-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TyBfLqY+3Fh3xg4q1R9nwT2hhOuxUsn78s/wY4j56UUx3DTVaB4o/F6bex3+AyhM EpXwWz45SsE2rKaPEcpIRg== 0000891618-98-000491.txt : 19980210 0000891618-98-000491.hdr.sgml : 19980210 ACCESSION NUMBER: 0000891618-98-000491 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19971228 FILED AS OF DATE: 19980209 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SUN MICROSYSTEMS INC CENTRAL INDEX KEY: 0000709519 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRONIC COMPUTERS [3571] IRS NUMBER: 942805249 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-15086 FILM NUMBER: 98525881 BUSINESS ADDRESS: STREET 1: 901 SAN ANTONIO RD CITY: PALO ALTO STATE: CA ZIP: 94303 BUSINESS PHONE: 6509601300 MAIL ADDRESS: STREET 1: 901 SAN ANTONIO ROAD CITY: PALO ALTO STATE: CA ZIP: 94303 10-Q 1 FORM 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended December 28, 1997 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) Registrant's telephone number, including area code: (650) 960-1300 N/A (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. YES [ ] NO [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. CLASS OUTSTANDING AT DECEMBER 28, 1997 Common stock - $0.00067 par value 377,366,835 2 INDEX
PAGE ---- COVER PAGE 1 INDEX 2 PART I - FINANCIAL INFORMATION Item 1 - Financial Statements Condensed Consolidated Balance Sheets 3 Condensed Consolidated Statements of Income 4 Condensed Consolidated Statements of Cash Flows 5 Notes to Condensed Consolidated Financial Statements 7 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 10 PART II - OTHER INFORMATION Item 1 - Legal Proceedings 16 Item 4 - Submission of Matters to a Vote of Security Holders 16 Item 5 - Other Information 17 Item 6 - Exhibits and Reports on Form 8-K 18 Item 7a - Quantitative and Qualitative Disclosures About Market Risk 18 SIGNATURES 19
2 3 PART I - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS SUN MICROSYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands)
December 28, June 30, 1997 1997 ----------- ----------- (unaudited) ASSETS Current assets: Cash and cash equivalents $ 573,268 $ 660,170 Short-term investments 329,476 452,590 Accounts receivable, net 1,652,871 1,666,523 Inventories 459,579 437,978 Deferred tax assets 305,291 286,720 Other current assets 275,156 224,469 ----------- ----------- Total current assets 3,595,641 3,728,450 Property, plant and equipment, at cost 1,933,511 1,658,341 Accumulated depreciation and amortization (862,278) (858,448) ----------- ----------- 1,071,233 799,893 Other assets, net 269,730 168,931 ----------- ----------- $ 4,936,604 $ 4,697,274 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term borrowings $ 482 $ 100,930 Accounts payable 520,999 468,912 Accrued liabilities 938,846 963,012 Other current liabilities 311,287 316,184 ----------- ----------- Total current liabilities 1,771,614 1,849,038 Long-term debt and other obligations 137,782 106,299 Stockholders' equity 3,027,208 2,741,937 ----------- ----------- $ 4,936,604 $ 4,697,274 =========== ===========
See accompanying notes. 3 4 SUN MICROSYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited) (in thousands, except per share amounts)
Three Months Ended Six Months Ended -------------------------- -------------------------- December 28, December 29, December 28, December 29, 1997 1996 1997 1996 ---------- ---------- ---------- ---------- Net revenues $2,450,243 $2,081,588 $4,548,847 $3,940,607 Cost and expenses: Cost of sales 1,171,630 1,033,402 2,199,064 2,005,503 Research and development 259,228 201,010 481,846 387,278 Selling, general and administrative 696,450 591,331 1,311,943 1,115,997 Purchased in-process research and development 110,100 -- 162,284 -- ---------- ---------- ---------- ---------- Total costs and expenses 2,237,408 1,825,743 4,155,137 3,508,778 Operating income 212,835 255,845 393,710 431,829 Interest income, net 10,197 6,421 20,768 11,893 ---------- ---------- ---------- ---------- Income before income taxes 223,032 262,266 414,478 443,722 Provision for income taxes 73,600 83,925 156,613 141,991 ---------- ---------- ---------- ---------- Net income $ 149,432 $ 178,341 $ 257,865 $ 301,731 ========== ========== ========== ========== Net income per common share - basic $ 0.40 $ 0.48 $ 0.69 $ 0.82 ========== ========== ========== ========== Net income per common share - diluted $ 0.38 $ 0.46 $ 0.65 $ 0.77 ========== ========== ========== ========== Shares used in the calculation of net income per share - basic 373,875 368,381 372,968 367,748 ========== ========== ========== ========== Shares used in the calculation of net income per share - diluted 393,231 388,738 394,165 389,428 ========== ========== ========== ==========
