Change
                                      --------          ---------           ------      --------         ---------      ------
<S>                                   <C>               <C>                 <C>         <C>              <C>            <C>
Products gross margin                 $  1,398          $  1,887            -25.9%      $  5,752          $ 4,974        15.6%
  Percentage of products
   net revenues                           42.9%             55.0%                           48.2%            54.7%
Services gross margin                 $    294          $    205             43.4%      $    814          $   586        38.9%
  Percentage of services
   net revenues                           35.3%             35.6%                           34.9%            36.4%
Total gross margin                    $  1,692          $  2,092            -19.1%      $  6,566          $ 5,560        18.1%
  Percentage of net revenues              41.3%             52.2%                           46.1%            51.9%
</TABLE>

Products gross margin

Products gross margin was 42.9% and 48.2% for the third quarter and first nine
months of fiscal 2001, respectively, as compared with 55.0% and 54.7% for the
corresponding periods in fiscal 2000. The decline in products gross margin for
the third quarter of fiscal 2001, as compared with the corresponding period of
fiscal 2000, was primarily due to: (1) lower than expected volume of products;
(2) additional pricing discounts; and (3) a shift in product mix to lower margin
products. The decline in products gross margin for the first nine months of
fiscal 2001, as compared with the corresponding period of fiscal 2000, was
primarily due to: (1) increased component costs; (2) lower than expected volume
of products; and (3) additional pricing discounts.

Lower than expected volume of products significantly reduced the products gross
margin for the third quarter of fiscal 2001. This contributed to the greater
decline in products gross margin for the third quarter of fiscal 2001, as
compared with the first nine months of fiscal 2001.

For the fourth quarter of fiscal 2001, we expect products gross margin will
continue to be negatively affected by volume of products, component costs,
product mix, and market conditions and therefore, to be in a similar range or to
improve slightly from what we reported for the third quarter of fiscal 2001.

Services gross margin

Services gross margin was 35.3% and 34.9% for the third quarter and first nine
months of fiscal 2001, respectively, as compared with 35.6% and 36.4% for the
corresponding periods in fiscal 2000. The slight decrease in services gross
margin, from the corresponding periods in fiscal 2000, was primarily due to the
impact of: (1) increased expenditures for both fixed and variable costs in
supporting infrastructures; (2) increased capital and operating expenditures
related to acquisition and deployment of service delivery technologies and
processes; and (3) expanded field service delivery headcount to support
increased customer service expectations and expected future growth in the
services business. For example, 650 of the fiscal 2001 third quarter Sun-wide
net headcount increase of approximately 1,180 represented service-related
employees. We expect to continue investing in our services business by hiring
field service delivery employees (but hiring at a slower rate), increasing
availability of spare parts inventory (particularly related to new products) to
improve customer service response time, and evaluating other
infrastructure-related initiatives. We are



                                       19


<PAGE>   20

currently expecting our services gross margin to remain in the mid-30% range for
the fourth quarter of fiscal 2001.

We continuously evaluate the competitiveness of our product and service
offerings. These evaluations could result in repricing actions in the near term.
Our future operating results would be adversely affected if we reduced prices
and we were unable to mitigate the resulting margin pressure by maintaining a
favorable mix of systems, software, service, and other products, or if we were
unsuccessful in achieving component cost reductions, operating efficiencies, and
increasing volumes.

OPERATING EXPENSES
(dollars in millions)

<TABLE>
<CAPTION>
                                              Three Months Ended                               Nine Months Ended
                                           ---------------------------                     -------------------------
                                           April 1,          March 26,                     April 1,         March 26,
                                             2001              2000              Change      2001              2000        Change
                                           --------          ---------           ------    --------         ---------      ------
<S>                                        <C>               <C>                 <C>       <C>              <C>            <C>
Research and development                   $    486          $    417            16.5%     $  1,473          $1,172          25.7%
  Percentage of net revenues                   11.9%             10.4%                         10.3%           10.9%
Selling, general and administrative
 (including amortization of goodwill)      $  1,053          $  1,067            -1.3%     $  3,531          $2,902          21.7%
Percentage of net revenues                     25.7%             26.6%                         24.8%           27.1%
Purchased in-process
  research and development                 $      1          $      5             -80%      $    72          $    9         700.0%
  Percentage of net revenues                    0.0%              0.1%                          0.5%            0.1%
</TABLE>


