-----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, ARj+FRX/K3DS4si/Rv1wUEeyK/u8b5zLYS/q84JfWihCDHZIIANNpuaW37OYr8+k wktOoyGJAnJN2FjykxrjSQ== 0000891618-98-004306.txt : 19980928 0000891618-98-004306.hdr.sgml : 19980928 ACCESSION NUMBER: 0000891618-98-004306 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980925 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-K SEC ACT: SEC FILE NUMBER: 000-15086 FILM NUMBER: 98714958 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-K 1 FORM 10-K 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ------------------------ (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM --------------- TO --------------- COMMISSION FILE NUMBER: 0-15086 SUN MICROSYSTEMS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) ------------------------ DELAWARE 94-2805249 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) 901 SAN ANTONIO ROAD (650) 960-1300 PALO ALTO, CA 94303 (REGISTRANT'S TELEPHONE NUMBER (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING AREA CODE) INCLUDING ZIP CODE)
------------------------ SECURITIES PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK COMMON SHARE PURCHASE RIGHTS ------------------------ Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference on Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the Registrant, as of September 15, 1998, was approximately $18,682,000,000 based upon the last sale price reported for such date on the Nasdaq National Market. For purposes of this disclosure, shares of Common Stock held by persons who hold more than 5% of the outstanding shares of Common Stock and shares held by officers and directors of the Registrant have been excluded because such persons may be deemed to be affiliates. This determination is not necessarily conclusive. The number of shares of the Registrant's Common Stock outstanding as of September 15, 1998 was 381,262,063. ------------------------ DOCUMENTS INCORPORATED BY REFERENCE Parts of the Annual Report to Stockholders for the fiscal year ended June 30, 1998 are incorporated by reference into Items 1, 5, 6, 7, 8 and 14 hereof. Parts of the Proxy Statement for the 1998 Annual Meeting of Stockholders are incorporated by reference into Items 10, 11, 12 and 13 hereof. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 PART I ITEM 1. BUSINESS This Annual Report on Form 10-K contains forwarding-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, particularly statements regarding market opportunities, market share growth, competitive growth, new product introductions, success of research and development, research and development expenses, customer acceptance of new products, gross margin and selling, general and administrative expenses. These forward-looking statements involve risks and uncertainties, and the cautionary statements set forth below, including those contained in "Additional Factors Affecting the Company's Business" identify important factors that could cause actual results to differ materially form those predicted in any such forward looking statements. Such factors include, but are not limited to, adverse changes in general economic conditions, including adverse changes in the specific markets for the Company's products, adverse business conditions, decreased or lack of growth in the computing industry, adverse changes in customer order patterns, increased competition, lack of acceptance of new products, pricing pressures, lack of success in technological advancement, risks associated with foreign operations (including the downturn of economic trends and unfavorable currency movements in the Asia Pacific marketplace), risks associated with the Company's efforts to comply with Year 2000 requirements, and other factors, including those listed below. GENERAL Sun Microsystems, Inc. (Sun or the Company) was incorporated in California in February, 1982 and reincorporated in Delaware in July, 1987. Sun is a leading supplier of enterprise network computing products including desktop systems, servers, storage subsystems, network switches, software, microprocessors, and a full range of services and support. Sun's products command a significant share of a rapidly growing segment of the computer industry: networked computing environments. The Company's products are used for many demanding commercial and technical applications in various industries. Sun has differentiated itself from its competitors by its commitment to the network computing model and the UNIX(R) operating system, its rapid innovation and its open systems architecture. During the last fiscal year, Sun began reorganizing its business around specific product development competencies operating under the direction of Sun's new Chief Operating Officer, Ed Zander. This reorganization was effective July 1, 1998. Sun's new divisions generally operate within their own charters, but with the common corporate strategic vision of being a leading force in network computing. Sun believes this new organizational structure allows it to more efficiently focus on its customers and the products, channels and markets necessary to serve them. The Company continually evaluates the effectiveness of its organizational structure and at any time may create, merge or discontinue various businesses to increase customer and product focus. Sun's business is now organized as follows: Computer Systems -- Computer Systems designs, manufactures, and sells a broad range of desktop systems, servers and network switches, incorporating the Scaleable Processor Architecture (SPARC) microprocessors and the Solaris(TM)software operating environment and it also sells storage subsystems, as well as software to enterprise customers. Network Storage -- Network Storage develops Sun's storage hardware and software platforms. Consumer and Embedded -- Consumer and Embedded develops and markets Sun's core technologies for consumers and embedded markets which includes Chorus and Java OS(TM) for Business(TM), PersonalJava(TM), EmbeddedJava(TM), Java Card(TM) implementations, the hardware and software for the set-top, auto and phone markets, Diba technologies and the Jini and Persona projects. - --------------- Sun, the Sun Logo, Sun Microsystems, Sun Workshop, Solaris Solstice, Sun Enterprise, Sun Internet Mail Server, Java, EmbeddedJava, PersonalJava, Java Card, Java OS, Java OS for Business, Ultra, Ultra Enterprise, Java Studio, Java Beans, JDK, Sunergy, Gigaplane-XB, Sun Spectrum, Java Compatible, the Java Compatible logo are trademark or registered trademarks of Sun Microsystems, Inc. in the United States and other countries. All SPARC trademarks, including UltraSPARC, are used under license and are trademarks or registered trademarks of SPARC International, Inc. in the United States and other countries. Products bearing SPARC trademarks are based upon an architecture developed by Sun Microsystems, Inc. UNIX is a registered trademark in the United States and other countries, exclusively licensed through X/OpenCompany Ltd. 1 3 Enterprise Services -- Enterprise Services, a leading UNIX service organization, provides a full range of global services for heterogeneous network computing environments, including system/network management and support, education, information technology (IT) consulting and systems integration. Solaris Software -- Solaris Software develops and supports Solaris, a leading UNIX operating system software environment for enterprise-wide distributed computing on SPARC and other volume platforms. Solaris Software also develops software products for network management, messaging/mail management, security, and eCommerce. Microelectronics -- Microelectronics designs, develops and markets high performance SPARC(TM) and Java(TM) microprocessors, as well as enabling technologies, for Sun products and third-party customers. Java Software -- Java Software develops, markets and supports the Java(TM) software technology. Java Software also develops applications, tools, and systems platforms to further enhance Java(TM) technology as a programming standard for complex networks. Java Software oversees Sun's efforts to continue enhancing the Java platform and works with third parties to create products and technologies that will augment the Java platform's capabilities. Sun's network computing model and its hardware and software implementations have attracted and encouraged a large number of software vendors to port their applications to Sun platforms, including an increasing number of vendors of commercial applications. The availability of such third-party software vendors provides Sun and its customers with a competitive advantage and strengthens the Company's presence in network computing. PRODUCTS Sun believes that customers increasingly demand computer systems that do not limit them to any one vendor's proprietary technology. To respond to customer needs, Sun has been a proponent of the open systems strategy. This open systems strategy offers users and software developers the benefits of compatibility, interoperability, portability, upgradeability and scalability in products. Sun's open systems architecture protects existing customer investments while providing customers with new, innovative technology to allow them to be competitive in their own markets. SYSTEMS Workstations -- The Company offers a full line of UltraSPARC(TM)-based workstations from low-cost high-performance workstations to high-end, multi-processor capable graphics systems. The Ultra(TM) 5, based on the UltraSPARC IIi processor, is a reliable, scaleable entry level workstation designed for customers seeking high performance for computer intensive software development, digital content creation and database applications at a low cost. The Ultra 10 based on a 333 MHz Ultra SPARC IIi processor with a 2MB cache and the Sun Elite3D graphics accelerator offers customers point-of-entry to high-end graphical computing. The Ultra 10 was designed for graphics intensive, price sensitive markets such as health care, software development, entry-level MCAD, animation and digital content creation. Sun's Ultra 60 and Ultra 450 workstations offer a combination of high-end workstation performance and functionality at a competitive price. Available in both uniprocessor and multiprocessor versions, these systems achieve higher performance from the use of UltraSparc II processors at speeds of up to 360 MHz, as well as high performance motherboards and ASIC's. The Ultra 60 workstation, with up to two 300 or 360 MHz UltraSPARC II processors, is designed for customers who require power for the most demanding scientific and technical applications. The Ultra 450 workstation is Sun's most expandable and flexible workstation. The Ultra 450 can support two of Sun's high-end Elite3D m6 graphics cards and scales to include up to four 300 MHz UltraSPARC II 2 4 processors, 180GB of hard disk drive space, 4GB of memory and 10 PCI slots, allowing customers to grow and tailor the system to address specific application requirements. Workgroup Servers -- The Company also offers a wide range of binary compatible servers from the entry level high performance Ultra Enterprise(TM) 5S Server to the Ultra Enterprise 1000 Server, a highly scaleable, reliable, enterprise-wide symmetric multiprocessor server. Sun's entry level server products are designed to provide high performance, reliable, easy to use, scaleable architecture with exceptional throughput at prices comparable to PC server products. These servers run the Solaris operating system and provide software solutions to connect to any client as well as the ability to simply install and manage a customer's servers. The Ultra Enterprise 5S Server and Ultra Enterprise 10S Server utilize the high performance UltraSPARC IIi processor and offer customers low priced solutions that function as file and print servers, internet/intranet solutions as well as platforms for eCommerce and Internet Service Providers. The Company's Sun(TM) Enterprise(TM) 450 Servers provide the scalability, performance and reliability for critical business needs. The Enterprise 450 Server supports up to four 300 MHz UltraSPARC II processors and utilizes the 1.6 GB/second UPA interconnect and 10 PCI slots, which allows the Sun Enterprise 450 to scale as application demand grows. The Sun Enterprise 450 Server is designed with up to 20 hot pluggable disk drives, hot pluggable N+1 power, and features such as Automatic System Recovery, providing the reliability features that are usually found in more expensive enterprise servers. The Sun Enterprise 450 provides customers with the reliability, availability and scalability needed for demanding applications and solutions such as groupware, distributed database applications, clustering, enterprise resource planning as well as email and internet/intranet requirements. Sun Enterprise Servers -- Sun offers to its enterprise customers its Sun Enterprise Server family. This includes the Sun Enterprise 10000 that scales to 64 processors. The Sun Enterprise Server family offers upgradeability and expandability across the product line. The entry level Sun Enterprise 3500 is a powerful, scaleable, versatile and upgradeable departmental UNIX server in a compact package. The Sun Enterprise 3500 is expandable up to 8 Central Processing Units ("CPU") and shares common CPU boards and peripherals that can be used across the Ultra Enterprise product line to provide flexibility and protect the customer's investment. The Sun Enterprise 4500 is expandable up to 14 processors and is one of the most modular and powerful departmental servers, offering outstanding performance and the ability to scale system performance and capacity as needs grow. The Sun Enterprise 5500, Sun's entry level data center system is expandable up to 14 processors and is packaged in a rack configuration to enable bundling of additional storage in a single enclosure. The Sun Enterprise 6500 is expandable up to 30 processors and provides customers the ability to deploy large scale, mission critical applications in a network based environment. It offers the performance and availability required for mainframe-class mission critical applications. The Sun Enterprise 10000 is the most scaleable system in the product line and incorporates mainframe features such as dynamic system domains which allow for dynamic partioning of the system, super computer class interconnection called the Gigaplane-XB(TM) which speeds internal data handling and a separate service processor/console for system monitoring and management. SYSTEM AND INTERNET SOFTWARE The system and internet software environment is a key component for fulfilling customer needs around the network. The Company continues to focus on providing customer-centric solutions, including the Solaris operating environment with built-in networking, Sun(TM) WorkShop(TM) tools for building network applications, and internet products including the Sun(TM) Internet Mail Server that affords reliability and scalability across an 3 5 enterprise. The Company believes it derives competitive advantage from the stability resulting from its many years of experience with operating system software. The Company's principal software products are as follows: Solaris Operating Environment -- The Solaris product line includes desktop, intranet, ISP and enterprise operating environments for SPARC and Intel platforms. Solaris is a fast, highly reliable, scaleable and secure operating environment, easy to install and use, optimized for the Java platform and supports more than 12,000 applications. The Solaris environment is optimized for corporate computing, Internet business requirements, powerful enterprise databases and high performance technical computing environments. Network Management Products -- These products are central to Sun's open systems architecture and provide networking capabilities that make distributed resources easily accessible by PCs, workstations, servers and other computing devices on a single network. These products also integrate heterogeneous global, department, local and remote network resources into company-wide information systems. The Company is committed to developing networking products that adhere to and promote open industry networking standards and technologies in emerging areas such as the Internet and intranet. Network Security Solutions -- Sun provides businesses with a comprehensive set of modular, heterogeneous, and scaleable security solutions for protecting corporate assets, enabling new business models such as secure intranets, establishing tighter relationships with partners via secure extranets, and supporting secure remote access for mobile and remote employees. The Network Security Solutions include encryption, authentication, access control, and firewall defense products needed to make use of the Internet, intranets and extranets, as communications and trading channels. Internet Products -- The Company's Sun Internet Mail Server software helps companies consolidate their business on a single, scaleable email architecture, enabling open, reliable, and cost-effective communication. For service providers, Sun Internet Mail Server delivers the superior scalability, reliability and performance needed for finding and retaining customers and growing their business. Built on internet and industry standards such as SMTP and MIME, Sun Internet Mail Server offers a single, open internet alternative to proprietary mail systems. Sun Internet Mail Server provides the industry's most complete implementation of the latest internet standard, Internet Message Access Protocol version 4 (IMAP4), for reliable mail messaging. JavaSoftware Products -- The Java(TM) Application Environment (JAE) is one of the first widely accepted application environments to enable the platform independent of the development of application software. In fiscal 1998, Sun broadly expanded the definition and availability of the Java platform, to extend the adoption of the Java platform to the smallest devices (smart cards and embedded controllers) and set-top boxes (PersonalJava), in addition to the high-end enterprise platform. Java technology is licensed to over 150 system software vendors and OEM ("Original Equipment Manufacturers") manufacturers. The Company continues to invest in the performance, stability and compatibility of the Java platform, to ensure its continued acceptance and deployment across the internet. Developer Products -- The Workshop integrated development tool suites support the Java(TM) programming language, C++, C, and Sun(TM) FORTRAN. In addition, Sun offers an integrated development environment for MicroFocus COBOL. Visual Workshop for C++ and Performance Workshop Fortran provide tightly integrated visual programming environments for professional developers to build and deploy high-performance client-server and computing applications. Java(TM) Workshop(TM) is a powerful and streamlined Internet programming environment allowing developers to create and publish Internet applications. Java(TM) Studio(TM) is an easy to use point and click environment for assembling solutions from reusable JavaBeans(TM) components. Sun's extensive line of software development products provide life cycle support from database modeling to testing, improving productivity and quality of the application. The Java(TM) Developer's Kit enables developers to create and run applets (which are miniature applications written in the Java programming language) that run inside a compatible web browser, and full applications written using the Java programming language. 4 6 SALES, DISTRIBUTION AND MARKETING Sun maintains a presence in most major markets and sells computer systems, software and services to its customers worldwide through a combination of direct and indirect channels. The Company also offers off-the-shelf software and component products such as CPU chips, ASICs and embedded boards on an OEM basis to other hardware manufacturers, and supplies after-market and peripheral products to its end-user installed base, both directly and through independent distributors and resellers. In general, the Company's direct sales force was recently reorganized within Sun into two primary direct sales forces concentrating on enterprise systems, storage, and software and consumer and embedded products. These sales forces sell to selected end-user named accounts and numerous indirect channels and are compensated on a channel-neutral basis to reduce potential channel conflict with the Company distribution partners. Other distribution channels include: - systems integrators, both government and commercial, who serve the market for large commercial projects requiring substantial analysis, design, development, implementation and support of custom solutions; - master resellers who supply product and provide product marketing and technical support services to the Company's smaller Value Added Resellers (VARs); - VARs who provide added value in the form of software packages, proprietary software development, high-end networking integration, vertical integration, vertical industry expertise, training, installation and support; - OEMs who integrate the Company's products with other hardware and software; and - independent distributors who primarily cover markets in which Sun does not have a direct presence. The growth and management of the reseller channels is very important to the future revenues and profitability of the Company. Channel partners account for greater than 50% of Sun's revenue and will continue to play a key role in providing the value, service and support that are critical to Sun's long-term success. The Company's direct systems sales force serves educational institutions, software vendors, governments, businesses and other strategic accounts. The Company has approximately 100 sales and service offices in the United States and approximately 135 sales and service offices in 45 other countries. In addition, the Company uses independent distributors in approximately 150 countries, sometimes in concert with other resellers and direct sales operations. Revenues from outside the United States, including those from end-users, resellers and distributors, constituted approximately 48%, 49% and 50% of total revenues in fiscal 1998, 1997, and 1996, respectively. Direct sales made in countries outside of the United States are generally priced in local currencies and are, therefore, subject to currency exchange fluctuations. The net impact of currency fluctuations on net revenues and operating results cannot be precisely measured as the Company's product mix and pricing change over time in various markets, partially in response to currency movements. The Company is primarily exposed to changes in exchange rates on the Japanese yen, British pound sterling, French franc, and German mark. When the U.S. dollar strengthens against these currencies, the U.S. dollar value of non-U.S. dollar-based sales decreases. When the U.S. dollar weakens against these currencies, the dollar value of non-U.S. dollar-based sales increases. Correspondingly, the U.S. dollar value of non-U.S. dollar-based costs increases when the U.S. dollar weakens and decreases when the U.S. dollar strengthens. Overall the Company is a net receiver of currencies other then the U.S. dollar and, as such, benefits from a weaker dollar and is adversely affected by a stronger dollar relative to major currencies worldwide. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, may adversely affect the Company's consolidated sales and gross margins as expressed in U.S. dollars. To minimize currency exposure gains and losses, the Company borrows funds in local currencies, enters into forward exchange contracts, purchases foreign currency options and promotes natural hedges by purchasing components and incurring expenses in local currencies whenever feasible. Sun's sales to overseas customers are made under export licenses that must be obtained from the 5 7 United States Department of Commerce. Protectionist trade legislation in either the United States or other countries, such as a change in the current tariff structures, export compliance laws or other trade policies, could adversely affect Sun's ability to sell or to manufacture in international markets. Furthermore, revenues from outside the United States are subject to inherent risks related thereto, including the general economic and political conditions in each country. Sales to or through C. Itoh Technoscience Co. Ltd., Fujitsu, Ltd. and Toshiba Corporation together represent a significant portion of Sun's revenues in Japan. There can be no assurance that the economic crisis and currency issues currently being experienced in certain parts of Asia will not have a material adverse effect on the Company's revenue, revenue growth rates, or operating results in the future. One customer accounted for more than 10% of revenues in fiscal 1998. Sales to MRA Systems, Inc. for fiscal 1998 were approximately 14% of total revenues. No individual customer accounted for more than 10% of revenues in fiscal 1997 or 1996. Any termination by a significant customer of its relationship with the Company or material reduction in the amount of business such a customer does with the Company could materially adversely effect the Company's business, financial condition or operating results. Also see Note 9 of Notes to Consolidated Financial Statements incorporated by reference herein for additional information concerning sales to foreign customers and industry segments. Seasonality also affects the Company's revenues and operating results, particularly in the first and third 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 proportionately. The Company's marketing activities include advertising in computer publications and the business press, direct mailings to customers and prospects, televised programs and attendance at trade shows. Sun maintains a customer resource program, Sunergy(SM), which includes live interactive satellite broadcasts and provides electronic access to newsletter and technical information. Sun also sponsors a series of seminars to specific resellers, university customers, end-users and government customers and prospects designed to familiarize attendees with the capabilities of the Sun product line. Sun's order backlog at June 30, 1998 was approximately $599 million, compared with approximately $378 million at June 30, 1997. Backlog includes only orders for which a delivery schedule within six months has been specified by the customer. Backlog levels vary with demand, product availability and the Company's delivery lead times and are subject to significant decreases as a result of, among other things, customer order delays, changes or cancellations. As such, backlog levels are not a reliable indicator of future operating results. CUSTOMER SERVICE AND SUPPORT The Company provides expertise in heterogeneous network computing through a full range of global services, including support services (systems support for hardware and software), educational services (education consulting, skills migration and training) and professional services (IT consulting, systems integration and system/network management). Sun assists both technical and commercial customers, supporting more than 1 million systems in 174 countries, training more than 75,000 students annually, and providing consulting, integration and operations assistance to IT organizations worldwide. In support services, Sun has increased field resources in direct service delivery, especially software support engineers based in solution centers and field offices. Higher levels of field resources are critical to the overall investments being made in mission-critical support capability. This direct Sun capability is complemented by third-party service providers who primarily deliver hardware support services. Software support continues to be primarily delivered by Sun software support engineers. Third-party service providers provide necessary leverage on critical field resources such as parts inventories and staff to meet the service requirements of the growing installed base. Investments by these third-party service providers in complementary support infrastructure facilitates expansion of geographical coverage without additional fixed cost investment by the Company. 6 8 The Company offers a warranty for parts and labor on its hardware products generally for one year from date of sale and a limited warranty on software generally for 90 days from date of sale. The Company maintains and services the products during the warranty period and on a contractual basis after the initial product warranty has expired. Post-warranty support services are primarily offered through a tiered support offering called SunSpectrum(SM). SunSpectrum offers four levels of differentiated support that package hardware, software and peripherals in a single price support service. Warranty and post-warranty services are provided through 36 solution centers worldwide. Sun's educational services offers comprehensive skills migration, enterprise consulting and courseware. Consultants can perform needs analysis, skills assessment and migration, curriculum design and course customization. Instructor-led courseware addresses the educational needs of many customers including managers, operators, developers, system administrators, and end-users. As an alternative to the classroom, customers may select self-study training, including more than 50 interactive training products geared for all levels of expertise. In professional services, Sun provides the people, processes and technology to deliver single point-of-contact solutions tailored to meet customer needs. Sun technical and project management experts help customers plan, implement, and manage heterogeneous computing environments. Sun consultants also help design IT architectures and plan migrations from legacy systems to network computing. To implement solutions, integration experts help customers develop and deploy distributed computing environments for new applications. To keep the environment operating at peak performance, operations experts help customers manage the complexity of the heterogeneous systems and networks. In addition, Sun helps with all phases of creating and implementing internet solutions. Investments have been made in competencies in Internet/Java technologies, business applications and systems and network management. Certain complex systems sold by Sun require a high level of implementation support and consequently, the customer's acceptance of such systems may be delayed in the event Sun does not provide a sufficient level of such service. Delays in customer acceptance could adversely affect the future operating results of the Company. PRODUCT DEVELOPMENT The Company's research and product development programs are intended to sustain and enhance its competitive position by incorporating the latest worldwide advances in hardware, software, graphics, networking, data communications and storage technologies. Sun's product development efforts, conducted within each of its businesses, are currently focused on enhancing its products' performance and price/performance, as well as reliability, availability, and serviceability, of both the Company's hardware and systems software for the Company's expanding enterprise client-server computing customer base. Additionally, Sun remains focused on system software platforms for Internet and intranet applications, developing advanced workstation and server architectures, designing application-specific integrated circuits and software for networking and distributed computing. Sun's product development continues to be committed to including the high-performance implementation of existing standards and the development of new technology standards. Sun conducts research and development worldwide principally through facilities in the United States, France, and Japan. Research and development expenses were approximately $1,014 million, $826 million and $653 million in fiscal 1998, 1997 and 1996, respectively. In recent years, Sun's research and development efforts have focused increasingly on the Java architecture, Solaris software and SPARC microprocessors. Sun believes that software development provides and will continue to provide significant competitive differentiation. Therefore, Sun currently devotes substantial resources to the development of workgroup software, networking and data communications, video, graphics, disk array, object technology and the software development environment. 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, 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 is a complex and uncertain process requiring high 7 9 levels of innovation from the Company's designers and suppliers, as well as accurate anticipation of customer requirements and technological trends. MANUFACTURING AND SUPPLY The Company's manufacturing operations consist primarily of final assembly, test and quality control of systems, materials and components. Sun has manufacturing facilities in California, Oregon, and Scotland, and distribution facilities in California, the Netherlands and Japan. The Company has continued its efforts to simplify its manufacturing process by reducing the diversity of system configurations offered to customers, increasing the standardization of components across product types and establishing local sources of supply in major geographies. Sun uses many standard parts and components in its products and believes there are a number of competent vendors for most parts and components. However, a number of important components are developed by and purchased from single sources due to price, quality, technology or other considerations. In some cases, those components are available only from single sources. In particular, Sun is dependent on Sony Corporation for various monitors and on Texas Instruments Incorporated for different implementations of SPARC microprocessors. Certain custom silicon parts are designed by and produced on a contractual basis for Sun. The process of substituting a new producer of such parts could materially adversely affect Sun's operating results. Some suppliers of certain components, including color monitors and custom silicon parts, require long lead times such that it can be difficult for the Company to plan inventory levels of components to consistently meet demand for Sun's products. Certain other components, especially memory integrated circuits such as DRAMs, SRAMs, and VRAMs, have from time to time been subject to industry wide shortages. Future shortages of components could negatively affect the Company's ability to match supply and demand, and therefore could materially adversely impact the Company's future operating results. 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 material 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 materially 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 materially adversely affected due to the Company's obligations to fulfill such noncancelable purchase commitments. Once a hardware product is developed the Company must rapidly bring it 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 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 materially 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. 8 10 Generally, the computer systems sold by Sun, such as the products based on UltraSPARC processors are the result of both hardware and software development, such that delays in software development can delay the Company's ability 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 materially adversely affect the future operating results of the Company. COMPETITION The markets for the Company's products and services are 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 Sun's product lines and the scalability of its products and network computing model, the Company competes in many segments of the network computing market across a broad spectrum of customers. Sun's traditional customer base has been in the technical and scientific markets. Competition in this segment is based primarily on system performance, price/performance, availability and performance of application software, robustness of the software development environment, system expandability and upgrade ability, adherence to standards, graphics features and performance and product quality and reliability. Increasingly, Sun is finding that its strengths in technical markets, particularly software development, design automation and decision support, along with its network computing focus are enabling expansion into mission critical enterprise applications. Sun's competitors in the technical and scientific markets are primarily Hewlett-Packard Company (HP), International Business Machines Corporation (IBM), Compaq Computer Corporation (Compaq) and Silicon Graphics, Inc. (SGI). Sun has been making inroads into commercial markets both with Global 1000 companies which are downsizing and distributing their computer resources, as well as with smaller companies which are upsizing and increasing the capabilities of their network computing systems. Traditionally, competition in these markets has been based on price/performance, capabilities and stability of the systems software, product quality and reliability, ease of system operation and administration, service and support, availability and performance of applications and middleware, database performance, global marketing and distribution capabilities, and corporate reputation and name recognition. Increasingly, companies which are downsizing their operations are focusing on distributing their computing capabilities and adopting a model of network computing. Companies which are upsizing typically are increasing their experience in managing larger heterogeneous environments. In addition, Sun is continuing to expand into the Internet and intranet markets. As a result, in both the upsizing and downsizing competitive scenarios, networking capabilities, internet and intranet capabilities and the ability to obtain all of the traditional security, stability and administrative features of a central computing model in a networked environment are significant factors that influence the buying decision and the relative strength of the competition. In both upsizing and downsizing opportunities, Sun's competition tends to come principally from IBM, HP, and Compaq, as well as other mini and mainframe computer suppliers. In addition, the Company is facing increasing competition from these competitors as well as from certain systems manufacturers such as Dell Computer Corporation and certain of its competitors listed above, whose products are based on microprocessors from Intel Corporation (Intel) coupled with Windows NT operating system software from Microsoft Corporation (Microsoft). 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. Sun has encouraged the proliferation of its SPARC technology as a standard in the computer marketplace by licensing much of the technology and promoting open interfaces to the Solaris operating environment, as well as by offering microprocessors and enabling technologies to third party customers. As a result, several licensees also offer SPARC/Solaris based products that compete directly with Sun's products primarily in the desktop markets. 9 11 Sun has also strived to make its Java technology a programming standard for complex networks. Sun develops applications, tools and systems platforms, as well as works with third-parties to create products and technologies, in order to continue enhance the Java platform's capabilities. As part of this effort, Sun licenses its Java technology widely encouraging competitors of Sun to also develop products competing with these applications, tools and platforms. The Company expects that the markets for its products, technology and services 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 HP, IBM, Compaq and SGI, aggressively position themselves to benefit from this shifting of customer buying patterns and demand. The ability to continue to develop leading edge products and rapidly bring them to market will continue to have a significant impact on Sun's competitiveness and its operating results. Also, 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. In addition, Sun expects to see continued performance improvements in microprocessor technology and products introduced by Intel and Motorola, Inc. Such products, coupled with enhanced operating systems software from Microsoft and other competitors, are expected to continue to provide competitive pressure throughout the Company's product range. The Company expects this pressure to continue and intensify into fiscal 1999 with the increased availability of products based on microprocessors from Intel coupled with Windows NT operating system software. While many other technical, service and support capabilities affect a customer's buying decision, Sun's future operating results will depend, in part, on its ability to compete with these technologies. PATENTS AND LICENSES Sun currently holds a number of U.S. and foreign patents relating to various aspects of its products and technology. While the Company believes that such patent protection is important, it also believes that patents are of less competitive significance than such factors as innovative skills and technological expertise. As is common in the computer industry, the Company has from time to time been notified that it may be infringing certain patents or other intellectual property rights of others, although no material litigation has arisen out of any of these claims. Several pending claims are in various stages of evaluation. The Company is evaluating the desirability of entering into licensing agreements in certain of these cases. Based on industry practice, the Company believes that any necessary licenses or other rights could be obtained on commercially reasonable terms. However, no assurance can be given that licenses can be obtained on acceptable terms or that litigation will not occur. The failure to obtain necessary licenses or other rights, or litigation arising out of such claims, could have a material adverse effect on the Company's operations. In March 1990, Texas Instruments Incorporated (TI) alleged that a substantial number of the Company's products infringe certain of TI's patents. Based on its discussions with TI, the Company believes that it will be able to negotiate a license agreement with TI, if necessary, and that the outcome of this matter will not have a material adverse effect on Sun's financial position or its results of operations or cash flows in any given fiscal year. Such a negotiated license may or may not have a material adverse impact on Sun's results of operations or cash flows in a given fiscal quarter depending upon various factors including, but not limited to, the structure and amount of royalty payments, offsetting consideration from TI, if any, and the allocation of royalties between past and future product shipments, none of which can be forecast with reasonable certainty at this time. EMPLOYEES As of June 30, 1998, Sun had approximately 26,300 employees. The Company's future operating results will depend on its ability to continue to broaden and develop senior management to attract and retain skilled employees, and on the ability of its management and key employees to manage growth successfully through the enhancement of management information systems and financial controls. The Company expects to continue to increase its number of employees to support demand creation programs, service and support 10 12 operations, and overall projected growth. None of Sun's employees in the United States are represented by a labor union. ADDITIONAL FACTORS AFFECTING THE COMPANY'S BUSINESS 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 value of its assets, and when necessary, make adjustments thereto. Acquisitions may involve the amortization of acquired intangible assets in periods following such acquisitions. In addition, acquisition transactions are accompanied with a number of risks, including, among other things, those associated with integrating operations, personnel and technologies acquired and the potential for unknown liabilities of the acquired business. 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 across the enterprise that affect numerous operational and financial systems and processes. Such activities are currently planned to be fully operational in the first half of fiscal 1999. The time period in which the new business practices and related information systems will be implemented are forward-looking statements subject to risks and uncertainties, and actual results may differ materially from those set forth above as a result of a number of risk factors. In particular, the timing and duration of the implementation of the new business practices and information systems is subject to a number of risks, including the complexity of the conversion process and the new systems themselves, the transfer of business data and information from the previous system to the new system and the need for substantial and comprehensive employee training in connection with the adoption of such new business practices and information systems. 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 implementing these systems. In addition, the implementation of these systems will require the Company to be without certain capabilities critical to normal operation of its business (such as processing orders and shipping product) for a period of time as the Company shifts to the new systems. There can be no assurance that this interruption in the use and availability of enterprise-wide information systems will not have a material adverse effect on the Company's business and operating results. In addition, 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 currently installed computer systems and software products are coded to accept only two digit entries in the date code field. As the Year 2000 approaches, these code fields will need to accept four digit entries to distinguish years beginning with "19" from those beginning with "20". 