See accompanying notes. 4 5 SUN MICROSYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (in thousands)
Six Months Ended ---------------------------- December 28, December 29, 1997 1996 ------------ ------------ Cash flow from operating activities: Net income $ 257,865 $ 301,731 Adjustments to reconcile net income to net cash provided from operating activities: Depreciation, amortization and other non-cash items 183,472 180,820 Tax benefit of options exercised 74,466 17,968 Purchased in-process research and development 162,284 -- Decrease (increase) in accounts receivable 16,004 (186,261) (Increase) decrease in inventories (15,765) 65,995 Increase in accounts payable 14,414 58,914 Net increase in other current and non-current assets (97,594) (37,045) Net increase in other current and non-current liabilities 19,301 12,517 --------- --------- Net cash provided from operating activities 614,447 414,639 --------- --------- Cash flow from investing activities: Acquisition of property, plant and equipment (410,453) (301,582) Acquisition of other assets (49,080) (22,241) Payment for acquisitions, net of cash acquired (227,655) -- Acquisition of short-term investments (305,738) (221,081) Maturities of short-term investments 438,431 371,676 --------- --------- Net cash (used by) investing activities (554,495) (173,228) --------- --------- Cash flow from financing activities: Issuance of common stock 37,189 18,101 Acquisition of treasury stock (140,537) (329,531) Proceeds from employee stock purchase plans 50,649 37,303 Reduction of short-term borrowings, net (100,448) (22,260) Increase (reduction) of long-term borrowings 6,293 (35,795) --------- --------- Net cash used by financing activities (146,854) (332,182) --------- --------- Net decrease in cash and cash equivalents $ (86,902) $ (90,771) ========= =========
5 6 Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 388 $ 8,198 Income taxes $ 55,503 $ 122,888 Supplemental schedule of non-cash investing and financing activities: The Company purchased Diba, Inc., Integrity Arts, Inc. and certain assets of Chorus Systems, S.A. and Encore Computer Corporation. In conjunction with these acquisitions, liabilities were assumed as follows: Fair value of assets acquired $ 284,294 Cash paid for assets (233,111) --------- Liabilities assumed $ 51,183 =========
See accompanying notes. 6 7 SUN MICROSYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) BASIS OF PRESENTATION The consolidated financial statements include the accounts of Sun Microsystems, Inc. ("Sun" or "the Company") and its wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated. Certain amounts from prior years have been reclassified to conform to current year presentation. While the quarterly financial information is unaudited, the financial statements included in this report reflect all adjustments (consisting only of normal recurring accruals) that the Company considers necessary for a fair presentation of the results of operations for the interim periods covered and of the financial condition of the Company at the date of the interim balance sheet. The results for the interim periods are not necessarily indicative of the results for the entire year. The information included in this report should be read in conjunction with the 1997 Annual Report to Stockholders which is incorporated by reference in the Company's 1997 Form 10-K (as amended on Form 10-K/A). INVENTORIES (IN THOUSANDS)
December 28, June 30, 1997 1997 ------------ -------- Raw materials $158,450 $236,900 Work in process 74,977 50,577 Finished goods 226,152 150,501 -------- -------- $459,579 $437,978 ======== ========
INCOME TAXES The Company accounts for income taxes under the liability method of Statement of Financial Accounting Standards No. 109. The provision for income taxes during the interim periods considers anticipated annual income before taxes, earnings of foreign subsidiaries permanently invested in foreign operations, and other differences. STOCK DIVIDEND The Company declared a two-for-one stock split (effected in the form of a stock dividend) to stockholders of record as of the close of business on November 18, 1996. Share and per share amounts presented have been adjusted to reflect the stock dividend. 7 8 EARNINGS PER SHARE The Company adopted Financial Accounting Standards No. 128 (FAS 128), "Earnings Per Share" in the second quarter of fiscal 1998. Share and per share amounts for all periods presented have been restated to comply with FAS 128.