Research and development expenses

Research and development (R&D) expenses, as a percentage of net revenues,
increased to 11.9% for the third quarter of fiscal 2001 and slightly decreased
to 10.3% for the first nine months of fiscal 2001, from 10.4% and 10.9% for the
corresponding periods of fiscal 2000, respectively. The changes in R&D as a
percentage of net revenues were primarily due to changes in net revenues for the
third quarter and the first nine months of fiscal 2001. The dollar increase in
R&D expenses reflected our continued development of a broad line of scalable and
reliable systems, including servers, workstations, storage technologies, and
SPARC (TM) microprocessors, as well as software products which utilize the Java
(TM) platform, Solaris Operating Environment software, and Jini (TM) connection
technology. Furthermore, R&D expenses increased due to additional development of
products acquired through acquisitions and increased compensation and
compensation-related costs related to higher levels of R&D staffing. For
example, 180 of the fiscal 2001 third quarter Sun-wide net headcount increase of
approximately 1,180 were engineers. The increases in R&D spending reflect our
belief that to maintain our competitive position in a market characterized by
rapid rates of technological advancement, we must continue to invest significant
resources in new systems, software, and microprocessor development, as well as
continue to enhance existing products. All R&D is expensed as incurred. We are
planning to increase our R&D spending on a dollar basis during the fourth
quarter of fiscal 2001.



                                       20
<PAGE>   21

Selling, general and administrative expenses (including amortization of
goodwill)

Selling, general, and administrative (SG&A) expenses (including amortization of
goodwill), as a percentage of net revenues, decreased to 25.7% and 24.8% for the
third quarter and first nine months of fiscal 2001, respectively, from 26.6% and
27.1% for the corresponding periods of fiscal 2000, as a result of: (1) third
quarter adjustments in accruals for variable compensation to reflect the lower
actual results versus plan for the current fiscal year; (2) significant cost
cutting measures in the areas of travel, capital acquisition, facilities and
other types of discretionary spending in the second and third quarters of fiscal
2001; and (3) operating efficiencies. We are continuing to focus on efforts to
achieve additional future operating efficiencies through the continual review
and improvement of business processes. We anticipate the dollar amount of SG&A
expenses for the fourth quarter of fiscal 2001 will be in the range of the
dollar amounts of SG&A expenses (excluding acquisition-related charges) incurred
in each of the first two quarters of fiscal 2001. In addition, we expect to
continue to focus on our cost structure, gradually decreasing our level of SG&A
expenses, as a percentage of total net revenues, on a year-over-year basis
(excluding acquisition-related charges).

Purchased in-process research and development expenses

Overview

In the third quarter of fiscal 2001, we acquired InfraSearch, Inc.
(InfraSearch). Purchased in-process research and development expenses (IPRD) of
$72.3 million in the first nine months of fiscal 2001 represented the write-off
of in-process technologies associated with our acquisitions of (1) InfraSearch
($1.0 million); (2) Cobalt Networks, Inc. and its wholly-owned subsidiaries
(Cobalt) ($70.8 million); and (3) grapeVINE Technologies, LLC (grapeVINE) ($0.5
million). Purchased IPRD of $9.0 million in the first nine months of fiscal 2000
represented the write-off of in-process technologies associated with our
acquisitions of (1) Trustbase Limited (Trustbase) and JCP Computer Services
Limited (JCP); and (2) Star Division Corporation (Star Division) and certain
assets and liabilities of Star Division Software-Entwicklung und Vertriebs GmbH
(Star Company), a related part of Star Division. All these business combinations
are known collectively as "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 of "Notes to Condensed
Consolidated Financial Statements (Unaudited) - Business Combinations".

See "Purchased In-Process Research and Development," in our Annual Report on
Form 10-K for fiscal 2000 for additional discussion on our valuation of IPRD,
overview of purchased IPRD and overall status of IPRD and intangible assets
acquired during fiscal 2000, 1999, and 1998.

Valuation of IPRD

We used independent third-party sources to calculate the amounts allocated to
IPRD. In calculating IPRD, the independent third party used established
valuation techniques accepted in the high-technology industry. These
calculations gave consideration to relevant market sizes and growth factors,
expected industry trends, the anticipated nature and timing of new product
introductions by us and our competitors, individual product sales cycles, and
the estimated lives of each of the product's underlying technology. The value of
the IPRD reflects the relative value and contribution of the acquired research
and development. 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 projected cost to
complete the project in determining the value assigned to IPRD.