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 resources to review its products and services, as well as its internal use software in order to identify and modify those products, services and systems that are not Year 2000 compliant. The costs associated with this effort are not incremental to the Company, but represents a reallocation of existing resources. The Company believes any modifications deemed necessary 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. In addition, the Company believes that its internal system implementation efforts (as described in the above paragraph), principally conducted to improve operating efficiencies, will also address the Company's internal Year 2000 compliance issues. Additionally, the Company is in the process of evaluating the need for contingency plans with respect to Year 2000 requirements. The necessity of any contingency plan must be evaluated on a case-by-case basis and will vary considerably in nature depending on the Year 2000 issue it may need to address. The Company's expectations as to the extent and timeliness of modifications required in order to achieve Year 2000 compliance is a forward-looking statement subject to risks and uncertainties. Actual results may vary materially as a result of a number of factors, including, among others, those described in this paragraph and the paragraph below. There can be no assurance however, that the Company will be able to successfully 11 13 modify on a timely basis such products, services and systems to comply with Year 2000 requirements, which failure 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. To the extent that Sun is not able to test technology provided by third-party hardware or software vendors, Sun is in the process of obtaining assurances from such vendors that their systems are Year 2000 compliant. In the event any such third parties cannot in a timely manner provide the Company with products, services or systems that meet the Year 2000 requirements, the Company's operating results could be materially adversely effected. Although the Company believes that the cost of Year 2000 modifications for both internal-use software and systems or the Company's products are not material, there can be no assurance that various 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 position. Eleven of the 15 member countries of the European Union are scheduled to establish fixed conversion rates between their existing sovereign currencies and the Euro and to adopt the Euro as their common legal currency effective January 1, 1999. The Euro will then trade on currency exchanges and be available for non-cash transactions. The Company is currently expending resources to review and modify its products to support the Euro's requirements, determine pricing strategies in the new economic environment, analyze the legal and contractual implications for contracts, evaluate system capabilities, and ensure banking vendors can support the Company's operations with respect to Euro transactions. The Company expects that modifications will be made to its business operations and systems on a timely basis and does not believe that the cost of such modifications will have a material adverse impact on the Company's operating results. There can be no assurance, however, the Company will be able to complete such modifications to comply with Euro requirements, which could have a material adverse effect on the Company's operating results. In addition, the Company faces risks to the extent that vendors upon whom the Company relies and their suppliers are unable to make appropriate modifications to support Euro transactions. The Company has not yet completed it evaluation of the impact of the Euro upon its functional currency designations. ITEM 2. PROPERTIES Sun conducts its worldwide operations using a combination of leased and owned facilities. The Company believes that while it currently has sufficient facilities to conduct its operations during fiscal 1999, it will continue to lease and acquire facilities throughout the world as its business requires. Properties owned by the Company consist of approximately 1,000,000 square feet on approximately 55 acres in Menlo Park, California; an approximately 300,000 square foot facility on approximately 60 acres in Newark, California where an additional 400,000 square feet of facilities are under construction; an approximately 260,000 square foot facility on approximately 20 acres in Palo Alto, California; an approximately 230,000 square foot facility on approximately 30 acres in Linlithgow, Scotland; an approximately 235,000 square foot facility in Plantation, Florida; an approximately 140,000 square foot facility in Melbourne, Florida; an approximately 30,000 square foot facility on approximately 2.5 acres in Bagshot, England; 40 acres in Farnborough England; two separate parcels of land in Newark, California of approximately 90 acres and 50 acres, approximately 120 acres in Broomfield, Colorado on which an approximately 500,000 square foot facility is under construction; and approximately 158 acres in Burlington, Massachusetts on which an approximately 530,000 square foot facility is under construction. The Company acquired an approximately 82 acre site in Santa Clara, California. The Company also leases approximately 7.2 million square feet, of which, approximately 3.1 million square feet is in the San Francisco Bay Area with the remainder in approximately 230 sales and service offices located around the world. A substantial portion of the Company's facilities, including its corporate headquarters and other critical business operations are located near major earthquake faults. The Company is uninsured and does not fund for earthquake-related losses. In addition, the Company faces risks to the extent that suppliers 12 14 of products, services and systems purchased by the Company and others with whom the Company transacts business on a worldwide basis are impacted by an earthquake. As a result, the Company's business, financial condition or operating results could be materially adversely effected in the event of a major earthquake. ITEM 3. 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. On March 24, 1998 the United States District Court judge ruled in favor of the Company granting a preliminary injunction directing Microsoft Corporation to cease using the Company's Java Compatible Logo(TM) on Microsoft products that failed to pass the applicable test suites from Sun. In addition, on May 12, 1998, the Company filed a second amended complaint alleging copyright infringement by Microsoft and motions requesting further preliminary injunctive relief directed against the planned release by Microsoft of additional products that failed to pass the applicable test suites from Sun. The Court held hearings and arguments on such motions on September 8, 9, and 10, 1998 and took the matter under advisement. 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 Not applicable EXECUTIVE OFFICERS OF THE REGISTRANT The following sets forth certain information regarding the Executive Officers of the Company as of September 15, 1998:
NAME AGE POSITION ---- --- -------- Scott G. McNealy 43 Chairman of the Board of Directors, President and Chief Executive Officer William T. Agnello 49 Vice President, Real Estate and the Workplace Kenneth M. Alvares 54 Vice President, Human Resources Alan E. Baratz 43 President, Java Software Mel Friedman 60 President, Microelectronics Lawrence W. Hambly 52 President, Enterprise Services Masood A. Jabbar 48 President, Computer Systems James Judson 44 Vice President, Finance, Worldwide Operations Michael E. Lehman 48 Vice President, Corporate Resources and Chief Financial Officer Marc L. Loupe 44 Vice President, Finance and Planning, World-wide Field Operations, Computer Systems John S. McFarlane 49 President, Solaris Software Stephen T. McGowan 50 Vice President, Finance, Computer Systems Michael H. Morris 50 Vice President, General Counsel and Secretary Michael Murray 42 Vice President, Finance and Administration, Enterprise Services Alton D. Page 42 Vice President, Treasurer Gregory M. Papadopoulos 40 Vice President and Chief Technology Officer Marissa Peterson 36 Vice President, Worldwide Operations, Computer Systems
13 15
NAME AGE POSITION ---- --- -------- Frank A. Pinto 53 Vice President, Sales, The Americas, Computer Systems Michael L. Popov 52 Vice President, COO Staff Operations William J. Raduchel 52 Chief Strategy Officer George Reyes 44 Vice President, Corporate Controller Joseph P. Roebuck 62 Vice President, Worldwide Sales, Computer Systems Edward Saliba 49 Vice President, Finance, Solaris Software Janpieter T. Scheerder 49 President, Network Storage John C. Shoemaker 55 Vice President and General Manager, Enterprise Desktop and Server Systems, Computer Systems Mark E. Tolliver 46 President, Consumer and Embedded Kevin Walsh 56 Vice President, Operations, Corporate Resources Edward J. Zander 51 Chief Operating Officer
Mr. McNealy is a founder of the Company and has served as Chairman of the Board, President and Chief Executive Officer since December 1984, as President and Chief Operating Officer from February 1984 to December 1984 and as Vice President of Operations from February 1982 to February 1984. Mr. McNealy has served as a Director of the Company since the incorporation of the Company in February 1982. Mr. Agnello has served as Vice President, Real Estate and the Workplace of the Company since March 1994. From June 1991 to March 1994 he served as President, CB Madison Advisory Group, CB Commercial Real Estate Services Inc. Mr. Alvares has served as Vice President, Human Resources of the Company since June 1992. Mr. Baratz has served as President, Java Software of the Company since April 1998 and as President, JavaSoft from January 1996 to April 1998. From August 1994 to November 1995 Mr. Baratz served as President and Chief Executive Officer of Delphi Internet Services Corp., an Internet services provider. He held various positions at IBM Corporation, including Director of Strategic Development from July 1993 to July 1994 and as a Director of High Performance Computing and Communication from January 1991 to June 1993. Mr. Friedman has served as President, Microelectronics of the Company since March 1998 and as Vice President, Worldwide Operations of Sun Microsystems Computer Company ("SMCC") from April 1996 to March 1998. Prior to such time, since 1989, Mr. Friedman served the Company in various positions including Vice President Supply Management, Vice President California Operations and Vice President Workstations, Servers and Graphics. Mr. Hambly has served as President, Enterprise Services of the Company since April 1998, as President, SunService from July 1993 to April 1998, as Vice President, Marketing of SMCC from July 1991 to July 1993, as President of Sun Microsystems Federal, Inc. from July 1988 to July 1991 and in various sales management capacities of the Company from April 1983 to July 1988, most recently as Vice President, Western Area Sales. Mr. Jabbar has served as President, Computer Systems of the Company since April 1998 and President of SMCC from February 1998 to April 1998. He served as Vice President and Chief Financial Officer of SMCC from June 1994 to April 1998, as Vice President, Finance and Planning, Worldwide Field Operations of SMCC from July 1992 to June 1994 and as Vice President, Finance and Administration, United States Field Operations for SMCC from July 1991 to June 1992. Mr. Jabbar served as Director, Finance Administration, United States Field Operations for the Company from October 1990 to June 1991, as Director of United States Field Market for the Company from October 1989 to October 1990, as United States Sales and Service Controller for the Company from April 1988 to October 1989 and as United States and Intercontinental Sales Controller for the Company from December 1986 to April 1988. Mr. Judson has served as Vice President, Finance, Worldwide Operations of the Company since May 1998. He served as SMCC Controller from May 1995 to May 1998 and as Assistant Controller for SMCC 14 16 Worldwide Field Operations from November 1993 to May 1995. Mr. Judson served as Director of Financial Planning & Analysis, Worldwide Operations of the Company from February 1992 to November 1993, as Director of Finance, Product Development of the Company from November 1989 to August 1991, as Director and Division Controller, Sun Microsystems Federal, Inc. from July 1986 to November 1989 and as Plant Controller, Cost Accounting Manager, Financial Analyst of the Company from July 1983 to July 1986. Mr. Lehman has served as Vice President, Corporate Resources and Chief Financial Officer of the Company since January 1998. He has served as Vice President and Chief Financial Officer from February 1994 to January 1998, as Vice President and Corporate Controller from June 1990 to February 1994, as Director of Finance and Administration of Sun Microsystems of California, Ltd. from September 1989 to June 1990, as Assistant Corporate Controller of the Company from September 1988 to August 1989 and as External Reporting Manager from August 1987 to August 1988. Mr. Loupe has served as Vice President, Finance and Planning, Worldwide Field Operations (WWFO), Computer Systems of the Company since May 1998. He served as Director, International Development from June 1997 to May 1998, as Director of Internal Audit from April 1994 to June 1997, as Director of Finance, Intercontinental Operations from April 1991 to April 1994 and as Vice President -- Finance & Operations, Sitka Corporation from July 1990 to April 1991. From July 1987 to July 1990, he served as Controller, Centram Systems West. Mr. McFarlane has served as President, Solaris Software of the Company since April 1998. He served as Vice President, Solaris and Network Software from December 1997 to April 1998 and as Vice President, Network Software Group from May 1997 to December 1997. Mr. McFarlane served as Vice President, Technology at Northern Telecom from 1993 to 1997. Mr. McGowan has served as Vice President, Finance, Computer Systems of the Company since March 1998. He served as Vice President, Finance, WWFO from June 1995 to March 1998 and as Vice President, Finance, Noth American Field Operations (NAFO) from October 1992 to June 1995. Mr. Morris has served as Vice President, General Counsel and Secretary of the Company since October 1987. Mr. Murray has served as Vice President, Finance and Administration, Enterprise Services of the Company since April 1998 and as Assistant Corporate Controller from August 1996 to April 1998. He served as Director, Finance, Sun Microsystems Australia Pty. Ltd. from August 1994 to August 1996 and as Director, Finance, Sun Microsystems of California, Ltd. from April 1992 to August 1994. Mr. Murray served as Director, Internal Audit of the Company from October 1989 to April 1992 and as Manager, Internal Audit from March 1989 to October 1989. Mr. Page has served as Vice President, Treasurer of the Company since February 1996. Prior to that time, Mr. Page was a Partner of Ernst & Young, LLP. Mr. Papadopoulos has served as Vice President and Chief Technology Officer of the Company since March 1998. He served as Vice President and Chief Technology Officer of SMCC from March 1996 to March 1998, as Chief Technology Officer of SMCC from December 1995 to March 1996 and as Chief Scientist, Server Systems Engineering of the Company from September 1994 to December 1995. Mr. Papadopoulos served as Senior Architect, Thinking Machines Corporation from May 1993 to September 1994 and as Associate Professor, MIT from June 1991 to June 1995. Ms. Peterson has served as Vice President, Worldwide Operations, Computer Systems of the Company since April 1998. She served as Vice President, Worldwide Logistics from October 1996 to April 1998. Prior to such time, since 1989 Ms. Peterson served the Company in various positions, including Director, Worldwide Manufacturing, Director, Sun Manufacturing and Director, Business Proc. Mr. Pinto has served as Vice President, Sales, The Americas, Computer Systems of the Company since July 1998. He served as Vice President, NAFO of SMCC from July 1995 to July 1998, as Vice President, Northeast Area for SMCC from January 1993 to June 1995, as Metro Regional Director of the Company 15 17 from June 1989 to December 1992 and as the Company's District Manager, Northeast Major OEM District from November 1988 to June 1989. Mr. Popov has served as Vice President, COO Staff Operations of the Company since April 1998. He served as Vice President, Finance, SunService from June 1994 to April 1998 and as Assistant Corporate Controller of the Company from January 1992 to June 1994. Mr. Raduchel has served as Chief Strategy Officer of the Company since January 1998. He served as Vice President, Corporate Planning and Development and as Chief Information Officer from July 1991 to January 1998, as Vice President Human Resources (acting) from July 1991 to June 1992, as Vice President and Chief Financial Officer from June 1989 to July 1991, as well as Chief Information Officer (acting) from November 1990 to July 1991 and as Vice President, Corporate Planning and Development from October 1988 to June 1989. Mr. Reyes has served as Vice President, Corporate Controller of the Company since April 1994. He served as Audit Director from April 1992 to March 1994, as Director of Finance for the Company's ICON operations from April 1991 to April 1992, as Assistant Controller from June 1989 to April 1991, as the Controller of the Company's General Systems Group from July 1988 to June 1989 and as the Company's Marketing Controller from March 1988 to June 1988. Mr. Roebuck has served as Vice President, Worldwide Sales, Computer Systems of the Company since April 1998. He served as Vice President, WWFO of SMCC from April 1992 to April 1998, as Vice President, United States Field Operations, SMCC from November 1988 to April 1992, and as Vice President of Sales for the Company from January 1986 to November 1988. Mr. Saliba has served as Vice President, Finance, Solaris Software of the Company since May 1998. He served as Vice President, Finance, SunSoft, Inc. from February 1996 to May 1998, as Finance Director, Sun Microelectronics from May 1994 to February 1996, as Finance Director, SMCC Worldwide Operations from May 1993 to May 1994, as Finance Director, SMCC Engineering from June 1991 to May 1993 and as Finance Manager and Director, East Coast Operations from April 1989 to June 1991. Mr. Scheerder has served as President, Network Storage of the Company since April 1998. He served as President, SunSoft, Inc. from August 1995 to April 1998, as Vice President, Server Products, SMCC from April 1995 to August 1995, as Vice President, Solaris Products, SunSoft, Inc. from March 1992 to April 1995 and as Director of Marketing and Programming, SunSoft, Inc. from August 1991 to March 1992. Mr. Shoemaker has served as Vice President, General Manager, Enterprise Desktop and Server Systems, Computer Systems of the Company since April 1998. He served as Vice President, General Manager, Enterprise Server and Storage Group, SMCC from April 1996 to April 1998, as Vice President, Worldwide Operations, SMCC from July 1993 to April 1996, as Vice President, U.S. Operations, SMCC from June 1992 to July 1993, as Vice President, Finance and Planning, Worldwide Operations of the Company (on an acting basis since July 1992) from May 1990 to July 1993, and as Vice President (acting), Materials, Worldwide Operations from October 1991 to June 1992. Mr. Tolliver has served as President, Consumer and Embedded of the Company since April 1998. He served as Vice President, Market Development from July 1996 to April 1998 and as Vice President, Strategy from December 1995 to July 1996. Mr. Tolliver served as Vice President, Marketing, MasPar Computer Corporation from 1991 to 1994. Mr. Walsh has served as Vice President, Operations, Corporate Resources of the Company since March 1998. He served as Vice President, Worldwide Operations, Finance and Planning, from February 1993 to March 1998. Mr. Zander has served as Chief Operating Officer of the Company since January 1998. He served as President, SMCC from February 1995 to January 1998, as President, SunSoft, Inc. from July 1991 to February 1995 and as Vice President, Corporate Marketing of the Company from October 1987 to July 1991. 16 18 PART II ITEM 5.MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information required by this item is incorporated by reference to the inside back cover of Sun's 1998 Annual Report to Stockholders. At September 15, 1998 there were 9,145 stockholders of record. The following is a summary of all sales of the Company's Common Stock by the Company's directors and executive officers who are subject to Section 16 of the Securities Exchange Act of 1934, as amended, during the fiscal quarter ended June 30, 1998:
NUMBER OF OFFICER DATE PRICE SHARES SOLD ------- ------- ------ ----------- Michael L. Popov............................................ 4/28/98 $40.50 10,160 Janpieter T. Scheerder...................................... 5/21/98 $41.50 4,024 5/21/98 $41.50 687
ITEM 6. SELECTED FINANCIAL DATA The information required by this item is incorporated by reference to the information included under the caption "Historical Financial Review" on pages 18 and 19 of Sun's 1998 Annual Report to Stockholders. ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this item is incorporated by reference to the information included under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 20 through 25 of Sun's 1998 Annual Report to Stockholders. ITEM 7A.QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK The Company's market risk disclosures pursuant to item 7A are not material and are therefore not required. ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item, is incorporated by reference to the information included under the captions "Consolidated Statements of Income", "Consolidated Balance Sheets", "Consolidated Statements of Cash Flows", "Consolidated Statements of Stockholders' Equity", "Notes to Consolidated Financial Statements" and "Report of Ernst & Young LLP, Independent Auditors" on pages 26 through 44 of Sun's 1998 Annual Report to Stockholders. ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding directors of the Company is incorporated by reference from the information contained under the caption "Election of Directors" in Sun's 1998 Proxy Statement for the Company's 1998 Annual Meeting of Stockholders. Information regarding current executive officers of the Registrant found under the caption "Executive Officers of the Registrant" in Part 1 hereof is also incorporated by reference into this Item 10. Information regarding Section 16 reporting compliance is incorporated by reference from information contained under the caption "Executive Compensation -- Section 16(a) Beneficial Ownership Reporting Compliance" in Sun's 1998 Proxy Statement. 17 19 ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference from the information contained under the caption "Executive Compensation" in Sun's 1998 Proxy Statement. ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference from the information contained under the caption "Information Concerning Solicitation and Voting -- Record Date and Outstanding Shares" and "Security Ownership of Management" in Sun's 1998 Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference from the information contained under the caption "Executive Compensation -- Summary Compensation Table", "-- Certain Transactions With Management" and "-- Employment Contracts and Change-In-Control Arrangements" in Sun's 1998 Proxy Statement. PART IV ITEM 14.EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: 1. Financial statements that are incorporated herein by reference to the following in Sun's 1998 Annual Report to Stockholders. Consolidated Statements of Income for each of the three years in the period ended June 30, 1998 (page 26). Consolidated Balance Sheets at June 30, 1998 and 1997 (page 27). Consolidated Statements of Cash Flows for each of the three years in the period ended June 30, 1998 (page 28). Consolidated Statements of Stockholders' Equity for each of the three years in the period ended June 30, 1998 (page 29). Notes to Consolidated Financial Statements (pages 30 through 43). Report of Ernst & Young LLP, Independent Auditors (page 44). The Company's 1998 Annual Report to Stockholders is not deemed filed as part of this report except for those parts specifically incorporated herein by reference. 2. Financial Statement schedule:
PAGE SCHEDULE TITLE ---- -------- ----- S-1... II Valuation and Qualifying Accounts
All other schedules have been omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements, including the notes thereto. 3. Exhibits
EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1(11) Registrant's Restated Certificate of Incorporation, as amended February 12, 1998. 3.2(11) Registrant's Bylaws, as amended February 11, 1998.