THREE MONTHS ENDED December 28, 1997 December 29, 1996 ------------------------------- --------------------------------- Net income Shares EPS Net income Shares EPS ---------- ------- ------ ---------- ------- -------- Basic $149,432 373,875 $ 0.40 $178,341 368,381 $ 0.48 Effect of dilutive securities - options and warrants 19,356 20,357 ------- ------- Diluted $149,432 393,231 $ 0.38 $178,341 388,738 $ 0.46 ======= =======
SIX MONTHS ENDED December 28, 1997 December 29, 1996 ------------------------------- --------------------------------- Net income Shares EPS Net income Shares EPS ---------- ------- ------ ---------- ------- -------- Basic $257,865 372,968 $ 0.69 $301,731 367,748 $ 0.82 Effect of dilutive securities - options and warrants 21,197 21,680 ------- ------- Diluted $257,865 394,165 $ 0.65 $301,731 389,428 $ 0.77 ======= =======
ACQUISITIONS On August 22, 1997, the Company acquired all of the outstanding stock of Diba, Inc. for $25,000,000 in cash. The transaction was accounted for as a purchase and, on this basis, the excess purchase price over the estimated fair value of net tangible assets has been allocated, based upon an independent third-party valuation, to various intangible assets, primarily consisting of purchased in-process research and development and goodwill. In connection with this acquisition, purchased in-process research and development of $22,300,000, associated with products which had not achieved technological feasibility and for which no alternative uses have been established by the Company, was written off. Intangible assets, including goodwill, are being amortized over three years. The results of operations of Diba, Inc. from the date of acquisition through December 28, 1997 are included in the Company's consolidated statements of income and are not material to the Company. On September 22, 1997, the Company acquired all of the outstanding stock of Integrity Arts, Inc. for $30,200,000 in cash. The transaction was accounted for as a purchase and, on this basis, the excess purchase price over the estimated fair value of net tangible assets has been allocated, based upon an independent third-party valuation, to various intangible assets, primarily consisting of purchased in-process research and development and goodwill. In connection with this acquisition, purchased in-process research and development of approximately $29,900,000, associated with products which had not achieved technological feasibility and for which no alternative uses have been established by the Company, was written off. Intangible assets, including goodwill, are being amortized over three years. The results of operations of Integrity Arts, Inc. from the date of acquisition through December 28, 1997 are included in the Company's consolidated statements of income and are not material to the Company. On October 21, 1997, the Company acquired substantially all of the assets and certain liabilities of Chorus Systems, S.A. and its wholly-owned subsidiaries for approximately $26,500,000 in cash. The transaction was accounted for as a purchase and, on this basis, the excess purchase price over the estimated fair value of net tangible assets has been allocated, based upon an independent third-party valuation, to various intangible assets, primarily consisting of purchased in-process research and development and goodwill. In connection with this 8 9 acquisition, purchased in-process research and development of $13,100,000, associated with products which had not achieved technological feasibility and for which no alternative uses have been established by the Company, was written off. Intangible assets, including goodwill, are being amortized over three years. The results of operations of Chorus Systems, S.A. from the date of acquisition through December 28, 1997 are included in the Company's consolidated statements of income and are not material to the Company. On November 24, 1997, the Company acquired substantially all of the assets and certain liabilities of Encore Computer Corporation's storage products business for approximately $186,000,000 in cash, $35,000,000 of which is due in July 1998. The transaction was accounted for as a purchase and, on this basis, the excess purchase price over the estimated fair value of net tangible assets has been allocated, based upon an independent third-party valuation, to various intangible assets, primarily consisting of purchased in-process research and development and goodwill. In connection with this acquisition, purchased in-process research and development of $97,000,000, associated with products which had not achieved technological feasibility and for which no alternative uses have been established by the Company, was written off. Intangible assets, including goodwill, are being amortized over three years. The results of operations of the storage products business of Encore Computer Corporation from the date of acquisition through December 28, 1997 are included in the Company's consolidated statements of income and are not material to the Company. REGISTRATION STATEMENT On October 16, 1997, the Company filed a Registration Statement with the Securities and Exchange Commission relating to the registration for public offering of senior and subordinated debt securities and common stock with an aggregate initial public offering price of up to $1,000,000,000. On October 24, 1997, the Registration Statement became effective, so that the Company may now choose to offer, from time to time, the debt securities and common stock pursuant to Rule 415 in one or more separate series, in amounts, at prices and on terms to be set forth in the prospectus contained in the Registration Statement and in one or more supplements to the prospectus. 9 10 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table sets forth items from the Condensed Consolidated Statements of Income as a percentage of net revenues:
Three Months Ended Six Months Ended -------------------------- -------------------------- December 28, December 29, December 28, December 29, 1997 1996 1997 1996 ------------ ------------ ------------ ------------ Net revenues 100.0% 100.0% 100.0% 100.0% Cost of sales 47.8 49.6 48.3 50.9 ----- ----- ----- ----- Gross margin 52.2 50.4 51.7 49.1 Research and development 10.6 9.7 10.6 9.8 Selling, general and administrative 28.4 28.4 28.8 28.3 Purchased in-process research and development 4.5 -- 3.6 -- ----- ----- ----- ----- Operating income 8.7 12.3 8.7 11.0 Interest income, net 0.4 0.3 0.4 0.3 ----- ----- ----- ----- Income before income taxes 9.1 12.6 9.1 11.3 Provision for income taxes 3.0 4.0 3.4 3.6 ----- ----- ----- ----- Net income 6.1% 8.6% 5.7% 7.7% ===== ===== ===== =====
The following sections contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve risk and uncertainties such that actual results may vary materially. Certain factors that may affect the Company's results and financial condition over the next few quarters are discussed under the caption "Future Operating Results" below. Other factors that may affect such results and financial condition are set forth in the Company's 1997 Annual Report to Stockholders which is incorporated by reference in the Company's Form 10-K (as amended on Form 10-K/A), and the Company's Form 10-K, as amended. RESULTS OF OPERATIONS NET REVENUES Net revenues were $2.450 billion for the second quarter and $4.549 billion for the first six months of fiscal 1998, representing increases of 17.7% and 15.4%, respectively, over the comparable periods of fiscal 1997. The growth in revenue resulted primarily from strong demand for work group, enterprise and departmental servers, and from high-end storage, memory and related products. The remaining increase reflects growth in revenues from other Sun businesses, primarily service. 10 11 Domestic net revenues increased by 19.4% and 18% while international net revenues (including United States exports) grew 16.1% and 12.8% in the second quarter and first six months of fiscal 1998, respectively, compared with the corresponding periods of fiscal 1997. In US dollars, European net revenues increased 22.3% and 14.8%, Japanese net revenues decreased 3.8% and increased 2.8%, and net revenues in Rest of World increased 23% and 19.2% in the second quarter and first six months of fiscal 1998, respectively, when compared with the same periods of fiscal 1997. These increases are due primarily to continued strengthening of the markets in Europe and many of the markets in Asia, and are partially offset by the strengthening of the U.S. dollar. Japan experienced a modest increase in local currency revenue, but, when translated into US dollars, showed a decline for the second quarter of fiscal 1998 as compared with the same period of fiscal 1997. The Company generally manages currency exposure through the use of simple, short-term forward foreign exchange and currency option contracts, the objective of which is to minimize the impact of currency fluctuations on the results of operations. As the Company utilizes projected data to establish its forward foreign exchange and currency option contracts, variances which result from forecasting differences and the extent of currency movement during the quarter could have a material adverse effect on the results of operations and cash flows. GROSS MARGIN Gross margin was 52.2% for the second quarter and 51.7% for the first six months of fiscal 1998, compared with 50.4% and 49.1%, respectively, for the corresponding periods in fiscal 1997. The increase in the gross margin for the periods compared primarily reflects the effects of increased revenues generated from higher margin servers and storage products, as well as continued decreases in costs of key components, including chips, memory and storage. The factors described above resulted in a favorable impact on gross margin for the second quarter and first six months of fiscal 1998. The Company continuously evaluates the competitiveness of its product offerings. These evaluations could result in repricing actions in the near term. Sun's future operating results would be adversely affected if such repricing actions were to occur and the Company were unable to mitigate the resulting margin pressure by maintaining a favorable mix of systems, storage, software, service, and other products and by achieving component cost reductions, operating efficiencies and by increasing volumes. RESEARCH AND DEVELOPMENT Research and development (R&D) expenses were $259.2 million in the second quarter and $481.8 million for the first six months of fiscal 1998, compared with $201.0 and $387.3 million for the same periods of fiscal 1997. As a percentage of net revenues, R&D expenses increased to 10.6% for both the second quarter and the first six months of fiscal 1998 from 9.7% and 9.8%, respectively, in the corresponding periods of fiscal 1997. These increases reflect the increased expenditures focused on the development of hardware and software products which utilize the Java architecture, as well as the continued development of ULTRASparc systems, low-end desktop systems, storage products, products acquired through acquisitions, and increased compensation due primarily to an increase in personnel. 