                                       21
<PAGE>   22

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

Valuation Assumptions

The following table summarizes the significant assumptions underlying the
valuation related to the IPRD for the quarter ended April 1, 2001 (dollars in
millions):

<TABLE>
<CAPTION>
                                 ESTIMATED
                                  COST TO
                                  COMPLETE       PERCENTAGE     AVERAGE
                                 TECHNOLOGY       COMPLETE      REVENUE          PERCENTAGE OF REVENUE
ACQUIRED                         AT TIME OF      AT TIME OF     GROWTH        AVG.        AVG.        AVG.      DISCOUNT
COMPANY/BUSINESS      IPRD       ACQUISITION     ACQUISITION     RATE         COS         SG&A        R&D       RATE USED
-----------------     ----       -----------     -----------    -------       ---         ----        ---       ---------
<S>                   <C>        <C>             <C>            <C>           <C>         <C>         <C>       <C>
InfraSearch           $1.0           $0.8           75%           247%         18%         50%         1%         30%
</TABLE>

Overview of Significant Purchased IPRD in the quarter ended April 1, 2001

Included below are further details regarding the nature of the significant
amounts of purchased technology acquired during the quarter ended April 1, 2001.

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

On March 14, 2001, we acquired InfraSearch in a stock-for-stock merger valued at
approximately $8.5 million. This merger was accounted for as a purchase, with
the purchase price being allocated to tangible assets, intangible assets, and
IPRD.

At the acquisition date, InfraSearch was engaged in development activity
associated with distributed search technology. As of the acquisition date, this
technology was still under development and substantial efforts needed to be
completed prior to the release of a commercially viable product.



                                       22
<PAGE>   23

Overall Status of Business Combinations Prior to the quarter ended April 1, 2001

With respect to acquisitions completed prior to the quarter ended April 1, 2001,
we believe that the projections we used in performing our valuations for each
acquisition are still valid in all material respects; however, we cannot assure
you that the projected results will be achieved. We continue to make substantial
progress related to the development and commercialization of acquired
technologies. Although we have experienced delays in the completion of certain
of our development efforts and their related commercialization, the expected
total costs to complete such technologies have not materially increased,
individually or in the aggregate. We periodically evaluate our product
development timeline and modify our overall business plan in response to various
factors. Modifications to our business plan include the reallocation of
resources among various alternative development projects. The impact of delays
in the realization of economic benefits related to acquired technologies,
individually or in the aggregate, has not been material to our overall
consolidated financial position or results of operations as of and for the
quarter ended April 1, 2001.

INTEREST INCOME, NET
(dollars in millions)

<TABLE>
<CAPTION>
                                 Three Months Ended                         Nine Months Ended
                             ---------------------------               -------------------------
                             April 1,        March 26,                 April 1,         March 26,
                               2001            2000          Change      2001              2000        Change
                             --------        ---------       ------    --------         ---------      ------
<S>                          <C>             <C>             <C>       <C>              <C>            <C>
Interest income, net         $  110          $   44          150.0%        $  276          $105          162.9%
  Percentage of net
    revenues                    2.7%            1.1%                          1.9%          1.0%
</TABLE>

The increase in interest income (net of interest expense) of 150.0% and 162.9%
for the third quarter and first nine months of fiscal 2001, as compared with the
corresponding periods in fiscal 2000, was primarily due to higher average
balances of cash and marketable securities as well as higher yields resulting
from additional long-term securities. These increases are partially offset by
interest expense related to our issuance of the $1.5 billion of unsecured debt
securities in August 1999.

We expect our average balances of cash and marketable securities and related
interest income, net to decrease as a result of additional share repurchases
from Sun's stock repurchase programs in the fourth quarter of fiscal 2001.

Our interest income and expenses are sensitive 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. In
addition, to mitigate the impact of fluctuations in U.S. interest rates on our
fixed-rate unsecured debt securities, we have entered into interest rate swap
transactions so that the interest associated with these debt securities
effectively becomes variable.


                                       23
<PAGE>   24

INCOME TAXES
(dollars in millions)

<TABLE>
<CAPTION>
                                    Three Months Ended                            Nine Months Ended
                                ---------------------------                  -------------------------
                                April 1,        March 26,                    April 1,         March 26,
                                  2001            2000          Change         2001              2000        Change
                                --------        ---------       ------       --------         ---------      ------
<S>                             <C>             <C>             <C>          <C>              <C>            <C>
Provision for income taxes      $  113          $  250          -54.8%        $  685          $ 560           22.3%
Percentage of income
  before income taxes             45.4%           32.9%                         39.1%          33.1%
</TABLE>

Our effective income tax rate was 45.4% and 39.1% for the third quarter and
first nine months of fiscal 2001, as compared with 32.9% and 33.1% for the
corresponding periods in fiscal 2000. The changes in our effective tax rate were
primarily due to the nondeductibility of certain accounting charges associated
with our merger and acquisition activities, such as IPRD and goodwill. Excluding
these accounting charges, our effective rate was 33.6% for the third quarter and
first nine months of fiscal 2001, as compared with 32.1% for the corresponding
periods in fiscal 2000. The remaining increase in effective tax rate was
primarily due to proportionately greater forecasted earnings in higher tax rate
jurisdictions.