18 20
EXHIBIT NUMBER DESCRIPTION ------- ----------- 4.8(12) Second Amended and Restated Shares Rights Agreement dated as of February 11, 1998. 10.1(1) Technology Transfer Agreement dated February 27, 1982, for the purchase by the Registrant of certain technology for cash, and related Assumption Agreement dated February 27, 1982. 10.3(1) Form of Founders' Restricted Stock Purchase Agreement. 10.8(1) Registration Rights Agreement dated as of November 26, 1984. 10.8A(1) Amendment to Registration Rights Agreement. 10.9(2) Registrant's 1982 Stock Option Plan, as amended, and representative forms of Stock Option Agreement. 10.10(2) Registrant's Restricted Stock Plan, as amended, and representative form of Stock Purchase Agreement. 10.11(4) Registrant's 1984 Employee Stock Purchase Plan, as amended. 10.21(1) License Agreement dated July 26, 1983, by and between Registrant and The Regents of the University of California. 10.22(1) Software Agreement effective as of April 1, 1982 by and between Registrant and American Telephone and Telegraph Company, and Supplemental Agreement dated effective as of May 28, 1983. 10.48(2) Registrant's 1987 Stock Option Plan and representative form of Stock Option Agreement. 10.56(3) Building Loan Agreement dated May 11, 1989, between Sun Microsystems Properties, Inc. and the Toyo Trust and Banking Company Limited, New York Branch and the related Promissory Note; First Deed of Trust, Assignment of Leases, Rents and Other Income and Security Agreement; Guaranty of Payment; Guaranty of Completion (Sun Microsystems Properties, Inc.); Guaranty of Completion (Sun Microsystems, Inc.; Shortfall Agreement and Indemnity. 10.64(10) Registrant's 1988 Directors' Stock Option Plan as amended on August 13, 1997. 10.65(10) Registrant's 1990 Employee Stock Purchase Plan, as amended on August 13, 1997. 10.66(6) Registrant's 1990 Long-Term Equity Incentive Plan, as amended on August 15, 1996. 10.66A(5) Representative form of agreement to Registrant's 1990 Long-Term Equity Incentive Plan. 10.74(5) Software Distribution Agreement dated January 28, 1991 by and between the Registrant and UNIX Systems Laboratories, Inc. 10.82(9) Revolving Credit Agreement dated August 28, 1997, between the Registrant; Citicorp USA, Inc.; Bank of America National Trust and Savings Association; ABN AMRO Bank N.V.; The First National Bank of Boston; Barclays Bank PLC; Morgan Guaranty Trust Company of New York; The Fuji Bank Limited, San Francisco Agency: The Toyo Trust and Banking Co. Ltd.: The Sumitomo Bank, Limited; The Sakura Bank Limited, San Francisco Agency; Banque Nationale de Paris; Bayerische Vereinsbank AG, Los Angeles Agency; The Industrial Bank of Japan, Limited, San Francisco Agency; The Bank of New York; Cariplo -- Cassa Di-Risparmio Delle Provincie Lombade SPA; Corestes Bank NA; The Northern Trust Company; Royal Bank Of Canada; Union Bank of California, N.A.; and The Sumitomo Trust Banking Co., Ltd. 10.84 Registrant's Non-Qualified Deferred Compensation Plan, as amended July 1, 1998. 10.85(7) Registrant's Section 162(m) Executive Officer Performance-Based Bonus Plan dated August 9, 1995. 10.87(9) Registrant's Equity Compensation Acquisition Plan, as amended on August 28, 1997.
19 21
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.89(8) Form of Change of Control Agreement executed by each corporate executive officer of Registrant. 10.90(8) Form of Change of Control Agreement executed by Chief Executive Officer of Registrant. 10.91(8) Form of Vice President Change of Control Severance Plan. 10.92(8) Form of Director-Level Change of Control Severance Plan. 13.0 Registrant's 1998 Annual Report to Stockholders (to be deemed filed only to the extent required by the instructions to exhibits for reports on Form 10-K). 21.0 Subsidiaries of Registrant. 23.1 Consent of Ernst & Young LLP, Independent Auditors. 24 Power of Attorney (See pages 21-22). 27 Financial Data Schedule.
- --------------- (1) Incorporated by reference to the Registrant's Registration Statement on Form S-1 (No. 33-2897), which became effective March 4, 1986. (2) Incorporated by reference to Exhibits 19.1, 19.3 or 19.4, filed as Exhibits to the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 25, 1987. (3) Incorporated by reference to identically numbered exhibits filed as exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1989. (4) Incorporated by reference to Exhibit 4.1 filed as an Exhibit to Registrant's Registration Statement on Form S-8 file number 33-38220, filed with the Securities and Exchange Commission on December 14, 1990. (5) Incorporated by reference to identically numbered exhibits filed as exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1991. (6) Incorporated by reference to identically numbered exhibits filed as exhibits to Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1996. (7) Incorporated by reference to identically numbered exhibits filed as exhibits to Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1995. (8) Incorporated by reference to identically numbered exhibits filed as exhibits to Registrant's Quarterly Report on Form 10-Q for the quarter ended December 29, 1996. (9) Incorporated by reference to identically numbered exhibits filed as exhibits to Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1997. (10) Incorporated by reference to Exhibits 4.2 and 4.1, respectively filed as exhibits to Registrant's Registration Statement on Form S-8 file number 333-40677, filed with the Securities and Exchange Commission on November 20, 1997. (11) Incorporated by reference to identically numbered exhibits filed as exhibits to Registrant's Quarterly Report on Form 10-Q for the quarter ended March 29, 1998. (12) Incorporated herein by reference to the Registrant's Registration Statement on Form 8-A/A Amendment No. 6 filed on February 13, 1998. 20 22 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized. SUN MICROSYSTEMS, INC. Registrant September 24, 1998 By: /s/ MICHAEL E. LEHMAN ------------------------------------ Michael E. Lehman Vice President, Corporate Resources and Chief Financial Officer POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Scott G. McNealy and Michael E. Lehman jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, which include the Chief Executive Officer, the Chief Financial Officer and Corporate Controller and a majority of the Board of Directors, on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ SCOTT G. MCNEALY Chairman of the Board of September 24, 1998 - ------------------------------------------ Directors, President and Chief (Scott G. McNealy) Executive Officer (Principal Executive Officer) /s/ MICHAEL E. LEHMAN Vice President, Corporate September 24, 1998 - ------------------------------------------ Resources and Chief Financial (Michael E. Lehman) Officer (Principal Financial Officer) /s/ GEORGE REYES Vice President and Corporate September 24, 1998 - ------------------------------------------ Controller (Principal Accounting (George Reyes) Officer) /s/ L. JOHN DOERR Director September 24, 1998 - ------------------------------------------ (L. John Doerr) /s/ JUDITH L. ESTRIN Director September 24, 1998 - ------------------------------------------ (Judith L. Estrin) /s/ ROBERT J. FISHER Director September 24, 1998 - ------------------------------------------ (Robert J. Fisher)
21 23
SIGNATURE TITLE DATE --------- ----- ---- /s/ ROBERT L. LONG Director September 24, 1998 - ------------------------------------------ (Robert L. Long) /s/ M. KENNETH OSHMAN Director September 24, 1998 - ------------------------------------------ (M. Kenneth Oshman) /s/ A. MICHAEL SPENCE Director September 24, 1998 - ------------------------------------------ (A. Michael Spence)
22 24 SCHEDULE II SUN MICROSYSTEMS, INC. VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND DEDUCTION/ END OF DESCRIPTION OF PERIOD EXPENSES WRITE-OFF PERIOD ----------- ---------- ---------- ---------- ---------- Year ended June 30, 1996: Accounts receivable allowances..................... $ 99,607 $195,840 $194,717 $100,730 ======== ======== ======== ======== Year ended June 30, 1997: Accounts receivable allowances..................... $100,730 $273,959 $178,598 $196,091 ======== ======== ======== ======== Year ended June 30, 1998: Accounts receivable allowances..................... $196,091 $345,071 $305,599 $235,563 ======== ======== ======== ========
25 EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1(11) Registrant's Restated Certificate of Incorporation, as amended February 12, 1998. 3.2(11) Registrant's Bylaws, as amended February 11, 1998. 4.8(12) Second Amended and Restated Shares Rights Agreement dated as of February 11, 1998. 10.1(1) Technology Transfer Agreement dated February 27, 1982, for the purchase by the Registrant of certain technology for cash, and related Assumption Agreement dated February 27, 1982. 10.3(1) Form of Founders' Restricted Stock Purchase Agreement. 10.8(1) Registration Rights Agreement dated as of November 26, 1984. 10.8A(1) Amendment to Registration Rights Agreement. 10.9(2) Registrant's 1982 Stock Option Plan, as amended, and representative forms of Stock Option Agreement. 10.10(2) Registrant's Restricted Stock Plan, as amended, and representative form of Stock Purchase Agreement. 10.11(4) Registrant's 1984 Employee Stock Purchase Plan, as amended. 10.21(1) License Agreement dated July 26, 1983, by and between Registrant and The Regents of the University of California. 10.22(1) Software Agreement effective as of April 1, 1982 by and between Registrant and American Telephone and Telegraph Company, and Supplemental Agreement dated effective as of May 28, 1983. 10.48(2) Registrant's 1987 Stock Option Plan and representative form of Stock Option Agreement. 10.56(3) Building Loan Agreement dated May 11, 1989, between Sun Microsystems Properties, Inc. and the Toyo Trust and Banking Company Limited, New York Branch and the related Promissory Note; First Deed of Trust, Assignment of Leases, Rents and Other Income and Security Agreement; Guaranty of Payment; Guaranty of Completion (Sun Microsystems Properties, Inc.); Guaranty of Completion (Sun Microsystems, Inc.; Shortfall Agreement and Indemnity. 10.64(10) Registrant's 1988 Directors' Stock Option Plan as amended on August 13, 1997. 10.65(10) Registrant's 1990 Employee Stock Purchase Plan, as amended on August 13, 1997. 10.66(6) Registrant's 1990 Long-Term Equity Incentive Plan, as amended on August 15, 1996. 10.66A(5) Representative form of agreement to Registrant's 1990 Long-Term Equity Incentive Plan. 10.74(5) Software Distribution Agreement dated January 28, 1991 by and between the Registrant and UNIX Systems Laboratories, Inc. 10.82(9) Revolving Credit Agreement dated August 28, 1997, between the Registrant; Citicorp USA, Inc.; Bank of America National Trust and Savings Association; ABN AMRO Bank N.V.; The First National Bank of Boston; Barclays Bank PLC; Morgan Guaranty Trust Company of New York; The Fuji Bank Limited, San Francisco Agency: The Toyo Trust and Banking Co. Ltd.: The Sumitomo Bank, Limited; The Sakura Bank Limited, San Francisco Agency; Banque Nationale de Paris; Bayerische Vereinsbank AG, Los Angeles Agency; The Industrial Bank of Japan, Limited, San Francisco Agency; The Bank of New York; Cariplo -- Cassa Di-Risparmio Delle Provincie Lombade SPA; Corestes Bank NA; The Northern Trust Company; Royal Bank Of Canada; Union Bank of California, N.A.; and The Sumitomo Trust Banking Co., Ltd. 10.84 Registrant's Non-Qualified Deferred Compensation Plan, as amended July 1, 1998.
26
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.85(7) Registrant's Section 162(m) Executive Officer Performance-Based Bonus Plan dated August 9, 1995. 10.87(9) Registrant's Equity Compensation Acquisition Plan, as amended on August 28, 1997. 10.89(8) Form of Change of Control Agreement executed by each corporate executive officer of Registrant. 10.90(8) Form of Change of Control Agreement executed by Chief Executive Officer of Registrant. 10.91(8) Form of Vice President Change of Control Severance Plan. 10.92(8) Form of Director-Level Change of Control Severance Plan. 13.0 Registrant's 1998 Annual Report to Stockholders (to be deemed filed only to the extent required by the instructions to exhibits for reports on Form 10-K). 21.0 Subsidiaries of Registrant. 23.1 Consent of Ernst & Young LLP, Independent Auditors. 24 Power of Attorney (See pages 21-22). 27 Financial Data Schedule.