11 12 SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative (SG&A) expenses were $696.5 million in the second quarter and $1,311.9 million in the first six months of fiscal 1998, compared with $591.3 and $1,116.0 million for the same periods of fiscal 1997. As a percentage of net revenues, SG&A expenses were 28.4% and 28.8% in the second quarter and first six months of fiscal 1998, respectively, and 28.4% and 28.3%, respectively in the corresponding periods of fiscal 1997. The dollar increases are primarily attributable to increased compensation resulting from higher levels of headcount (principally in the sales organization) in addition to marketing costs related to demand creation programs. The increase is also due to costs incurred in connection with the Company's ongoing efforts to improve business processes and cycle times. The Company expects to continue to hire personnel to further expand its demand creation programs and support organizations. PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT Purchased in-process research and development represents the write-off of purchased in-process research and development associated with the Company's acquisitions of Diba, Inc., Integrity Arts, Inc., Chorus Systems, S.A. and the storage products business of Encore Computer Corporation. Such write-offs were $110.1 million and $162.3 million, respectively, for the second quarter and first six months of fiscal 1998. There were no such charges in the corresponding periods of fiscal 1997. INTEREST INCOME, NET Net interest income was $10.2 million for the second quarter and $20.8 million for the first six months of fiscal 1998, compared with $6.4 million and $11.9 million, respectively, for the corresponding periods in fiscal 1997. The increases are primarily the result of higher interest earnings due to a larger average portfolio of cash and short-term investments. INCOME TAXES The Company's effective income tax rate was 33% for the second quarter and first six months of fiscal 1998 before a $19.8 million tax charge resulting from a non-recurring write-off of in-process research and development associated with the acquisitions of Diba, Inc. and Integrity Arts, Inc. during the first quarter of fiscal 1998. The effective income tax rate for the first six months of fiscal 1998 including such tax charge was 38%. The effective income tax rate for the second quarter and first six months of fiscal 1997 was 32%. The increase in the overall effective tax rate to 33% for fiscal 1998 is attributable to an increase in anticipated worldwide earnings without offsetting tax credits or other tax savings. FUTURE OPERATING RESULTS The market for Sun's products and services is intensely competitive and subject to continuous, rapid technological change, short product life cycles and frequent product performance improvements and price reductions. Due to the breadth of the Company's product lines and the scalability of its products and network computing model, Sun competes in many segments of the network computing market across a broad spectrum of customers. The Company expects the markets for its products and technologies, as well as its competitors within such markets, will continue to change as the rightsizing trend shifts customer buying patterns to network based systems which often employ solutions from multiple vendors. Competition in these markets will also continue to intensify as Sun and its competitors, principally Hewlett-Packard Corporation, International Business Machines Corporation, Digital Equipment Corporation, and Silicon Graphics, Inc., aggressively position themselves to benefit from this shifting of customer buying patterns and demand. The Company is also facing competition from these competitors, as well as other systems manufacturers, such as Compaq Computer Corporation and Dell Computer Corporation, with respect to products based on microprocessors from Intel Corporation coupled with Windows NT operating system software from Microsoft Corporation. These products demonstrate the viability of certain networked personal computer solutions and have increased the competitive pressure, particularly in the Company's workstation and lower-end server product lines. Finally, the timing of introductions of new products and services by Sun's competitors may negatively impact the future operating results of the Company, particularly when such introductions occur in periods leading up to the Company's introduction of its own new enhanced products. The Company expects this pressure to continue and intensify throughout fiscal 1998 and beyond. While many other technical, service and support capabilities affect a customer's buying decision, the Company's future operating results will depend, in part, on its ability to compete with these technologies. 12 13 The Company's future operating results will depend to a considerable extent on its ability to rapidly and continuously develop, introduce, and deliver in quantity new systems, storage, software, and service products, as well as new microprocessor technologies, that offer its customers enhanced performance at competitive prices. The development of new high-performance computer products, such as the Company's development of the UltraSPARC microprocessor is a complex and uncertain process requiring high levels of innovation from the Company's designers and suppliers, as well as accurate anticipation of customer requirements and technological trends. Once a hardware product is developed, the Company must rapidly bring such products to volume manufacturing, a process that requires accurate forecasting of volumes, mix of products and configurations, among other things in order to achieve acceptable yields and costs. Future operating results will depend to a considerable extent on the Company's ability to closely manage product introductions in order to minimize unfavorable patterns of customer orders, to reduce levels of older inventory and to ensure that adequate supplies of new products can be delivered to meet customer demand. The ability of the Company to match supply and demand is further complicated by the Company's need to adjust prices to reflect changing competitive market conditions as well as the variability and timing of customer orders with respect to the Company's older products. As a result, the