We currently expect our effective tax rate to remain at 33.6% for the fourth
quarter of fiscal 2001. This excludes the impact of accounting charges
associated with our merger and acquisition activities. Our expected rate is
based on current tax law and current estimates of earnings, and is subject to
change. While our effective tax rate under generally accepted accounting
principles for the fourth quarter of fiscal 2001 is expected to be approximately
39.1%, this rate may change upon the completion of new mergers and acquisitions,
such as the recently closed acquisitions of HighGround Systems, Inc.
(HighGround) and LSC, Incorporated (LSC) or changes in the amount of goodwill
amortization we recognize.

OPERATING EBITDA
(dollars in millions)

<TABLE>
<CAPTION>
                                    Three Months Ended                             Nine Months Ended
                                ---------------------------                   -------------------------
                                April 1,        March 26,                     April 1,          March 26,
                                  2001            2000           Change         2001               2000        Change
                                --------        ---------        ------       --------          ---------      ------
<S>                             <C>             <C>              <C>          <C>               <C>            <C>
Operating EBITDA                $    526        $    787          -33.2%      $  2,380          $2,022         17.7%
 Percentage of net revenues         12.8%           19.7%                         16.7%           18.9%
</TABLE>


Operating EBITDA represents earnings before interest, income taxes,
depreciation, amortization (including amortization of stock-based compensation),
and other non-operating items, such as gain (loss) on investments and IPRD. We
believe that operating EBITDA is a useful measure of operating performance which
provides focus on business fundamentals that track critical longer term trends.
Though operating EBITDA as a measure of performance is significantly more
cash-like, it is not intended to represent, nor does it represent, cash flows
for the period, or funds available for dividends, reinvestment or other
discretionary uses. Operating EBITDA has been presented as a useful supplement,
not as a substitute, for measures of performance prepared and presented in
accordance with generally accepted accounting principles.

During the third quarter and first nine months of fiscal 2001, operating EBITDA
as a percentage of net revenues decreased, as compared with the corresponding
periods in fiscal 2000. The decrease in operating EBITDA as a percentage of net
revenues was primarily due to the decline in total gross margins as a percentage
of net revenues in the third quarter and first nine months of fiscal 2001.
Despite this decline, our operating EBITDA as a percentage of net revenues
decreased at a lesser rate in the third quarter and the first nine months



                                       24
<PAGE>   25

of fiscal 2001, as compared with the corresponding periods in fiscal 2000, due
to decreased operating expenses. The decrease in operating expenses for the
third quarter from the corresponding period in fiscal 2000 was primarily due to
the third quarter adjustments in accruals for variable compensation. The
decrease in operating expenses for the first nine months of fiscal 2001 from the
corresponding period in fiscal 2000 was primarily due to our ability to operate
efficiently and manage operating expenses. We are continuing to focus on
improving this leverage on our cost structure.


LIQUIDITY AND CAPITAL RESOURCES
(dollars in millions)

<TABLE>
<CAPTION>
                                           April 1, 2001     June 30, 2000               Change
                                           -------------     -------------               ------
<S>                                        <C>               <C>                         <C>
Cash, cash equivalents, and investments         $  7,249          $  6,971               4.0%
Percentage of total assets                          40.5%             49.3%
Days sales outstanding (DSO)                          64                48
Inventory turns                                     13.9              17.5
</TABLE>


<TABLE>
<CAPTION>
                                                               Nine Months Ended
                                                         -------------------------------
                                                         April 1, 2001    March 26, 2000       Change
                                                         -------------    --------------       ------
<S>                                                      <C>              <C>                 <C>
Net cash provided by operating activities                   $ 2,023          $ 2,002             1.0%
Net cash used in investing activities                       $(2,044)         $(2,873)          (28.9)%
Net cash (used in) provided by financing activities         $  (541)         $ 1,234          (143.8)%
</TABLE>