- --------------- (1) Incorporated by reference to the Registrant's Registration Statement on Form S-1 (No. 33-2897), which became effective March 4, 1986. (2) Incorporated by reference to Exhibits 19.1, 19.3 or 19.4, filed as Exhibits to the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 25, 1987. (3) Incorporated by reference to identically numbered exhibits filed as exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1989. (4) Incorporated by reference to Exhibit 4.1 filed as an Exhibit to Registrant's Registration Statement on Form S-8 file number 33-38220, filed with the Securities and Exchange Commission on December 14, 1990. (5) Incorporated by reference to identically numbered exhibits filed as exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1991. (6) Incorporated by reference to identically numbered exhibits filed as exhibits to Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1996. (7) Incorporated by reference to identically numbered exhibits filed as exhibits to Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1995. (8) Incorporated by reference to identically numbered exhibits filed as exhibits to Registrant's Quarterly Report on Form 10-Q for the quarter ended December 29, 1996. (9) Incorporated by reference to identically numbered exhibits filed as exhibits to Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1997. (10) Incorporated by reference to Exhibits 4.2 and 4.1, respectively filed as exhibits to Registrant's Registration Statement on Form S-8 file number 333-40677, filed with the Securities and Exchange Commission on November 20, 1997. (11) Incorporated by reference to identically numbered exhibits filed as exhibits to Registrant's Quarterly Report on Form 10-Q for the quarter ended March 29, 1998. (12) Incorporated herein by reference to the Registrant's Registration Statement on Form 8-A/A Amendment No. 6 filed on February 13, 1998. EX-10.84 2 NON-QUALIFIED DEFERRED COMPENSATION PLAN 1 EXHIBIT 10.84 SUN MICROSYSTEMS, INC. U.S. NON-QUALIFIED DEFERRED COMPENSATION PLAN (As Amended through July 1, 1998) 2 TABLE OF CONTENTS
Page ---- 1. Purpose. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2. Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 3. Eligibility. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 4. Election to Participate in Plan . . . . . . . . . . . . . . . . . . . . . . . 5 5. Accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 6. Deferral Increments and Growth. . . . . . . . . . . . . . . . . . . . . . . . 6 7. Earnings or Losses on Accounts. . . . . . . . . . . . . . . . . . . . . . . . 6 8. Certain In-Service Account Distributions . . . . . . . . . . . . . . . . . . 7 9. Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 10. Form and Time of Payment of Accounts . . . . . . . . . . . . . . . . . . . 7 11. Effect of Death of Participant. . . . . . . . . . . . . . . . . . . . . . . 8 12. General Duties of Trustee. . . . . . . . . . . . . . . . . . . . . . . . . . 9 13. Withholding Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 14. Participant's Unsecured Rights . . . . . . . . . . . . . . . . . . . . . . . 9 15. Non-assignability of Interests . . . . . . . . . . . . . . . . . . . . . . . 9 16. Limitation of Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 17. Administration of the Plan . . . . . . . . . . . . . . . . . . . . . . . . . 10 18. Amendment or Termination of the Plan . . . . . . . . . . . . . . . . . . . . 10 19. Choice of Law and Claims Procedure . . . . . . . . . . . . . . . . . . . . . 10 20. Execution and Signature. . . . . . . . . . . . . . . . . . . . . . . . . . . 11
2 3 SUN MICROSYSTEMS, INC. U.S. NON-QUALIFIED DEFERRED COMPENSATION PLAN (As Amended through July 1, 1998) Sun Microsystems, Inc. (the "Company"), acting on behalf of itself and its U.S. subsidiaries, initially adopted the Sun Microsystems, Inc. U.S. Non-Qualified Deferred Compensation Plan (the "Plan"), effective July 1, 1995. RECITALS 1. The Company maintains the Plan, a deferred compensation plan for the benefit of a select group of management or highly compensated employees of the Company as well as members of the Company's Board of Directors. 2. Under the Plan, the Company is obligated to pay vested accrued benefits to Plan Participants and their Beneficiary or Beneficiaries from the Company's general assets. 3. The Company intends to enter into an agreement (the "Trust Agreement") with a person or persons, including an entity, who shall serve as trustee (the "Trustee") under an irrevocable trust, to be used in connection with the Plan (the "Trust"). 4. The Company intends to make contributions to the Trust so that such contributions will be held by the Trust and invested, reinvested and distributed, all in accordance with this Plan and the Trust Agreement. 5. The Company intends that amounts contributed to the Trust and the earnings thereon shall be used by the Trustee to satisfy the liabilities of the Company under the Plan with respect to each Plan Participant for whom an Account has been established and such utilization shall be in accordance with the procedures set forth herein. 6. The Company intends that the Trust be a "grantor trust" with the principal and income of the Trust treated as assets and income of the Company for federal and state income tax purposes. 7. The Company intends that the assets of the Trust shall at all times be subject to the claims of the general creditors of the Company as provided in the Trust Agreement. 8. The Company intends that the existence of the Trust shall not alter the characterization of the Plan as "unfunded" for purposes of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and shall not be construed to provide income to Plan Participants under the Plan prior to actual payment of the vested accrued benefits hereunder. NOW THEREFORE, the Company does hereby adopt this amended and restated Plan as follows and does also hereby agree that the Plan shall be structured, held and disposed of as follows: 3 4 1. Purpose: The Plan provides Participants an opportunity to defer payment of a portion of: * Employee salary and incentive bonus/commissions (for Sales Vice Presidents and Directors); * Employee annual bonus awards; and * Board of Directors retainer payments. 2. Definitions: (a) Account means a bookkeeping account established pursuant to Section 5(a) for Compensation that is subject to a Participant's deferral election. (b) Beneficiary means the person or persons designated by the Participant or by the Plan under Section 11(b) to receive payment of the Participant's Account in the event of the Participant's death. (c) Board means the Board of Directors of the Company, as constituted from time to time. (d) Committee means the Benefits Plan Committee, appointed by the Board from time to time. (e) Company means Sun Microsystems, Inc. and its U.S. subsidiaries. (f) Compensation means: (i) The amount of the Eligible Employee's base salary paid by the Company or one of its U.S. subsidiaries; and (ii) The amount paid by the Company or one of its U.S. subsidiaries to an Eligible Employee as an annual corporate bonus award and any other bonus/incentive award that is approved by the Committee as earnings that can be deferred under the Plan (some incentive/bonus awards will not be eligible for deferral); and (iii) For Sales Vice Presidents and Directors, incentive bonus/commissions; and (iv) In the case of an Eligible Board Member, the amount of his or her director's fees from the Company, which includes only retainer payments. Compensation does not include directors' expense reimbursements or meeting fees. For purposes of the foregoing, Compensation as described in clauses (i), (ii) and (iii) shall be eligible for deferral only to the extent such amounts are otherwise subject to U.S. payroll reporting and withholding. (g) Election Period means: (i) Generally June of each year; and (ii) For newly hired vice presidents, at the sole discretion of the Benefits Plan Committee, may be eligible to enroll within thirty (30) days of hire. 4 5 (iii) With respect to the Plan Restatement, September, 1997. (h) Eligible Board Member means a member of the Board (other than a member who is also an Eligible Employee). (i) Eligible Employee means an officer of the Company or other common-law employee of the Company or one of its U.S. subsidiaries. (j) Participant means an Eligible Board Member or an Eligible Employee who has elected to defer Compensation. (k) Plan means this Sun Microsystems, Inc. U.S. Non-Qualified Deferred Compensation Plan, as amended from time to time. (l) Plan Restatement means the amendment and restatement of the Plan as approved by the Board on August 13, 1997. (m) Plan Restatement Effective Date means October 1, 1997. (n) Retirement Date means the first day of the month coinciding with or next day following the Participant's termination of employment following the earlier of his or her: (i) 65th birthday; (ii) 60th birthday if the Participant has 5 years of Service; (iii) 55th birthday if the Participant has 10 years of Service; or (iv) 20th year anniversary of Service. (o) Service means: (i) Employment as a common-law employee of the Company or one of its subsidiaries; or (ii) Period served as an elected Board Member. A Participant's Service shall be determined by the Committee in its sole discretion. (p) Total Disability means that the Participant is unable to engage in any substantial gainful activity by reason of a medically determinable physical or mental impairment which may result in Participant's death, or condition which lasts, or may last, a continuous period of not less than twelve consecutive months. Total Disability shall be determined by the Committee in its sole discretion. (q) Unforeseeable Emergency means a severe financial hardship to the Participant resulting from: (i) Sudden or unexpected illness or accident of either the Participant or dependent of same; or 5 6 (ii) Loss of the Participant's property due to casualty or other extraordinary and unforeseeable circumstances beyond the control of the Participant. Hardship shall not constitute an unforeseeable Emergency under the Plan to the extent that it is, or may be, relieved by: (i) Reimbursement or compensation, by insurance or otherwise; or (ii) Liquidation of the Participant's assets to the extent that the liquidation of such assets would not itself cause severe financial hardship. An Unforeseeable Emergency under the Plan does not include: (i) Sending a child to college; or (ii) Purchasing a home, per Rev. Proc. 95-64. (r) Year means the Company's fiscal year unless otherwise noted. 3. Eligibility: Participation in the Plan is limited to Eligible Board Members, and Eligible Employees, who are eligible to participate in the Plan if: (a) He or she is subject to U.S. income and social security taxes and not covered under a non-U.S. retirement plan; (b) He or she is an officer, or his or her position is approved as a director level, or higher; or (c) He or she has been designated expressly as an Eligible Employee by the Committee. If a Participant receives a distribution described in Section 10(c), the Participant shall be ineligible to participate in the Plan for the balance of the Plan Year in which the distribution occurs and the following Plan Year. 4. Election to Participate in Plan: (a) Deferral Election. A Participant may elect to participate in the Plan by filing a written "Deferred Compensation Election Form" with the Company during any Election Period. Such election applies to applicable Compensation paid in payroll periods commencing after the close of the Election Period. A new election must be made for each Election Period. The Participant shall specify any amount subject to the limits described in Section 6(a). This can be expressed as a fixed dollar amount or as a percentage. (b) Election Form. All deferral elections under this Section 4 shall be made in a manner prescribed for this purpose by the Committee. 5. Accounts: (a) Establishment of Account. The Company shall establish an Account for each Participant who duly files a Deferred Compensation Election Form. 6 7 (b) Credits to Account. A Participant's Account shall be credited with an amount equal to the percentage of each Compensation payment which would have been payable currently to the Participant but for the terms of the Deferred Compensation Election Form. Deferred Compensation for Participants shall be credited to the Participant's Account as of the first day of the month in which such deferred amounts would otherwise be paid to the Participant. (c) Vesting. Participants shall at all times be 100% vested in their deferrals under the Plan and all earnings allocable thereto. 6. Deferral Increments and Growth: (a) The minimum deferral per year will be determined by the Committee. (b) The Participant who is an Eligible Employee may elect to defer (less any withholding requirements). (i) Up to 100% of any eligible annual bonus award; and (ii) Up to 60% of base salary and incentive awards/commissions. (c) The Participant who is an Eligible Board Member may elect to defer (less any withholding requirements), up to 100% of their retainer payments (to be credited to the account quarterly). 7. Earnings or Losses on Accounts: (a) General Rule. Subject to Section 7(c) below, the amount in a Participant's Account shall be adjusted for gain or loss on the last day of each month based on the performance of the investment options selected by the Participant in accordance with Section 7(b). Gain or loss shall be computed as if all amounts credited to the Account pursuant to Section 5(b) were credited as of the first day of the month, and all amounts withdrawn from the Account were withdrawn on the first day of the month. (b) Designation of Investment Indices by the Committee. The Committee shall specify two or more investment funds that shall serve as benchmarks for the investment performance of amounts credited to the Accounts. Accounts shall be adjusted to reflect the gain or loss, net of any allocable costs or expenses, such accounts would experience had they actually been invested in the specified funds at the relevant times. The Committee may vary the available investment funds from time to time, but not more frequently than quarterly. Subject to Section 7(c), a Participant may select his or her investment options for new deferrals and contributions, or for amounts already credited to his or her Account, once per calendar quarter effective as of the first day of the following quarter using such form or forms as the Committee may specify. (c) Pre-Plan Restatement Accounts. Notwithstanding anything in this Section 7 to the contrary, the balance in each Account as of the Plan Restatement Date shall be credited quarterly to reflect interest earned on the deferral in an amount determined by the Committee; provided, however, that Participants may elect to have earnings and losses on such Accounts credited instead in accordance with Section 7(a) and (b) after the Plan Restatement Date. Any such election shall be 7 8 made prior to the Plan Restatement Date in such form and subject to such other terms and conditions as the Committee shall specify. 8. Certain In-Service Account Distributions. (a) After Completion of Two Years of Plan Participation. Each Participant may elect in his or her Deferred Compensation Election Form to have one or more distributions of a specified percentage or dollar amount of his or her Account, not more frequently than once in a Plan Year, commencing in his or her third year of participation, provided that the Participant has not terminated his or her Service with the Company. A Participant may delay once or cancel such distribution at any time prior to the date which is one year prior to the calendar year in which the originally scheduled distribution would take place, but such election is otherwise irrevocable. (b) Previously Scheduled In-Service Distributions. Elections in effect prior to the Plan Restatement Date for in-service distributions prior to January 1, 2000 shall remain in full force and effect. 9. Statements: Quarterly, and/or at intervals determined by the Committee, the Company shall prepare and deliver to each Participant a statement listing the amount credited to such Account as of the applicable date. 10. Form and Time of Payment of Accounts: (a) Timing and Method of Distribution of Accounts. In the event of a Participant's termination of Service on or after his or her Retirement Date, distribution of the value of the Participant's Account balance shall be made as soon as practicable after such termination consistent with the form of distribution specified on the Participant's Deferred Compensation Election Form. Available forms shall include either a lump sum payment or a series of installments. Accounts subject to installment payouts shall continue to be adjusted for gains or losses in the same manner as active Accounts. Notwithstanding the foregoing, the Participant who is receiving an installment payout on or after his or her Retirement Date may request a lump sum distribution of such Participant's Account. Any such lump sum distribution shall be at the sole discretion of the Committee, and shall be reduced by a penalty equal to ten percent (10%) of the amount otherwise distributable, which penalty shall be forfeited to the Company. A Participant may modify his or her elected form of distribution (i.e., lump sum or installments) at any time prior to the date that is three years before his or her first post-employment distribution. If a Participant modifies his or her elected form of distribution but his or her first post-employment distribution is less than three years following the date of the modification election, his or her prior elected form of distribution shall apply. If the Participant terminates his or her service with the Company prior to his or her Retirement Date, (other than on account of death), he or she shall receive the value of his or her Account in one lump sum payment as soon as practicable after such termination. If a Participant elects a distribution date prior to termination of Service, the distribution will be paid as soon as reasonably practicable in a lump sum after such distribution date. (b) Disability or Emergency. In the event of Participant's Total Disability or Unforeseeable Emergency, and upon application by such Participant, the Committee may determine 8 9 at its sole discretion that payment of all, or part, of such Participant's Account shall be made in a different manner, or on an earlier date than the time or times specified in Subsection (a) above. Payments due to Participant's Total Disability or Unforeseeable Emergency shall be permitted only to the extent reasonably required to satisfy the Participant's need. (c) Early Distribution Penalty. Upon application by a Participant, the Committee may determine at its sole discretion that payments from such Participant's Account shall be made in a different manner, or on an earlier date than the time or times specified in Subsection (a) above. All distributions under this Subsection (c) shall be reduced by a penalty equal to 10 percent (10%) of the amount otherwise distributable. The penalty is forfeited to the Company. A Participant who receives a distribution under this Subsection (c) is ineligible to participate in the Plan for the balance of the Plan Year in which the distribution occurs and the following Plan Year. 11. Effect of Death of Participant: (a) Distributions. In the event of a Participant's death while an Eligible Employee or Eligible Board Member (except in the case of a Participant's suicide during the first two years of their participation in the Plan), the Participant's Account balance, together with an amount equal to two times the sum of (i) the Participant's actual deferrals under the Plan after the Plan Restatement Effective Date (exclusive of earnings), plus (ii) the Participant's actual deferrals under the Plan before the Plan Restatement Effective Date (exclusive of earnings) to the extent such deferrals are scheduled to be distributed on or after January 1, 2000, shall be distributed to the Participant's Beneficiary. In the event of (i) a Participant's death while no longer an Eligible Employee or Eligible Board Member (as applicable), or (ii) a Participant's suicide during the first two years of their participation in the Plan, the Account balance, if any, shall be distributed to the Participant's Beneficiary. Any distributions pursuant to this paragraph shall be made to the Beneficiary in three annual installments or, at the request of the Beneficiary and subject to the Committee's approval, in a single lump sum, commencing in either case as soon as reasonably practicable after the Participant's death. If installment payments are made, the remaining account balance (during the period of the installment payouts) shall cease to be credited with earnings on the investment chosen by the deceased Participant, and instead shall be credited with earnings based on a fixed rate of interest. (b) Beneficiary Designation. Upon enrollment in the Plan, each Participant shall file a prescribed form with the Company naming a person or persons as the Beneficiary who will receive distributions payable under the Plan in the event of the Participant's death. If the Participant does not name a Beneficiary, or if none of the named Beneficiaries is living at the time payment is due, then the Beneficiary shall be: (i) The spouse of the deceased Participant; or (ii) The living children of the deceased Participant, in equal shares, if no spouse of the Participant is living; or (iii) The estate of the Participant if neither spouse nor children of Participant are living. The Participant may change the designation of a Beneficiary at any time in accordance with procedures established by the Committee. Designations of a Beneficiary, or an amendment or 9 10 revocation thereof, shall be effective only if made in the prescribed manner and received by the Company prior to the Participant's death. 