Company's operating results could be adversely affected if the Company is not able to correctly anticipate the level of demand for the mix of products. Because the Company is continuously engaged in this product development, introduction, and transition process, its operating results may be subject to considerable fluctuation, particularly when measured on a quarterly basis. The Company is increasingly dependent on the ability of its suppliers to design, manufacture, and deliver advanced components required for the timely introduction of new products. The failure of any of these suppliers to deliver components on time or in sufficient quantities, or the failure of any of the Company's own designers to develop advanced innovative products on a timely basis, could result in a significant adverse impact on the Company's operating results. The inability to secure enough components to build products, including new products, in the quantities and configurations required, or to produce, test and deliver sufficient products to meet demand in a timely manner, would adversely affect the Company's net revenues and operating results. To secure components for development, production, and introduction of new products, the Company frequently makes advanced payments to certain suppliers and often enters into noncancelable purchase commitments with vendors early in the design process. Due to the variability of material requirement specifications during the design process, the Company must closely manage material purchase commitments and respective delivery schedules. In the event of a delay or flaw in the design process, the Company's operating results could be adversely affected due to the Company's obligations to fulfill such noncancelable purchase commitments. Generally, the computer systems sold by Sun, such as the UltraSPARC-based products, are the result of hardware and software development, such that delays in the software development can delay the ability of the Company to ship new hardware products. In addition, adoption of a new release of an operating system may require effort on the part of the customer and porting by software vendors providing applications. As a result, the timing of conversion to a new release is inherently unpredictable. Moreover, delays by customers in adopting a new release of an operating system can limit the acceptability of hardware products tied to that release. Such delays could adversely affect the future operating results of the Company. A significant portion of the Company's revenues is derived from international sales and is therefore subject to inherent risks related thereto, including the general economic and political conditions in each country, currency exchange rate fluctuations, the effect of the tax structures of various jurisdictions, changes to and compliance with a variety of foreign laws and regulations, trade protection measures and import and export licensing requirements. There can be no assurance that the economic crisis and currency issues currently being experienced in Asia will not have an adverse effect on the Company's revenue or revenue growth rates in the future. The impact of any of the foregoing factors could have an adverse effect on the Company's financial condition and operating results. 13 14 Seasonality also affects the Company's operating results, particularly in the first quarter of each fiscal year. In addition, the Company's operating expenses are increasing as the Company continues to expand its operations, and future operating results will be adversely affected if revenues do not increase accordingly. Additionally, the Company plans to continue to evaluate and, when appropriate, make acquisitions of complementary technologies, products or businesses. As part of this process, the Company will continue to evaluate the changing value of its assets, and when necessary, make adjustments thereto. In order to remain competitive in a rapidly changing industry, the Company is continually improving and changing its business practices, processes, and information systems. In this regard, the Company has begun to implement a number of new business practices and a series of related information systems; such activities are currently planned to be fully operational in the first half of fiscal year 1999. Implementing a number of new business practices and information systems is a complex process, affecting numerous operational and financial systems and processes as well as requiring comprehensive employee training. While the Company tests these new systems and processes in advance of implementation, there are inherent limitations in the Company's ability to simulate a full-scale operating environment in advance of the system cutover. To the extent that the Company encounters problems after introduction of these new systems and practices that prevent or limit their full utilization, there could be a material, adverse impact on the Company's operating results. Many installed computer systems and software products are coded to accept only two digit entries in the date code field. As the year 2000 approaches, these code fields will need to accept four digit entries to distinguish years beginning with "19" from those beginning with "20" dates. As a result, in less than two years, computer systems and/or software products used by many companies may need to be upgraded to comply with such year 2000 requirements. The Company is currently expending significant resources to review its products and services, as well as its internal management information systems in order to identify and modify those products, services and systems that are not year 2000 compliant. The Company expects such modifications will be made on a timely basis and does not believe that the cost of such modifications will have a material effect on the Company's