At April 1, 2001, cash, cash equivalents and investments increased $278 million
from June 30, 2000. The increase was partially due to cash flows generated from
operating activities of $2,023 million, which represented our principal source
of cash. Cash flows provided by operating activities were generated primarily
from net income as adjusted for income tax benefits from employee stock plans
and depreciation and amortization, and were partially offset by increases in
accounts receivable (net) and inventory. The cash flows provided by operating
activities were offset by the following investing and financing uses: (1)
capital spending of $942 million for real estate development and equipment
additions to support increased headcount, primarily in our services, engineering
and marketing organizations; and (2) acquisition of treasury stock for $804
million. On February 14, 2001, the Company's Board of Directors authorized a new
stock repurchase program to acquire its outstanding common stock in the open
market. Sun's management currently intends to buy back up to $1.5 billion of its
outstanding common stock. This new repurchase program is in addition to Sun's
other on-going stock repurchase programs. During the quarter ended April 1,
2001, the Company repurchased $493 million of common stock under all repurchase
programs (as compared with $804 million for the nine months ended April 1,
2001).

Accounts receivable (net) increased to $2,913 million at April 1, 2001 from
$2,690 million at June 30, 2000. The increase in accounts receivable (net) and
DSO were primarily due to the timing of sales and payments by customers.
Inventory increased to $899 million at April 1, 2001 from $557 million at June
30, 2000. The increase in inventory and decline in inventory turns was primarily
due to the impact of: (1) Sun's decision to carry more inventory to better meet
customer demand and provide better customer service; (2) current macroeconomic
conditions; and (3) product transitions which required us to carry inventory
relating to both new and old versions of our products.

We have a $500 million revolving credit facility ("Facility") with a syndicate
of commercial banks. The Facility is available subject to compliance with
certain covenants. Sun is currently in compliance with the covenants. No amounts
were outstanding under the Facility at April 1, 2001.



                                       25
<PAGE>   26

We currently have effective shelf registration statements on file with the
Securities and Exchange Commission that permit us to offer up to $4.0 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. On August 4, 1999, we issued $1.5 billion in unsecured debt
securities in four tranches (the "Senior Notes") under these registration
statements. The Senior Notes are due at various times between August 2002 and
August 2009.

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


RISK FACTORS

IF WE ARE UNABLE TO COMPETE EFFECTIVELY WITH EXISTING OR NEW COMPETITORS, OUR
RESULTING LOSS OF COMPETITIVE POSITION COULD RESULT IN PRICE REDUCTIONS, FEWER
CUSTOMER ORDERS, REDUCED REVENUES, REDUCED MARGINS, REDUCED LEVELS OF
PROFITABILITY, AND LOSS OF MARKET SHARE.

We compete in the hardware and software products and services markets. These
markets are intensely competitive. If we fail to compete successfully in these
markets, the demand for our products and services would decrease. Any reduction
in demand could lead to a decrease in the prices of our products and services,
fewer customer orders, reduced revenues, reduced margins, reduced levels of
profitability, and 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 Hewlett-Packard Company (HP), International Business Machines
Corporation (IBM), Compaq Computer Corporation (Compaq), and EMC Corporation
(EMC). Our future competitive performance depends on a number of factors,
including our ability to: continually develop and introduce new products and
services with better prices and performance than those offered by our
competitors; offer a wide range of products and solutions from small
single-processor systems to large complex enterprise-level systems; offer
solutions to customers that operate effectively within a computing environment
that includes hardware and software from multiple vendors; offer products that
are reliable and that ensure the security of data and information; create
products for which third party software vendors will develop a wide range of
applications; and offer high quality products and services.

We also compete with systems manufacturers and resellers of systems based on
microprocessors from Intel Corporation (Intel) and Windows operating system
software from Microsoft Corporation (Microsoft). These competitors include Dell
Computer Corporation (Dell), HP, and Compaq, in addition to Intel and Microsoft.
This competition creates increased pressure, including pricing pressure, on our
workstation and lower-end server product lines. We expect this competitive
pressure to intensify considerably during fiscal year 2001, with the anticipated
releases of new software products from Microsoft and new microprocessors from
Intel.

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



                                       26
<PAGE>   27

affected. In addition, if in responding to competitive pressures, we are forced
to lower the prices of our products or services and we are unable to reduce our
component costs or improve operating efficiencies, our business and operating
results would be adversely affected.

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

THE PRODUCTS WE MAKE ARE VERY COMPLEX. IF WE ARE UNABLE TO RAPIDLY AND
SUCCESSFULLY DEVELOP AND INTRODUCE NEW PRODUCTS, WE WILL NOT BE ABLE TO SATISFY
CUSTOMER DEMAND.