12. General Duties of Trustee: (a) Trustee Duties. The Trustee shall manage, invest and reinvest the Trust Fund as provided in the Trust Agreement. The Trustee shall collect the income on the Trust Fund, and make distributions therefrom, all as provided in this Plan and in the Trust Agreement. (b) Company Contributions. While the Plan remains in effect, the Company shall make contributions to the Trust Fund at least once each year. As soon as practicable after the close of each Plan Year, the Company shall make an additional contribution to the Trust Fund to the extent that previous contributions to the Trust Fund for the current Plan Year are less than total future liabilities (other than death benefits) created with respect to Participants' Accounts as of the close of the current Plan Year. Contributions to the Trust Fund are based on liabilities created with respect to Participants' Accounts on and after the Plan Restatement Effective Date. The Trustee shall not be liable for any failure by the Company to provide contributions sufficient to pay all accrued benefits under the Plan in accordance with the terms of this Plan. 13. Withholding Taxes: All distributions under the Plan shall be subject to reduction in order to reflect withholding tax obligations imposed by law. 14. Participant's Unsecured Rights: The Account of any Participant, and such Participant's right to receive distributions from his or her Account, shall be considered an unsecured claim against the general assists of the Company; such Accounts are unfunded bookkeeping entries. The Company considers the Plan to be unfunded for tax purposes and for purposes of Title I of ERISA. No Participant shall have an interest in, or make claim against, any specified asset of the Company pursuant to the Plan. 15. Non-assignability of Interests: The interest of a Participant under the Plan is not subject to option nor assignable by either voluntary or involuntary assignment or by operation of law, including without limitation to: bankruptcy, garnishment, attachment or other creditor's process. Any act in violation of this Section 15 shall make the Plan void. 16. Limitation of Rights: (a) Bonuses. Nothing in this Plan shall be construed to give any Eligible Employee any right to be granted a bonus award. (b) Employment Rights. Neither the Plan nor deferral of any Compensation, nor any other action taken pursuant to the Plan, shall constitute, or be evidence of, any agreement or understanding, express or implied, that the Company or any of its subsidiaries will employ an Eligible Employee for any period of time, in any position at any particular rate of compensation. The Company and its subsidiaries reserve the right to terminate an Eligible Employee's Service at any time for any reason, except as otherwise expressly provided in a written employment agreement. 10 11 17. Administration of the Plan: The Plan shall be administered by the Committee. The Committee shall have full power and authority to administer, interpret, establish procedures for administering the Plan, prescribe forms, and take any and all necessary actions in connection with the Plan. The Committee's interpretation and construction of the Plan shall be conclusive and binding on all persons. The Committee may appoint a plan administrator or any other agent and delegate to them such powers and duties in connection with the administration of the Plan as the Committee may from time to time prescribe. In the event that any Participants are found to be ineligible, that is, not members of a select group of management or highly compensated employees, according to a determination made by the U.S. Department of Labor, the Committee shall take whatever steps it deems necessary, in its sole discretion, to equitably protect the interests of the affected Participants. 18. Amendment or Termination of the Plan: The Board may amend, suspend, or terminate the Plan at any time; provided, however, that no such action shall reduce a Participant's Account under the Plan without the Participant's written consent. In the event of termination of the Plan, the Accounts of Participants shall continue to be credited with earnings until distributed pursuant to Section 10, unless the Board prescribes an earlier time or different manner for the payment of such Accounts. Without limiting the generality of the foregoing, termination of the Plan following Change in Control shall constitute an event giving rise to distribution of Accounts. In such event, the Company shall pay all Account balances in a lump sum or in annual installments over three years (with earnings), in its discretion, to Participants and Beneficiaries of deceased Participants; and all deferrals and payment of benefits except as provided above shall cease. For purposes of this Plan, the term "Change in Control" shall mean the purchase or acquisition by any person, entity or group of persons, within the meaning of Section 13(d) or 14(d) of the Securities Exchange Act of 1934, as amended (the "Act"), or any comparable successor provisions, of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Act) of 30% or more of either the outstanding shares of common stock or the combined voting power of the Company's then outstanding voting securities entitled to vote generally, where the approval by the stockholders of the Company or a reorganization, merger or consolidation, in each case with respect to which persons who are stockholders of the Company immediately prior to such reorganization, merger or consolidation do not, immediately thereafter, own more than 50% of the combined voting power entitled to vote generally in the election of directors of the reorganized, merged or consolidated Company's then outstanding securities, or a liquidation or dissolution of the Company or of the sale of all or substantially all of the Company's assets. 19. Choice of Law and Claims Procedure: (a) Choice of Law. The validity, interpretation, construction and performance of the Plan shall be governed by ERISA, and, to the extent that they are not preempted, by the laws of the State of California, excluding California's choice-of-law provisions. (b) Claims and Review Procedure. In accordance with the regulations of the U.S. Secretary of Labor, the Committee shall: (i) Provide adequate notice in writing to any Participant or Beneficiary whose claim for benefits under the Plan has been denied. Specific reasons for such denial must be presented in a clear and precise manner intended to be easily understood by such Participant or Beneficiary, and 11 12 (ii) Afford a reasonable opportunity for a full and fair review before the Board to any Participant or Beneficiary whose claim for benefits has been denied. 20. Execution and Signature: To record the adoption of the Plan by the Board, the Company has caused its duly authorized officer to affix the corporate name hereto: SUN MICROSYSTEMS, INC. By:___________________________________ Authorized Company Officer 12 EX-13.0 3 1998 ANNUAL REPORT TO STOCKHOLDERS 1 FINANCIAL REVIEW OPEN HERE FOR A LONG-TERM VIEW OF SUN'S GROWTH 2 HISTORICAL FINANCIAL REVIEW OF SUN MICROSYSTEMS, INC. SUMMARY CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED JUNE 30,
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 1998 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------ Dollars % Dollars % Dollars % Dollars % ----------------------------------------------------------------- Net revenues $9,791 100.0 $8,598 100.0 $7,095 100.0 $5,902 100.0 ----------------------------------------------------------------- Costs and expenses: Cost of sales 4,693 47.9 4,320 50.2 3,921 55.3 3,336 56.5 Research and development 1,014 10.4 826 9.6 653 9.2 563 9.5 Selling, general and administrative 2,777 28.4 2,402 27.9 1,788 25.2 1,503 25.5 Purchased in-process research and development 177 1.8 23 0.3 58 0.8 -- -- Total costs and expenses 8,661 88.5 7,571 88.0 6,420 90.5 5,402 91.5 ----------------------------------------------------------------- Operating income 1,130 11.5 1,027 12.0 675 9.5 500 8.5 Gain on sale of equity investment -- -- 62 0.7 -- -- -- -- Interest income (expense), net 46 0.5 32 0.4 34 0.5 23 0.4 Litigation settlement -- -- -- -- -- -- -- -- Income before income taxes 1,176 12.0 1,121 13.1 709 10.0 523 8.9 Provision for income taxes 413 4.2 359 4.2 232 3.3 167 2.8 ----------------------------------------------------------------- Net income $ 763 7.8 $ 762 8.9 $ 477 6.7 $ 356 6.1 Net income per common share--diluted $ 1.93 $ 1.96 $ 1.21 $ 0.91 ----------------------------------------------------------------- Shares used in the calculation of net income per common share--diluted 394 389 393 394 - ------------------------------------------------------------------------------------------------------------
OPERATING AND CAPITALIZATION DATA YEARS ENDED JUNE 30,
1998 1997 1996 1995 - ------------------------------------------------------------------------------------------------------- Total assets (millions) $ 5,771 $ 4,697 $ 3,801 $ 3,545 -------------------------------------------------- Long-term debt and other obligations (millions) $ 75 $ 106 $ 60 $ 91 -------------------------------------------------- Current ratio 2.0 2.0 2.0 2.2 -------------------------------------------------- Long-term debt-to-equity ratio -- 0.015 0.018 0.039 -------------------------------------------------- Return on average equity 24% 31% 22% 19% -------------------------------------------------- Return on average capital 24% 30% 23% 18% -------------------------------------------------- Return on average assets 15% 18% 13% 11% -------------------------------------------------- Effective income tax rate 35.1% 32% 33% 32% -------------------------------------------------- Average shares and equivalents (thousands) 394,274 388,967 393,380 393,700 -------------------------------------------------- Book value per outstanding share $ 9.34 $ 7.40 $ 6.05 $ 5.39 - -------------------------------------------------------------------------------------------------------
18 3 HISTORICAL FINANCIAL REVIEW OF SUN MICROSYSTEMS, INC. SUMMARY CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED JUNE 30,
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 1994 1993 1992 1991 1990 1989 - ----------------------------------------------------------------------------------------------------------------------------------- Dollars % Dollars % Dollars % Dollars % Dollars % Dollars % ------------------------------------------------------------------------------------------- Net revenues $4,690 100.0 $4,309 100.0 $3,589 100.0 $3,221 100.0 $2,466 100.0 $1,765 100.0 ------------------------------------------------------------------------------------------- Costs and expenses: Cost of sales 2,753 58.7 2,518 58.4 1,963 54.7 1,758 54.6 1,399 56.7 1,010 57.2 Research and development 500 10.7 445 10.3 382 10.6 356 11.1 302 12.2 234 13.3 Selling, general and administrative 1,160 24.7 1,105 25.7 983 27.4 812 25.2 588 23.9 433 24.5 Purchased in-process research and development -- -- -- -- -- -- -- -- -- -- -- -- Total costs and expenses 4,413 94.1 4,068 94.4 3,328 92.7 2,926 90.9 2,289 92.8 1,677 95.0 ------------------------------------------------------------------------------------------- Operating income 277 5.9 241 5.6 261 7.3 295 9.1 177 7.2 88 5.0 Gain on sale of equity investment -- -- -- -- -- -- -- -- -- -- -- -- Interest income (expense), net 6 0.1 (2) -- (6) (0.2) (11) (0.3) (23) (0.9) (10) (0.6) Litigation settlement -- -- (15) (0.4) -- -- -- -- -- -- -- -- Income before income taxes 283 6.0 224 5.2 255 7.1 284 8.8 154 6.3 78 4.4 Provision for income taxes 87 1.8 67 1.6 82 2.3 94 2.9 43 1.8 17 1.0 ------------------------------------------------------------------------------------------- Net income $ 196 4.2 $ 157 3.6 $ 173 4.8 $ 190 5.9 $ 111 4.5 $ 61 3.4 Net income per common share--diluted $ 0.50 $ 0.37 $ 0.42 $ 0.45 $ 0.30 $ 0.19 ------------------------------------------------------------------------------------------- Shares used in the calculation of net income per common share--diluted 388 430 431 439 395 348 - -----------------------------------------------------------------------------------------------------------------------------------
OPERATING AND CAPITALIZATION DATA YEARS ENDED JUNE 30,
1994 1993 1992 1991 1990 1989 - ---------------------------------------------------------------------------------------------------------------------------- Total assets (millions) $ 2,898 $ 2,768 $ 2,672 $ 2,326 $ 1,779 $ 1,269 ------------------------------------------------------------------------- Long-term debt and other obligations (millions) $ 122 $ 178 $ 348 $ 401 $ 359 $ 145 ------------------------------------------------------------------------- Current ratio 2.0 2.4 2.6 2.5 2.6 1.9 ------------------------------------------------------------------------- Long-term debt-to-equity ratio 0.075 0.11 0.23 0.33 0.39 0.22 ------------------------------------------------------------------------- Return on average equity 12% 10% 13% 18% 14% 12% ------------------------------------------------------------------------- Return on average capital 12% 9% 10% 13% 11% 9% ------------------------------------------------------------------------- Return on average assets 7% 6% 7% 9% 7% 6% ------------------------------------------------------------------------- Effective income tax rate 33% 30% 32% 33% 28% 22% ------------------------------------------------------------------------- Average shares and equivalents (thousands) 387,056 420,500 406,560 412,268 377,476 340,664 ------------------------------------------------------------------------- Book value per outstanding share $ 4.34 $ 4.03 $ 3.72 $ 3.15 $ 2.51 $ 1.97 - ----------------------------------------------------------------------------------------------------------------------------
19 4 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING TABLE SETS FORTH ITEMS FROM SUN'S CONSOLIDATED STATEMENTS OF INCOME AS A PERCENTAGE OF NET REVENUES:
1998 1997 1996 - -------------------------------------------------------------------------------------- Net revenues: Products 87.9 90.1 90.2 Services 12.1 9.9 9.8 ------------------------------------ Total net revenues 100.0% 100.0% 100.0% Cost of sales: Products 40.5 44.0 48.9 Services 7.4 6.2 6.4 ------------------------------------ Total cost of sales 47.9 50.2 55.3 Gross margin 52.1 49.8 44.7 Research and development 10.4 9.6 9.2 Selling, general and administrative 28.4 27.9 25.2 Purchased in-process research and development 1.8 0.3 0.8 ------------------------------------ Operating income 11.5 12.0 9.5 Gain on sale of investment -- 0.7 -- Interest income, net 0.5 0.4 0.5 ------------------------------------ Income before income taxes 12.0 13.1 10.0 Provision for income taxes 4.2 4.2 3.3 ------------------------------------ Net income 7.8% 8.9% 6.7% - --------------------------------------------------------------------------------------
This Annual Report, including the following sections, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, particularly statements regarding market opportunities, market share growth, competitive growth, new product introductions, success of research and development, research and development expenses, customer acceptance of new products, gross margin and selling, general and administrative expenses. These forward-looking statements involve risks and uncertainties, and the cautionary statements set forth below, specifically those contained in "Future Operating Results," identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. Such factors include, but are not limited to, adverse changes in general economic conditions, including adverse changes in the specific markets for the Company's products, adverse business conditions, decreased or lack of growth in the computing industry, adverse changes in customer order patterns, increased competition, lack of acceptance of new products, pricing pressures, lack of success in technological advancements, risks associated with foreign operations (including the downturn of economic trends and unfavorable currency movements in the Asia Pacific marketplace), risks associated with the Company's efforts to comply with Year 2000 requirements, and other factors, including those listed below. RESULTS OF OPERATIONS NET REVENUES Sun's products net revenues increased $856 million, or 11%, to $8,603 million in fiscal 1998, compared with an increase of $1,355 million, or 21%, in fiscal 1997. More than 50% of the increase in products revenues in fiscal 1998 resulted from increased demand throughout the fiscal year for workgroup, enterprise, and departmental servers and high-end desktop systems and to a lesser extent from high-end storage, memory and related products. The increase in products revenues in fiscal 1997 over fiscal 1996 was primarily attributable to increased shipments of richly configured servers, and higher revenues from memory, storage options, and accessories. Sun's services net revenues increased $336 million, or 40%, to $1,188 million in fiscal 1998, compared with an increase of $149 million, or 21%, in fiscal 1997. The increase in services revenues is primarily the result of a larger installed product base due to increased product unit sales as described above, as well as increased revenues associated with Sun professional services. The increase in services revenue from fiscal 1996 to fiscal 1997 is primarily the result of products revenue growth. In fiscal 1998 and fiscal 1997, domestic net revenues grew by 16% and 25%, respectively, while international net revenues (including United States exports) grew 12% and 17%, respectively. Revenues from international operations represented 48%, 49%, and 50% of total revenues in fiscal 1998, 1997, and 1996, respectively. European net revenues increased 20% in fiscal 1998 and 1997, primarily due to continued market acceptance of Sun's network computing products and services in most major European markets. Japan net revenues decreased 5% for fiscal 1998, compared to a decrease of 3% in fiscal 1997. The Company attributes 20 5 the decrease in revenues to current macroeconomic trends affecting the Japanese market, including currency movements against the U.S. dollar. The Company does not expect these trends to change materially in the near term. The foregoing is a forward-looking statement that is subject to risks and uncertainties, and actual results may differ materially from those set forth in such statement as a result of a number of factors. In particular, if the economic trends in Japan significantly worsen in a quarter or decline over an extended period of time, the Company's results from operations and cash flows would be adversely affected. Net revenues in Rest of World increased by 9% in fiscal 1998, compared with 33% in fiscal 1997, primarily due to expanding markets in China, Australia, and Latin America. This slowing in the growth rate in fiscal 1998 is attributable to a downturn in economic trends and unfavorable currency movements in the Asia Pacific marketplace. A portion of the Company's operations consists of manufacturing and sales activities in foreign jurisdictions. As a result, the Company's results could be significantly adversely affected by factors such as changes in foreign currency exchange rates or real economic conditions in the foreign markets in which the Company distributes its products. The Company is primarily exposed to changes in exchange rates on the Japanese yen, British pound sterling, French franc, and German mark. When the U.S. dollar strengthens against these currencies, the U.S. dollar value of non-U.S. dollar-based sales decreases. When the U.S. dollar weakens against these currencies, the U.S. dollar value of non-U.S. dollar-based sales increases. Correspondingly, the U.S. dollar value of non-U.S. dollar-based costs increases when the U.S. dollar weakens and decreases when the U.S. dollar strengthens. Overall the Company is a net receiver of currencies other than the U.S. dollar and as such, benefits from a weaker dollar, and is adversely affected by a stronger dollar relative to major currencies worldwide. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, may adversely affect the Company's consolidated sales and gross margins as expressed in U.S. dollars. To mitigate the short-term effect of changes in currency exchange rates on the Company's non-U.S. dollar-based sales, product procurement, and operating expenses, the Company regularly hedges its net non-U.S. dollar-based exposures by entering into foreign exchange forward and option contracts to hedge transactions. Currently, hedges of transactions do not extend beyond three months. Given the short-term nature of the Company's foreign exchange forward and option contracts, the Company's exposure to risk associated with currency market movement on these instruments is not material. See "Other Financial Instruments" in Note 1 of the "Notes to Consolidated Financial Statements" for more details. GROSS MARGIN Products gross margin was 53.8% for fiscal 1998, compared with 51.1% and 45.7% for fiscal 1997 and 1996, respectively. The increase in products gross margin in fiscal 1998 resulted primarily from sales of more richly configured, higher margin servers and desktop systems, and to a lesser extent, from decreased component costs. The increase in products gross margin in fiscal 1997 over fiscal 1996 was primarily due to increased shipments of richly configured servers and higher revenues from memory, storage options, and accessories. Services gross margin was 39.3% for fiscal 1998, compared with 37.7% and 35.5% for fiscal 1997 and 1996, respectively. These increases reflect the increase in services revenues year over year as the result of a larger installed base and increased investment by the Company in its services business. The factors described above resulted in a favorable impact on gross margin. 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 was unable to mitigate the resulting margin pressure by maintaining a favorable mix of systems, software, service, and other products, and by achieving component cost reductions, operating efficiencies, and increasing volumes. RESEARCH AND DEVELOPMENT Research and development (R&D) expenses increased $188 million, or 22.7%, in fiscal 1998 to $1,014 million, compared with an increase of $173 million, or 26.5%, in fiscal 1997. As a percentage of net revenues, R&D expenses were 10.4%, 9.6%, and 9.2% in fiscal 1998, 1997, and 1996, respectively. The increase in R&D spending, both in dollars and as a percentage of revenues, was a result of the Company's continued significant investment related to the development of hardware and software products that utilize the Java architecture, and new server and storage products. The remaining increase in dollar amount of such expenses is primarily attributable to continued development of UltraSPARC systems, further development of products obtained through acquisitions, and increased compensation due primarily to higher levels of staffing. The increase as a percentage of net revenues reflects the Company's belief that to maintain its competitive position in a market characterized by rapid rates of technological advancement for systems and software products, as well as microprocessor technologies, the Company must continue to invest significant resources in new systems, software, and microprocessor development, as well as in enhancements to existing products. The Company expects R&D expenses to increase in dollar amount in fiscal 1999 while remaining in the range of 10% of revenue. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative (SG&A) expenses increased $375 million, or 15.6%, in fiscal 1998 to $2,777 million compared with an increase of $615 million, or 34.4%, in fiscal 1997. As a percentage of net revenues, these expenses were 28.4%, 27.9%, and 25.2% in fiscal 1998, 1997, and 1996, respectively. The increase as a percentage of net revenues in fiscal 1998 21 6 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS reflects, in part, the Company's ongoing efforts to expand its demand creation programs and service and support organizations. The dollar increase also reflects investments aimed at improving Sun's own business processes. The increase in dollar amount of SG&A expenses in fiscal 1997 was primarily attributable to increased marketing costs related to new product introductions and other promotional programs, and an increase in compensation resulting primarily from higher levels of marketing and sales head count. In fiscal 1999, the Company expects SG&A expenses to increase in dollar amount, as the Company continues to invest in efforts to achieve additional operating efficiencies through the continual review and improvement of business processes. In addition, the Company expects to continue to hire personnel to drive its demand-creation programs and service and support organizations. PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT Purchased in-process research and development of $176.4 million, $23 million, and $57.9 million in fiscal 1998, 1997, and 1996, respectively, represents the write-off of technology associated with the Company's acquisitions of Diba, Inc.; Integrity Arts, Inc.; Chorus Systems, S.A.; Red Cape Software, Inc.; and the storage products business of Encore Computer Corporation in fiscal 1998, Long View Technologies, LLC in fiscal 1997 and Integrated Micro Products plc, and Lighthouse Design, Ltd. in fiscal 1996. See also "Acquisitions" in Footnote 2 of the "Notes to Consolidated Financial Statements." GAIN ON SALE OF EQUITY INVESTMENT In fiscal 1997, the gain on sale of equity investment of $62 million represents net proceeds from the sale of the Company's equity investment in Iona Technologies, plc. INTEREST INCOME (EXPENSE), NET The Company's interest income and expense are most sensitive to changes in the general level of U.S. interest rates. In this regard, changes in the U.S. interest rates affect the interest earned on the Company's cash equivalents and short-term investments as well as interest paid on its short-term borrowings. To mitigate the impact of fluctuations in U.S. interest rates, the Company has entered into an interest rate swap transaction. This swap is intended to better match the Company's floating-rate interest income on its cash equivalents and short-term investments with the interest expense on its note payable. Net interest income increased to $46.1 million in fiscal 1998, compared with $32.4 million and $33.9 million in fiscal 1997 and fiscal 1996, respectively. The increase in net interest income for fiscal 1998 is primarily the result of higher interest earnings due to a larger average portfolio of cash and investments as compared with the corresponding period in fiscal 1997. The decrease in net interest income for fiscal 1997, as compared with fiscal 1996, was primarily the result of lower interest earnings due to a smaller average portfolio of cash and investments as compared to the corresponding period in fiscal 1996. The principal/notional amount of the Company's cash equivalents and short-term investments at June 30, 1998 were $783.8 million. These investments, which generally mature in fiscal 1999, bear interest at an average rate of 5.2% and have a fair market value of $783.9 million. INCOME TAXES The effective tax rate for fiscal 1998 was 33% before a $25.2 million tax charge resulting from a nonrecurring write-off of in-process research and development associated with the acquisitions of Diba, Inc.; Integrity Arts, Inc.; and Red Cape Software, Inc. The effective tax rate for fiscal 1997 was 32%. The effective tax rate for fiscal 1996 was 32% before a $5.7 million tax charge resulting from a nonrecurring write-off of in-process research and development associated with the acquisition of Lighthouse Design, Ltd. The Company currently expects its effective tax rate to remain at 33% for fiscal 1999. This rate excludes the impact of potential mergers and acquisitions, the tax effect of which will be accounted for in the interim quarter in which the transaction takes place. The expected rate is based on current tax law and current estimate of earnings, and is subject to change. FUTURE OPERATING RESULTS The markets for Sun's products and services are 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 Co., International Business Machines Corporation, Compaq Computer 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 certain systems manufacturers, including Dell Computer Corporation and certain of its competitors listed above, whose products are based on micro-processors 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 22 7 in periods leading up to the Company's introduction of its own new enhanced products. The Company expects this pressure to continue and intensify into fiscal 1999. 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. 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, 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 non-cancelable 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 Company's 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 products based on UltraSPARC processors, 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 certain parts of 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 future financial condition and operating results. Seasonality also affects the Company's operating results, particularly in the first and third 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 value of its assets, and when necessary, make adjustments thereto. Acquisitions may involve the amortization of acquired intangible assets in periods following such acquisitions. In addition, acquisition transactions are accompanied by a number of risks, including, among other things, those associated with integrating operations, personnel, and technologies acquired, and the potential for unknown liabilities of the acquired business. 23 8 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION 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 across the enterprise that affect numerous operational and financial systems and processes. Such activities are currently planned to be fully operational in the first half of fiscal 1999. The time period in which the new business practices and related information systems will be implemented are forward-looking statements subject to risks and uncertainties, and actual results may differ materially from those set forth above as a result of a number of risk factors. In particular, the timing and duration of the implementation of the new business practices and information systems are subject to a number of risks, including the complexity of the conversion process and the new systems themselves, the transfer of business data and information from the previous system to the new system, and the need for substantial and comprehensive employee training in connection with the adoption of such new business practices and information systems. 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 implementing these systems. In addition, the implementation of these systems will require the Company to be without certain capabilities critical to normal operation of its business (such as processing orders and shipping product) for a period of time as the Company shifts to the new systems. There can be no assurance that this interruption in the use and availability of enterprise-wide information systems will not have a material adverse effect on the Company's business and operating results. In addition, 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 currently installed computer systems and software products are coded to accept only two digit entries in the date code field. As the year 2000 approaches, these code fields will need to accept four digit entries to distinguish years beginning with "19" from those beginning with "20." 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 resources to review its products and services, as well as its internal-use software in order to identify and modify those products, services, and systems that are not Year 2000 compliant. The costs associated with this effort are not incremental to the Company, but represent reallocation of existing resources. The Company believes any modifications deemed necessary 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. In addition, the Company believes that its internal system implementation efforts (as described in the above paragraph), principally conducted to improve operating efficiencies, will also address the Company's internal Year 2000 compliance issues. Additionally, the Company is in the process of evaluating the need for contingency plans with respect to Year 2000 requirements. The necessity of any contingency plan must be evaluated on a case-by-case basis and will vary considerably in nature depending on the Year 2000 issue it may need to address. The Company's expectations as to the extent and timeliness of modifications required in order to achieve Year 2000 compliance is a forward-looking statement subject to risks and uncertainties. Actual results may vary materially as a result of a number of factors, including, among others, those described in this paragraph and the paragraph below. There can be no assurance however, that the Company will be able to successfully modify on a timely basis such products, services, and systems to comply with Year 2000 requirements, which failure 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. To the extent that Sun is not able to test technology provided by third-party hardware or software vendors, Sun is in the process of obtaining assurances from such vendors that their systems are Year 2000 compliant. In the event any such third parties cannot, in a timely manner, provide the Company with products, services, or systems that meet the Year 2000 requirements, the Company's operating results could be materially adversely effected. Although the Company believes that the cost of Year 2000 modifications for both internal-use software and systems or the Company's products are not material, there can be no assurance that various 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 position. Eleven of the 15 member countries of the European Union are scheduled to establish fixed conversion rates between their existing sovereign currencies and the Euro, and to adopt the Euro as their common legal currency effective January 1, 1999. The Euro will then trade on currency exchanges and be available for non-cash transactions. The Company is currently expending resources to review and modify its products to support the Euro's requirements, determine pricing strategies in the new economic environment, analyze the legal and 24 9 contractual implications for contracts, evaluate system capabilities, and ensure banking vendors can support the Company's operations with respect to Euro transactions. The Company expects that modifications will be made to its business operations and systems on a timely basis and does not believe that the cost of such modifications will have a material adverse impact on the Company's operating results. There can be no assurance, however, the Company will be able to complete such modifications to comply with Euro requirements, which could have a material adverse effect on the Company's operating results. In addition, the Company faces risks to the extent that vendors upon whom the Company relies and their suppliers are unable to make appropriate modifications to support Euro transactions. The Company has not yet completed it evaluation of the impact of the Euro upon its functional currency designations. While the Company cannot 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. Also see Footnote 1 "Summary of Significant Accounting Policies." LIQUIDITY AND CAPITAL RESOURCES The Company's financial condition strengthened as of fiscal 1998 year end when compared with fiscal 1997. During fiscal 1998, operating activities generated $1,527 million in cash and cash equivalents, compared with $1,105 million in fiscal 1997. Accounts receivable increased $179 million, or 11%, to $1,846 million, due primarily to a 13% increase in net revenues in the fourth quarter of fiscal 1998 as compared with the corresponding period of 1997. Deferred tax assets and other current and noncurrent assets increased $240 million, or 35% to $920 million, due primarily to the timing of payments for income and other taxes, and due to the recording of goodwill and other intangible assets related to the Company's acquisitions. Accrued liabilities and other increased $185 million, or 30%, due in part to increases in sales and marketing costs. Accounts payable increased $27 million, or 6% due in part to additional operating expenses associated with the expansions of business and corresponding increase in head count. The Company's investing activities used $1,169 million of cash in fiscal 1998, an increase of $625 million from the $544 million used in fiscal 1997. The increase resulted primarily from payments made for additions to property, plant and equipment, and in connection with acquisitions. Additions to property, plant and equipment totaled $830 million, up $276 million, or 50%, from fiscal 1997 additions, primarily due to the real estate development of the Company's facilities and capital additions to support increased head count. The Company plans to expend $800 to $900 million during fiscal 1999 related to fixed asset additions, including approximately $300 million associated with the development of additional campuses in Colorado, Massachusetts, California, and the United Kingdom. In connection with the acquisition of NetDynamics, Inc. and other acquisitions expected to be completed in the first and second quarters of fiscal 1999, contingent upon the completion of various closing conditions, the Company also expects to record in-process research and development write-offs that are not likely to exceed $170 million. Approximately $195 million of cash was used by financing activities in fiscal 1998, compared with $430 million used in fiscal 1997. This change is primarily due to a reduction in the dollar value of shares repurchased, from $456 million for fiscal 1997 to $284 million for fiscal 1998, retirement of the receivable purchase agreement of $125 million in 1997, and repayment of short-term borrowings of $93 million. The Company's exposure to interest rate risk on the $40 million mortgage loan, due in May 1999, and the international short-term borrowings of $7 million is not material, given the short-term maturity of these instruments and the Company's evaluation of the potential for rate changes associated with such instruments. The Company has entered into an interest rate swap agreement (exchanging a fixed rate for variable) related to the $40 million mortgage loan. The potential impact of this swap agreement on the Company's mortgage loan interest rate is not expected to be material. At June 30, 1998, the Company's primary sources of liquidity consisted of cash, cash equivalents, and short-term investments of $1,298 million, and a revolving credit facility with banks aggregating $500 million, which was available subject to compliance with certain covenants, and $694 million of borrowings under available lines of credit to the Company's international subsidiaries. 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 billion. 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 borrowing arrangements described above will provide sufficient capital to meet the Company's requirements through fiscal 1999. 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. 25 10 CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30, (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1998 1997 1996 - ---------------------------------------------------------------------------------------- Net revenues: Products $8,603,259 $7,747,115 $6,392,358 Services 1,187,581 851,231 702,393 ----------------------------------------- Total net revenues 9,790,840 8,598,346 7,094,751 Costs and expenses: Cost of sales--products 3,972,283 3,790,284 3,468,416 Cost of sales--services 721,053 530,176 452,812 Research and development 1,013,782 825,968 653,044 Selling, general and administrative 2,777,264 2,402,442 1,787,567 Purchased in-process research and development 176,384 22,958 57,900 ----------------------------------------- Total costs and expenses 8,660,766 7,571,828 6,419,739 Operating income 1,130,074 1,026,518 675,012 Gain on sale of equity investment -- 62,245 -- Interest income 47,663 39,899 42,976 Interest expense (1,571) (7,455) (9,114) ----------------------------------------- Income before income taxes 1,176,166 1,121,207 708,874 Provision for income taxes 413,304 358,787 232,486 ----------------------------------------- Net income $ 762,862 $ 762,420 $ 476,388 ----------------------------------------- Net income per common share--basic $ 2.04 $ 2.07 $ 1.28 ----------------------------------------- Net income per common share--diluted $ 1.93 $ 1.96 $ 1.21 ----------------------------------------- Shares used in the calculation of net income per common share--basic 373,728 368,426 371,134 ----------------------------------------- Shares used in the calculation of net income per common share--diluted 394,274 388,967 393,380 - ----------------------------------------------------------------------------------------
See accompanying notes. 26 11 CONSOLIDATED BALANCE SHEETS
AT JUNE 30, (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) 1998 1997 ---------- ---------- ASSETS Current assets: Cash and cash equivalents $ 822,267 $ 660,170 Short-term investments 476,185 452,590 Accounts receivable, net of allowances of $235,563 in 1998 and $196,091 in 1997 1,845,765 1,666,523 Inventories 346,446 437,978 Deferred tax assets 371,841 286,720 Other current assets 285,021 224,469 ------------------------- Total current assets 4,147,525 3,728,450 Property, plant and equipment: Machinery and equipment 1,251,660 1,057,239 Furniture and fixtures 113,636 93,078 Leasehold improvements 256,233 166,745 Land and buildings 635,699 341,279 ------------------------- 2,257,228 1,658,341 Accumulated depreciation and amortization (956,616) (858,448) ------------------------- 1,300,612 799,893 Other assets, net 262,925 168,931 ------------------------- $5,711,062 $4,697,274 ------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term borrowings $ 7,169 $ 100,930 Accounts payable 495,603 468,912 Accrued payroll-related liabilities 315,929 337,412 Accrued liabilities and other 810,562 625,600 Deferred service revenues 264,967 197,616 Income taxes payable 188,641 118,568 Note payable 40,000 -- ------------------------- Total current liabilities 2,122,871 1,849,038 Deferred income taxes and other obligations 74,563 106,299 Commitments and contingencies Stockholders' equity: Preferred stock, $0.001 par value, 10,000,000 shares authorized; no shares issued and outstanding -- -- Common stock, $0.00067 par value, 950,000,000 shares authorized; issued: 430,311,441 shares in 1998 and 430,535,886 shares in 1997 288 288 Additional paid-in capital 1,345,508 1,229,797 Retained earnings 3,150,935 2,409,850 Treasury stock, at cost: 54,007,866 shares in 1998 and 60,050,380 shares in 1997 (1,003,191) (915,426) Currency translation adjustment and other 20,088 17,428 ------------------------- Total stockholders' equity 3,513,628 2,741,937 ------------------------- $5,711,062 $4,697,274 - --------------------------------------------------------------------------------------------------
See accompanying notes. 27 12 CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, (IN THOUSANDS) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------ Cash flows from operating activities: Net income $ 762,862 $ 762,420 $ 476,388 Adjustments to reconcile net income to operating cash flows: Depreciation and amortization 439,921 356,003 294,541 Gain on sale of equity investment -- (62,245) -- Tax benefit of options exercised 111,375 59,799 53,000 Purchased in-process research and development 176,384 22,958 57,900 Net increase in accounts receivable (176,075) (334,911) (160,238) Net (increase) decrease in inventories 97,394 22,936 (135,742) Net increase (decrease) in accounts payable (12,298) 143,845 17,275 Net increase in other current and non-current assets (206,210) (152,510) (43,701) Net increase in other current and non-current liabilities 333,159 286,793 128,891 ------------------------------------------ Net cash provided from operating activities 1,526,512 1,105,088 688,314 ------------------------------------------ Cash flows from investing activities: Additions to property, plant and equipment (830,143) (554,018) (295,638) Acquisition of other assets (91,521) (37,645) ( 83,889) Acquisition of short-term investments (958,354) (973,884) (1,301,798) Maturities of short-term investments 523,032 634,765 1,424,324 Sales of short-term investments 432,047 347,771 228,377 Proceeds from sale of equity investment -- 62,245 -- Payments for acquisitions, net of cash acquired (244,020) (22,958) (96,100) ------------------------------------------ Net cash used by investing activities (1,168,959) (543,724) (124,724) ------------------------------------------ Cash flows from financing activities: Issuance of stock, net of employee repurchases 71,975 52,969 59,554 Acquisition of treasury stock (284,396) (456,090) (522,336) Proceeds from employee stock purchase plans 93,581 81,313 54,840 Proceeds (reduction) of short-term borrowings, net (92,967) 51,769 (1,625) Repayment of receivable purchase agreement -- (125,000) -- Proceeds (reduction) of note payable and other 16,351 (35,009) (39,038) ------------------------------------------ Net cash used by financing activities (195,456) (430,048) (448,605) Net increase in cash and cash equivalents 162,097 131,316 114,985 Cash and cash equivalents, beginning of year 660,170 528,854 413,869 ------------------------------------------ Cash and cash equivalents, end of year $ 822,267 $ 660,170 $ 528,854 ------------------------------------------ Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 905 $ 15,126 $ 18,140 Income taxes $ 334,550 $ 380,814 $ 193,461 Supplemental schedule of non-cash investing and financing activities: In conjunction with the Company's acquisitions, liabilities were assumed as follows: Fair value of assets acquired $ 301,415 -- $ 101,500 Cash paid for assets (249,806) -- (96,100) ------------------------------------------ Liabilities assumed $ 51,609 -- $ 5,400 ------------------------------------------ Stock issued in conjunction with acquisitions -- -- $ 19,012 - ------------------------------------------------------------------------------------------------------------