operating results. There can be no assurance, however, that the Company will be able to modify timely and successfully such products, services and systems to comply with year 2000 requirements, which could have a material adverse effect on the Company's operating results. Based on the Company's assessment to date, most newly introduced products and services of the Company are year 2000 compliant, however some of the Company's customers are running product versions that are not year 2000 compliant. The Company has been encouraging such customers to migrate to current product versions. In addition, the Company faces risks to the extent that suppliers of products, services and systems purchased by the Company and others with whom the Company transacts business on a worldwide basis do not have business systems or products that comply with the year 2000 requirements. In the event any such third parties cannot timely provide the Company with products, services or systems that meet the year 2000 requirements, the Company's operating results could be materially adversely affected. Furthermore, there can be no assurance that these or other factors relating to the year 2000 compliance issues, including litigation, will not have a material adverse effect on the Company's business, operating results or financial condition. While the Company can not predict what effect these various factors may have on its financial results, the aggregate effect of these and other factors could result in significant volatility in the Company's future performance and stock price. 14 15 LIQUIDITY AND CAPITAL RESOURCES Total assets at December 28, 1997 increased by approximately $239.3 million from June 30, 1997, due principally to increases in inventory of $21.6 million, property, plant and equipment-net of $271.3 million, other current assets and deferred tax assets of $69.3 million and other assets of $100.8 million, offset by decreases in cash, cash equivalents and short-term investments of $210 million and accounts receivable of $13.7 million. The decrease in accounts receivable reflects slightly lower revenue in the second quarter of fiscal 1998 relative to the fourth quarter of fiscal 1997. The increase in inventory is the result of inventory acquired through acquisitions and is also due to the slightly lower revenue in the second quarter of fiscal 1998 as compared to the fourth quarter of fiscal 1997. The increase in property, plant and equipment reflects capital spending for real estate development of the Company's facilities, assets acquired through acquisitions and capital additions to support increased headcount, primarily in the Company's engineering, service and marketing organizations. Other current assets increased due to the timing of payments for insurance and other taxes and other assets increased due to the recording of goodwill and other intangible assets related to the Company's acquisitions. Total current liabilities decreased $77.4 million from June 30, 1997, due principally to decreases in short-term borrowings of $100.4 million, accrued liabilities of $24.2 million and other current liabilities of $4.9 million, offset by an increase in accounts payable of $52.1 million. The decrease in short-term borrowings reflects payments related to debt of subsidiaries. The decrease in accrued liabilities reflects the payment of performance-based compensation and commissions, offset by increases in warranty and the employee stock participation program liability. The decrease in other current liabilities is the offset of a decrease in deferred revenue and an increase in income taxes payable. The increase in accounts payable reflects increased inventory balances and a payment due on one of the Company's acquisitions. At December 28, 1997, the Company's primary sources of liquidity consisted of cash, cash equivalents and short-term investments of $902.7 million and a revolving credit facility with banks aggregating $500 million, which was available subject to compliance with certain covenants. On October 16, 1997, the Company filed a Registration Statement with the Securities and Exchange Commission relating to the registration for public offering of senior and subordinated debt securities and common stock with an aggregate initial public offering price of up to $1,000,000,000. On October 24, 1997, the Registration Statement became effective, so that the Company may now choose to offer, from time to time, the debt securities and common stock pursuant to Rule 415 in one or more separate series, in amounts, at prices and on terms to be set forth in the prospectus contained in the Registration Statement and in one or more supplements to the prospectus. The Company believes that the liquidity provided by existing cash and short-term investment balances and the offering and borrowing arrangements described above will be sufficient to meet the Company's capital requirements through fiscal 1998. However, the Company believes the level of financial resources is a significant competitive factor in its industry and may choose at any time to raise additional capital through debt or equity financing to strengthen its financial position, facilitate growth and provide the Company with additional flexibility to take advantage of business opportunities that may arise. 15 16 PART II - OTHER INFORMATION ITEM 1 - LEGAL PROCEEDINGS On October 7, 1997, the Company filed suit against Microsoft Corporation in the United States District Court for the Northern District of California alleging breach of contract, trademark infringement, false advertising, unfair competition, interference with prospective economic advantage and inducing breach of contract. The Company filed an amended complaint on October 14, 1997. Microsoft Corporation filed its answer, affirmative defenses and counterclaims to the amended complaint. The counterclaims include breach of contract, breach of the covenant of good faith and fair dealing, violation of the California Business & Professions Code and declaratory judgment. The Company believes that the counterclaims are without merit and/or that the Company has affirmative defenses and intends vigorously to defend itself with respect thereto. The Company believes that the outcome of this matter will not have a material adverse impact on Sun's financial condition, results of operations or cash flows in any given fiscal year. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On November 12, 1997, the Annual Meeting of Stockholders of the Company was held in Menlo Park, California. The results of voting of the 308,000,440 shares of common stock represented at the meeting are as described below. An election of directors was held with the following individuals being elected to the Board of Directors of the Company:
Shares Voted For Votes Withheld ---------------- -------------- Scott G. McNealy 306,596,583 1,403,857 L. John Doerr 306,572,798 1,427,642 Judith L. Estrin 306,568,115 1,432,325 Robert J. Fisher 306,545,429 1,455,011 Robert L. Long 306,581,242 1,419,198 M. Kenneth Oshman 306,609,507 1,390,933 A. Michael Spence 306,561,299 1,439,141
The seven nominees who received the highest number of votes (all of the above individuals) were elected to the Board of Directors. The stockholders approved an amendment to the Company's 1990 Employee Stock Purchase Plan in order to increase the number of shares of common stock reserved for issuance thereunder by 10,000,000 shares of common stock to an aggregate of 55,800,000 shares. There were 250,085,154 votes cast for the amendment, 52,803,996 votes against the amendment, 1,437,287 abstentions and 3,674,003 broker non-votes. The stockholders approved an amendment to the 1988 Directors' Stock Option Plan (1988 DSOP) in order to (i) extend the duration of the 1988 DSOP by approximately ten (10) additional years and (ii) increase the number of shares of common stock reserved for issuance thereunder by 600,000 shares of common stock to an aggregate of 2,200,000 shares. There were 214,860,004 votes cast for the amendment, 91,365,940 votes cast against the amendment and 1,774,496 abstentions. The stockholders approved the adoption of the 1997 French Stock Option Plan (1997 FSOP) and the reservation for issuance thereunder of 3,000,000 shares of common stock. There were 228,328,042 votes cast for the 1997 FSOP, 77,566,926 shares against the 1997 FSOP and 2,105,472 abstentions. 16 17 ITEM 5 - OTHER INFORMATION SCHEDULE OF SALES BY EXECUTIVE OFFICERS DURING THE QUARTER The following is a summary of all sales of the Company's Common Stock by the Company's executive officers and directors who are subject to Section 16 of the Securities Exchange Act of 1934, as amended, during the fiscal quarter ended December 28, 1997:
OFFICER/ NUMBER OF DIRECTOR DATE PRICE SHARES SOLD ================================================================= L. John Doerr 11/3/97 $35.75 10,000 11/3/97 $36.00 5,000 11/3/97 $36.25 5,000 Scott G. McNealy 11/13/97 $31.3958 150,000 11/18/97 $35.6310 150,000 John Shoemaker 10/24/97 $37.3675 1,000 10/24/97 $37.305 4,000 A. Michael Spence 11/18/97 $35.50 9,500 Edward J. Zander 10/29/97 $36.8958 15,000
17 18 ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K a) EXHIBITS 10.64(1) 1988 Directors' Stock Option Plan, as amended on August 13, 1997 10.65(1) 1990 Employee Stock Purchase Plan, as amended on August 13, 1997 10.94(2) 1997 French Stock Option Plan 27.0 Financial data for the period ended December 28, 1997 (1) Incorporated by reference to Exhibits 4.2 and 4.1, respectively, filed as exhibits to the Registrant's Registration Statement on Form S-8, file no. 333-40677, filed with the Securities and Exchange Commission on November 20, 1997. (2) Incorporated by reference to Exhibit 4.1 filed as an exhibit to the Registrant's Registration Statement on Form S-8, file no. 333-40675, filed with the Securities and Exchange Commission on November 20, 1997. b) REPORTS ON FORM 8-K No reports on Form 8-K were filed during the quarter ended December 28, 1997. ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's market risk disclosures set forth in the 1997 Annual Report to Stockholders have not changed significantly. 18 19 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SUN MICROSYSTEMS, INC. BY /s/ Michael E. Lehman ----------------------------------------- Michael E. Lehman Vice President, Corporate Resources and Chief Financial Officer /s/ George Reyes ----------------------------------------- George Reyes Vice President and Corporate Controller, Chief Accounting Officer Dated: February 9, 1998 19 20 EXHIBIT INDEX SUN MICROSYSTEMS, INC. EXHIBIT NUMBER EXHIBIT TITLE 10.64(1) 1988 Directors' Stock Option Plan, as amended on August 13, 1997 10.65(1) 1990 Employee Stock Purchase Plan, as amended on August 13, 1997 10.94(2) 1997 French Stock Option Plan 27.0 Financial data for the period ended December 28, 1997 (1) Incorporated by reference to Exhibits 4.2 and 4.1, respectively, filed as exhibits to the Registrant's Registration Statement on Form S-8, file no. 333-40677, filed with the Securities and Exchange Commission on November 20, 1997. (2) Incorporated by reference to Exhibit 4.1 filed as an exhibit to the Registrant's Registration Statement on Form S-8, file no. 333-40675, filed with the Securities and Exchange Commission on November 20, 1997. 20 EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS JUN-30-1997 SEP-29-1996 DEC-29-1996 438,083 312,657 1,392,873 154,086 394,919 2,968,890 1,549,677 848,739 3,866,620 1,481,451 40,000 0 0 73 2,304,094 3,866,620 2,081,588 2,081,588 1,033,402 1,825,743 0 9,160 2,132 262,266 83,925 178,341 0 0 0 178,341 0.46 0.46
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