We operate in a highly competitive, quickly changing environment, and our future
success depends on our ability to develop and introduce new products that our
customers choose to buy. If we are unable to develop new products, our business
and operating results 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 we plan to introduce later in
fiscal 2001 which incorporate our new UltraSPARC(TM) III architecture, the
Solaris Operating Environment, our Sun StorEdge(TM) storage products, and other
software products, such as those products under development or to be developed
under our alliance with AOL. The development process for these complicated
products is very uncertain. It requires high levels of innovation from both our
product designers and our suppliers of the components used in our products. The
development process is also lengthy and costly. If we fail to accurately
anticipate our customers' needs and technological trends, or are otherwise
unable to complete the development of a product on a timely basis, we will be
unable to introduce new products into the market on a timely basis, if at all,
and our business and operating results would be adversely affected. In addition,
the successful development of software products under our alliance with AOL
depends on many factors, including our ability to work effectively within the
alliance on complex product development, and any encumbrances on the licensed
technology that may arise from time to time may prevent us from developing,
marketing, or selling these alliance software products. If we are unable to
successfully develop, market, or sell the alliance software products or other
software products, our business and operating results could be adversely
affected.

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

The manufacture and introduction of our new hardware and software products is
also a complicated process. Once we have developed a new product we face several
challenges in the manufacturing process. We must be able to manufacture new
products in high enough volumes so that we can have an adequate supply of new
products to meet customer demand. We must be able to manufacture the new
products at acceptable costs. This requires us to be able to accurately forecast
customer demand so that we can procure the appropriate components at optimal
costs. Forecasting demand requires us to predict order volumes, the correct
mixes of our software and hardware products, and the correct configurations of
these products. We must manage new



                                       27
<PAGE>   28

product introductions, such as the introduction of our new UltraSPARC III
architecture during fiscal 2001, so that we can minimize the impact of customers
delaying purchases of existing products in anticipation of the new product
release. We must also try to reduce the levels of older product and component
inventories to minimize inventory write-offs. Additionally, we may decide to
adjust prices of our existing products during this process to try to increase
customer demand for these products. If we are introducing new products at the
same time or shortly after the price adjustment, this will complicate our
ability to anticipate customer demand for our new products.

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

OUR RELIANCE ON SINGLE SOURCE SUPPLIERS COULD DELAY PRODUCT SHIPMENTS AND
INCREASE OUR COSTS.

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

OUR FUTURE OPERATING RESULTS DEPEND ON OUR ABILITY TO PURCHASE A SUFFICIENT
AMOUNT OF COMPONENTS TO MEET THE DEMANDS OF OUR CUSTOMERS.

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

SINCE WE ORDER OUR COMPONENTS (AND IN SOME CASES COMMIT TO PURCHASE) FROM
SUPPLIERS IN ADVANCE OF RECEIPT OF CUSTOMER ORDERS FOR OUR PRODUCTS WHICH
INCLUDE THESE COMPONENTS, WE FACE A SUBSTANTIAL INVENTORY RISK.

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



                                       28
<PAGE>   29

component orders in advance of customer orders. Our business and operating
results could be adversely affected as a result of these increased costs.

DELAYS IN PRODUCT DEVELOPMENT OR CUSTOMER ACCEPTANCE AND IMPLEMENTATION OF NEW
PRODUCTS AND TECHNOLOGIES COULD SERIOUSLY HARM OUR BUSINESS.

Generally, the computer systems we sell to customers incorporate hardware and
software products that we sell, such as UltraSPARC microprocessors, the Solaris
Operating Environment and Sun StorEdge storage products. Any delay in the
development of the software and hardware included in our systems could delay our
shipment of these systems. Delays in the development and introduction of our
products may occur for various reasons. For example, delays in software
development could delay shipments of related new hardware products.

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

IF WE ARE UNABLE TO CONTINUE GENERATING SUBSTANTIAL REVENUES FROM INTERNATIONAL
SALES OUR BUSINESS COULD BE ADVERSELY AFFECTED.

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

WE EXPECT OUR QUARTERLY REVENUES AND OPERATING RESULTS TO FLUCTUATE FOR A NUMBER
OF REASONS.

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

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

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

Acquisitions/Alliances. If, in the future, we acquire technologies, products, or
businesses, or we form alliances with companies requiring technology investments
or revenue commitments (such as our alliance with AOL), we will face a number of
risks to our business. The risks we may encounter include those associated with
integrating or comanaging operations, personnel, and technologies acquired or
licensed, and the potential for unknown liabilities of the acquired or combined
business. Also, we will include amortization expense of



                                       29
<PAGE>   30

acquired intangible assets in our financial statements for several years
following these acquisitions. Our business and operating results on a quarterly
basis could be adversely affected if our acquisition or alliance activities are
not successful.

Significant Customers. Sales to a single customer accounted for approximately
19% and 15% of our fiscal 2000 and 1999 net revenues, respectively. The major
customer revenues in fiscal 2000 and 1999 were primarily generated by two
subsidiaries of an international organization: (1) a reseller (16% and 14% of
net revenues in 2000 and 1999, respectively), acquired by the international
organization in fiscal 1999; and (2) a finance/leasing company (3% and 1% of net
revenues in fiscal 2000 and 1999, respectively). Revenue is generated with the
finance/leasing company whenever a Sun customer elects to lease equipment; in
such cases, Sun sells the equipment to the leasing company. Our business could
suffer if these customers or any other significant customer terminated its
business relationship with us or significantly reduced the amount of business it
did with us.

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,
including our alliance with AOL. Acquisitions and alliance activities often
involve risks, including: difficulty in assimilating the acquired operations and
employees; difficulty in managing product codevelopment activities with our
alliance partners; retaining the key employees of the acquired operation;
disruption of our ongoing business; inability to successfully integrate the
acquired technology and operations into our business and maintain uniform
standards, controls, policies, and procedures; and lacking the experience to
enter into new markets, products, or technologies.

Failure to manage these 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. The expansion of high technology companies in
Silicon Valley and Colorado, as well as many other cities, has increased demand
and competition for qualified personnel. We may not be able to attract,
assimilate, or retain highly qualified employees in the future. These factors
could adversely affect our business.

BUSINESS INTERRUPTIONS COULD ADVERSELY AFFECT OUR BUSINESS.

Our operations are vulnerable to interruption by fire, earthquake, power loss,
telecommunications failure and other events beyond our control. A substantial
portion of our facilities, including our corporate headquarters and other
critical business operations, are located near major earthquake faults. In
addition, many of our facilities are located on filled land and, therefore, may
be more susceptible to damage if an earthquake occurs. We do not carry
earthquake insurance for direct earthquake-related losses. Our facilities in the
State of California, including our corporate headquarters and other critical
business operations, are currently subject to electrical blackouts as a
consequence of a shortage of available electrical power. In the event these
blackouts continue or increase in severity, they could disrupt the operations of
our affected facilities. In addition, we do not carry business interruption
insurance or carry financial reserves against business interruptions arising
from earthquakes,



                                       30
<PAGE>   31

electrical blackouts, or certain other causes. If a business interruption
occurs, our business could be seriously harmed.

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


ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk related to changes in interest rates, foreign
currency exchange rates, and equity security prices. To mitigate some of these
risks, we utilize derivative financial instruments. 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 April 1, 2001. Actual results may differ materially.

INTEREST RATE SENSITIVITY

Our investment portfolio consists primarily of fixed income instruments with an
average duration of less than 1.50 years. 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 and will decrease in value if market interest
rates increase. The sensitivity analysis applied to this investment portfolio
was based on a modeling technique that measures the hypothetical market value
changes that would result from a parallel shift in the yield curve of plus 150
basis points (BPS). The hypothetical 150 BPS increase in interest rates would
result in an approximate $55 million decrease in the fair value of our
investments in debt securities as of April 1, 2001.

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 and thus correlates with the
variable interest rate associated with our cash and marketable securities.


FOREIGN CURRENCY EXCHANGE RISK

The majority of our revenue, expense, and capital purchasing activities are
transacted in U.S. dollars. However, since a portion of our operations consists
of manufacturing and sales activities outside of the U.S., we enter into
transactions in other currencies, primarily the Japanese yen, the British pound
and the Euro. We enter into foreign exchange forward and option contracts to
hedge certain balance sheet exposures against future movements in foreign
exchange rates. The gains or losses on the forward and option contracts are
largely offset by gains or losses on the underlying transactions and,
consequently, a sudden or significant change in foreign exchange rates is not
expected to have a material impact on future net income or cash flows. Based on
our foreign currency exchange instruments outstanding at April 1, 2001, we
estimate a maximum potential one-day



                                       31
<PAGE>   32

loss in fair value of approximately $15 million, using a Value-at-Risk (VAR)
model. The VAR model estimates were made assuming normal market conditions and a
95% confidence level. We used a Monte Carlo simulation type model that valued
foreign currency instruments against three thousand randomly generated market
price paths. Anticipated transactions, firm commitments, receivables, and
accounts payable denominated in foreign currencies were excluded from the model.
The VAR model is a risk estimation tool, and as such is not intended to
represent actual losses in fair value that will be incurred by us. Additionally,
as we utilize foreign currency instruments for hedging anticipated and firmly
committed transactions, a loss in fair value for those instruments is generally
offset by increases in the value of the underlying exposure. Foreign currency
fluctuations did not have a material impact on our results of operations and
financial position for the first nine months of fiscal 2001. Also, refer to Note
5 of "Notes to Condensed Consolidated Financial Statements (Unaudited) -
Derivative Financial Instruments" for additional discussion.

EURO CONVERSION

On January 1, 1999, certain member countries of the European Union established
fixed conversion rates between their existing currencies and the Euro. The
transition period for the introduction of the Euro ends June 30, 2002. Issues
facing us as a result of the introduction of the Euro include converting
information technology systems, reassessing currency risk, negotiating and
amending licensing agreements and contracts, and processing tax and accounting
records. We continue to address these issues and do not currently expect the
Euro conversion to have a material effect on our financial conditions or results
of operations.

EQUITY SECURITY PRICE RISK

We are exposed to price fluctuations on the marketable portion of equity
securities included in our portfolio of strategic 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 $14 million decrease in the fair
value of our available-for-sale marketable strategic equity securities as of
April 1, 2001. At April 1, 2001, two equity securities represented approximately
$36 million of the total fair value of the marketable strategic equity
securities of $71 million. Also, refer to Note 4 of "Notes to Condensed
Consolidated Financial Statements (Unaudited) - Balance Sheet Details" for
additional discussion on Sun's marketable strategic equity securities.



                                       32
<PAGE>   33

                           PART II - OTHER INFORMATION

ITEM 1 - LEGAL PROCEEDINGS

On January 23, 2001, Sun and Microsoft Corporation agreed to settle the
litigation initiated by Sun on October 7, 1997 regarding Sun's Java technology.
Under the terms of the settlement agreement, Microsoft agreed to pay Sun $20
million and to terminate its license of the Java technology. In addition,
Microsoft was permanently enjoined from using Sun's JAVA COMPATIBLE (TM)
trademark and Sun agreed to grant Microsoft a new limited and conditional
license to continue shipping, essentially as is, its currently shipping
implementations of the 1.1.4 version of the Java technology. This new license
covers only the products that already contain the 1.1.4 version of the Java
technology and successor versions of those products, and lasts for seven years.
See Item 3 - Legal Proceedings in Sun's Form 10-K for the fiscal year ended June
30, 2000 for further discussion.


ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS

On March 14, 2001, Sun acquired InfraSearch, Inc. ("InfraSearch") in a
stock-for-stock merger. In exchange for all of the outstanding capital stock of
InfraSearch, we issued 331,593 shares of our common stock to the stockholders of
InfraSearch in a private placement pursuant to Section 4(2) of the Securities
Act of 1933, as amended.


ITEM 5 - OTHER INFORMATION

SCHEDULE OF SALES BY EXECUTIVE OFFICERS DURING THE QUARTER

The following is a summary of all sales of our common stock by our executive
officers and directors who are subject to Section 16 of the Securities Exchange
Act of 1934, as amended, during the fiscal quarter ended April 1, 2001:

<TABLE>
<CAPTION>
OFFICERS AND                       DATE OF                                 NUMBER OF
DIRECTORS                          TRANSACTION             PRICE           SHARES SOLD
<S>                                <C>                     <C>             <C>
Gregory M. Papadopoulos            1/24/01                 $32.5781        100,000 same-day-sale

Michael L. Popov                   1/24/01                 $31.6875        48,000 same-day-sale

Janpieter T. Scheerder             2/1/01                  $30.8750        80,000 same-day-sale

Jonathan I. Schwartz               2/6/01                  $27.5858        60,000 sale

John C. Shoemaker                  1/30/01                 $32.0234        160,000 same-day-sale

Edward J. Zander                   1/24/01                 $32.8500        250,000 same-day-sale
</TABLE>



                                       33
<PAGE>   34

ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K

  (a) Exhibits

      None.

  (b) Reports on Form 8-K

      No reports on Form 8-K were filed during the third quarter of fiscal 2001.



                                       34
<PAGE>   35

                                   SIGNATURES


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



                                         SUN MICROSYSTEMS, INC.


                                         BY

                                         /s/ Michael E. Lehman
                                         ------------------------------------
                                         Michael E. Lehman
                                         Executive Vice President, Corporate
                                         Resources and Chief Financial Officer
                                         (Principal Financial Officer)

                                         /s/ Michael L. Popov
                                         ------------------------------------
                                         Michael L. Popov
                                         Vice President and Corporate Controller
                                         (Chief Accounting Officer)


Dated:   May 16, 2001


                                       35