See accompanying notes. 28 13 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK TREASURY STOCK SHARES AMOUNT ADDITIONAL RETAINED SHARES AMOUNT CURRENCY TOTAL THREE YEARS ENDED JUNE 30, 1998 PAID-IN EARNINGS TRANSLATION STOCKHOLDERS' (in thousands, except share amounts) CAPITAL ADJUSTMENT EQUITY ------------------------------------------------------------------------------------------------- Balances at June 30, 1995 425,509,924 $ 72 $1,089,478 $1,205,483 (31,452,316) $ (206,067) $ 33,629 $2,122,595 Issuance of stock, net of employee repurchases (40,468) -- -- (19,516) 14,561,928 131,493 -- 111,977 Issuance of restricted stock 850,662 -- 19,012 -- -- -- -- 19,012 Treasury stock purchased -- -- -- -- (37,465,488) (522,336) -- (522,336) Net income -- -- -- 476,388 -- -- -- 476,388 Tax benefit and other -- -- 55,859 -- -- -- (12,009) 43,850 Balances at June 30, 1996 426,320,118 72 1,164,349 1,662,355 (54,355,876) (596,910) 21,620 2,251,486 Issuance of stock, net of employee repurchases (10,000) -- -- (14,710) 10,378,115 137,574 -- 122,864 Treasury stock purchased -- -- -- -- (16,072,619) (456,090) -- (456,090) Exercise of warrants 4,225,768 1 1,611 -- -- -- -- 1,612 Net income -- -- -- 762,420 -- -- -- 762,420 Tax benefit and other -- -- 63,837 -- -- -- (4,192) 59,645 Issuance of common stock dividend -- 215 -- (215) -- -- -- -- Balances at June 30, 1997 430,535,886 288 1,229,797 2,409,850 (60,050,380) (915,426) 17,428 2,741,937 Issuance of stock, net of employee repurchases (224,445) -- (2) (21,777) 12,638,384 196,631 -- 174,852 Treasury stock purchased -- -- -- -- (6,595,870) (284,396) -- (284,396) Net income -- -- -- 762,862 -- -- -- 762,862 Tax benefit and other -- -- 115,713 -- -- -- 2,660 118,373 Balances at June 30, 1998 430,311,441 $288 $1,345,508 $3,150,935 (54,007,866) $(1,003,191) $ 20,088 $3,513,628 -------------------------------------------------------------------------------------------------
See accompanying notes. 29 14 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS Sun Microsystems, Inc. (the Company or Sun) is a supplier of network computing products including workstations, servers, software, microprocessors, and a full range of services and support. The Company markets its products primarily to business, government, and education customers. The Company operates in a single industry segment across geographically diverse markets. BASIS OF PRESENTATION The consolidated financial statements include the accounts of Sun 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. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS Cash equivalents consist primarily of highly liquid investments with insignificant interest rate risk and original maturities of three months or less at the date of acquisition. Short-term investments consist primarily of time deposits, commercial paper, floating rate notes, tax exempt securities, and foreign debt with original maturities beyond three months. The Company's policy is to protect the value of its investment portfolio and minimize principal risk by earning returns based on current interest rates. The Company accounts for investments in accordance with Financial Accounting Standards No. 115 (FAS 115) "Accounting for Certain Investments in Debt and Equity Securities." Under FAS 115, debt securities that the Company does not have the positive intent and ability to hold to maturity and all marketable equity securities are classified as either trading or available-for-sale and are carried at fair market value. All of the Company's cash equivalents and short-term investments are classified as available-for-sale at June 30, 1998 and 1997. Realized and unrealized gains and losses are computed on the specific identification method based upon actual and quoted market prices, respectively. Unrealized holding gains and losses on available-for-sale securities are carried net of tax as a separate component of stockholders' equity in "currency translation adjustment and other." The change in net unrealized gains and losses in investments, net of income taxes, included in stockholders' equity at June 30, 1998 and 1997, was not material. INVENTORIES Inventories are stated at the lower of cost (first in, first out) or market (net realizable value). Given the volatility of the market for the Company's products, the Company makes inventory write downs for potentially excess and obsolete inventory based on backlog and forecast demand. However, such backlog and forecast demand is subject to revisions, cancellations, and rescheduling. Actual demand will inevitably differ from such backlog and forecast demand, and such differences may be material to the financial statements. Inventories consist of:
AT JUNE 30, (In thousands) 1998 1997 - --------------------------------------------------------------- Raw materials $ 92,197 $236,900 Work in progress 58,765 50,577 Finished goods 195,484 150,501 ---------------------- Total $346,446 $437,978 - ---------------------------------------------------------------
PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are stated at cost. Depreciation and amortization are provided principally on the straight-line method. Depreciation of fixed assets is generally calculated for machinery and equipment, furniture and fixtures, and buildings based upon useful lives of one to five years, five years and twenty-five years, respectively. Leasehold improvement useful lives are the shorter of five years or the applicable lease term. OTHER ASSETS Included in other assets are purchased technology rights, other intangibles, and spare parts that are amortized using the straight line method over their useful lives ranging from six months to seven years. Amortization expense for fiscal 30 15 1998, 1997, and 1996 was $41.8 million, $26.6 million, and $13.4 million, respectively. The Company evaluates the recoverability of intangibles on a quarterly basis. CURRENCY TRANSLATION Sun translates the assets and liabilities of international non- U.S. functional currency subsidiaries into dollars at the rates of exchange in effect at the end of the period. Revenues and expenses are translated using rates that approximate those in effect during the period. Gains and losses from currency translation are included in stockholders' equity in the consolidated balance sheets. Currency transaction gains or losses are recognized in current operations and have not been significant to the Company's operating results in any period. OTHER FINANCIAL INSTRUMENTS The Company enters into interest-rate swap agreements to modify the interest characteristics of its outstanding long-term debt. An interest-rate swap agreement is designated as a hedge and its effectiveness is determined by matching principal balance and terms with that of a specific debt obligation. Such an agreement involves the exchange of amounts based on a fixed interest rate for amounts based on variable interest rates over the life of the agreement without an exchange of the notional amount upon which payments are based. The differential to be paid or received as interest rates change is accrued and recognized as an adjustment of interest expense related to the debt (the accrual method of accounting). The related amount payable to or receivable from counterparties is included in accrued liabilities or other assets, respectively. The Company purchases foreign currency option contracts that effectively enable it to sell currencies expected to be received as a result of certain of its foreign currency denominated sales during the ensuing quarter at specified dollar amounts. The option contracts, which have only nominal intrinsic value at the time of purchase, are denominated in the same foreign currency in which sales are expected to be denominated. These contracts are designated and effective as hedges of a portion of probable foreign currency exposure on anticipated net sales transactions during the next quarter, which otherwise would expose the Company to foreign currency risk. Premiums related to option contracts are recognized into income over the life of the contract. Gains on foreign currency option contracts that are designated as hedges on anticipated transactions are deferred until the designated net sales are recorded. Option contracts that would result in losses if exercised are allowed to expire. The Company uses forward foreign exchange contracts that are designated to reduce a portion of its exposure to foreign currency risk from operational and balance sheet exposures resulting from changes in foreign currency exchange rates. Such exposures result from the portion of the Company's operations, assets, and liabilities that are denominated in currencies other than the functional currency of the legal entity in which the contracts are entered, including local currency denominated assets and liabilities in U.S. dollar functional currency entities. Forward contracts are accounted for on a mark-to-market basis with realized and unrealized gains or losses recognized currently. Discounts or premiums are recognized into income over the life of the contract. Amounts receivable and payable on certain forward foreign exchange contracts are recorded as other current assets or accrued liabilities, respectively. The Company does not use derivative financial instruments for speculative trading purposes, nor does it hold or issue leveraged derivative financial instruments. REVENUE RECOGNITION Sun generally recognizes revenue from hardware and software sales at the time of shipment, with allowances established for price protection, cooperative marketing programs with distributors, and estimated product returns. When significant obligations remain after products are delivered, revenue is only recognized after such obligations are fulfilled. Service revenues are recognized ratably over the contractual period or as the services are provided. ADVERTISING COSTS Advertising costs are charged to expense when incurred. Advertising expenses were $235 million, $272 million, and $168 million for fiscal years 1998, 1997, and 1996, respectively. SELF-INSURANCE The Company is self-insured up to specific levels for certain liabilities. Accruals are provided each year based on historical claim costs and include estimated amounts for incurred but not reported claims. The Company maintains stop loss coverage with third-party insurance companies to cover aggregate annual losses in excess of $25 million. 31 16 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS WARRANTY The Company provides currently for the estimated costs that may be incurred under warranties for product shipped. Included in the balance sheet caption "Accrued liabilities and other" is an accrued warranty liability of $115.5 million and $87.9 million at June 30, 1998 and 1997, respectively. NET INCOME PER COMMON SHARE In 1997, the Financial Accounting Standards Board issued Financial Accounting Standards No. 128 (FAS 128), "Earnings Per Share" which replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants, and convertible securities. Dilutive earnings per share is very similar to the previously reported fully diluted earnings per share. The Company adopted FAS 128 in the second quarter of fiscal 1998. Share and per share amounts for all periods presented have been restated to comply with FAS 128. (In thousands, except per share amounts)
YEARS ENDED JUNE 30, 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------- Net income $762,862 $762,420 $476,388 -------------------------------------------- Shares used to compute net income per common share--basic 373,728 368,426 371,134 Effect of dilutive securities, options and warrants 20,546 20,541 22,246 -------------------------------------------- Shares used to compute net income per common share--diluted 394,274 388,967 393,380 -------------------------------------------- Net income per common share--basic $ 2.04 $ 2.07 $ 1.28 -------------------------------------------- Net income per common share--diluted $ 1.93 $ 1.96 $ 1.21 - -----------------------------------------------------------------------------------------------------------------
CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of investment securities, foreign exchange contracts, and interest rate instruments as well as trade receivables. The counterparties to the agreements relating to the Company's investment securities, foreign exchange contracts, and interest rate instruments consist of various major corporations and financial institutions of high credit standing. The Company does not believe there is significant risk of non-performance by these counterparties because the Company limits the amount of credit exposure to any one financial institution and any one type of investment. The credit risk on receivables due from counterparties related to foreign exchange and currency option contracts is immaterial at June 30, 1998 and 1997. The Company's receivables are derived primarily from sales of hardware and software products and services to customers in diversified industries as well as to a network of resellers. The Company performs ongoing credit evaluations of its customers' financial condition and limits the amount of credit extended when deemed necessary but generally requires no collateral. In fiscal 1998 the Company provided approximately $23 million for doubtful accounts ($20 million and $11 million in 1997 and 1996, respectively). STOCK DIVIDEND The Company effected 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. STOCK-BASED COMPENSATION As permitted by Financial Accounting Standards No. 123 (FAS 123), "Accounting for Stock-Based Compensation," the 32 17 Company measures compensation expense for its stock-based employee compensation plans using the intrinsic method prescribed by APB No. 25 "Accounting for Stock Issued to Employees," and has provided in Note 8 pro forma disclosures of the effect on net income and net income per common share as if the fair value-based method prescribed by FAS 123 had been applied in measuring compensation expense. LONG-LIVED ASSETS The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. OTHER RECENT PRONOUNCEMENTS The Company intends to adopt Financial Accounting Standards No. 130 (FAS 130), "Reporting Comprehensive Income" and Financial Accounting Standards No. 131 (FAS 131), "Disclosures About Segments of an Enterprise and Related Information" in fiscal 1999. Both will require additional disclosure but will not have a material effect on the Company's consolidated financial position or results of operations. FAS 130 will be reflected in the Company's first quarter of 1999 interim financial statements. Components of comprehensive income for the Company include items such as net income and changes in the value of available-for-sale securities. FAS 131 requires segments to be determined based upon how management measures performance and makes decisions about allocating resources. FAS 131 will first be reflected in the Company's 1999 Annual Report. In 1998, Financial Accounting Standards No. 133 (FAS 133), "Accounting for Derivative Instruments and Hedging Activities" was issued and is effective for fiscal years commencing after June 15, 1999. The Company will comply with the requirements of FAS 133 in fiscal year 2000 and does not expect the adoption of FAS 133 will be material to the Company's consolidated results of operations. In 1997, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 97-2, "Software Revenue Recognition." SOP 97-2 establishes standards relating to the recognition of all aspects of software revenue. SOP 97-2, as amended by SOP 98-4 "Deferral of the Effective Date of a Provision of SOP 97-2, Software Revenue Recognition," is effective for all transactions entered into in fiscal years beginning after December 15, 1997. The Company will comply with the requirements of SOP 97-2, as amended by SOP 98-4, in fiscal year 1999. The Company has not yet completed its assessment of the impact of SOP 97-2, as amended by SOP 98-4, on the Company's consolidated results of operations. In 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 is effective for fiscal years beginning after December 15, 1998 with early adoption permitted. The Company has not yet completed its assessment of the impact of SOP 98-1 on the Company's consolidated financial position or results of operations and may adopt SOP 98-1 in fiscal 1999. 2. ACQUISITIONS During fiscal 1998, 1997, and 1996, the Company acquired all of the outstanding securities of a total of six technology companies (Diba, Inc.; Integrity Arts, Inc.; Red Cape Software, Inc.; Long View Technologies, LLC.; Integrated Micro Products, plc; and Lighthouse Design, Ltd.) and acquired the assets of two other technology companies (Chorus Systems, S.A. and the storage products business of Encore Computer Corporation), in separate transactions. These companies were principally engaged in the development and/or sale of software and hardware products. The aggregate consideration for all transactions was approximately $404 million in cash, 850,000 shares of common stock, and the assumption of certain liabilities. Sun has a payment due in fiscal 1999 of $35 million related to the Encore Computer Corporation transaction. These transactions were accounted for as purchases. The excess purchase price over the estimated fair value of the net tangible assets acquired was allocated, based upon independent third-party valuations, to various intangible assets, primarily consisting of purchased in-process research and development and goodwill. In connection with these acquisitions, purchased in-process research and development of approximately $176.4 million, $23 million, and $57.9 million, associated with products which had not achieved technological feasibility and for which no alternative future uses were established by the Company, was written off in 1998, 1997, and 1996, respectively. Intangible assets, including goodwill, are being amortized over their estimated useful lives, generally three years. The results of operations of each company acquired from the dates of acquisition are included in the Company's consolidated statements of income and are not material to the Company. On June 30, 1998, the Company entered into an Agreement and Plan of Reorganization (Merger Agreement) with NetDynamics, Inc. (NetDynamics). Upon the effectiveness of the Merger Agreement, NetDynamics' shareholders will exchange all of their shares of common stock and preferred stock for shares of common stock of Sun at an agreed-upon exchange ratio. See Footnote 12 "Subsequent Events." 33 18 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. FAIR VALUE OF FINANCIAL INSTRUMENTS Fair values of cash and cash equivalents and short-term investments approximate cost due to the short period of time to maturity. The fair value of long-term debt is estimated based on current interest rates available to the Company for debt instruments with similar terms, degrees of risk, and remaining maturities. The estimated fair value of forward foreign exchange contracts is based on the estimated amount at which they could be settled based on market exchange rates. The fair value of foreign currency option contracts and the interest-rate swap agreement is obtained from dealer quotes and represents the estimated amount the Company would receive or pay to terminate the agreements. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The fair value of the Company's cash equivalents and short-term investments is as follows:
GROSS GROSS AT JUNE 30, 1998 UNREALIZED UNREALIZED ESTIMATED (In thousands) COST GAINS LOSSES FAIR VALUE -------------------------------------------------------------------------------------------------------- State and local government debt $ 94,843 $ 22 $ 11 $ 94,854 Corporate and other non-governmental debt 421,573 -- -- 421,573 U.S. government debt 53,474 74 -- 53,548 Floating rate notes 99,460 -- -- 99,460 Money market fund 97,900 -- -- 97,900 Other investments 16,599 -- -- 16,599 -------------------------------------------------------- Total $783,849 $ 96 $ 11 $783,934 --------------------------------------------------------------------------------------------------------
GROSS GROSS AT JUNE 30, 1997 UNREALIZED UNREALIZED ESTIMATED (In thousands) COST GAINS LOSSES FAIR VALUE -------------------------------------------------------------------------------------------------------- State and local government debt $120,579 $ 16 $ 56 $120,539 Corporate and other non-governmental debt 282,240 5 89 282,156 U.S. government debt 85,628 233 13 85,848 Floating rate notes 45,870 -- -- 45,870 Foreign debt 15,026 24 -- 15,050 Money market fund 119,600 -- -- 119,600 Other investments 27,500 -- -- 27,500 -------------------------------------------------------- Total $ 696,443 $278 $158 $696,563 --------------------------------------------------------------------------------------------------------
34 19 The cost and estimated fair values of cash equivalents and short-term investments by contractual maturity are as follows:
CASH EQUIVALENTS AND SHORT-TERM AT JUNE 30, 1998 INVESTMENTS COST ESTIMATED (In thousands) FAIR VALUE ---------------------------------------------------------- Maturing in one year or less $684,389 $684,474 Maturing after one year 99,460 99,460 ----------------------- Total $783,849 $783,934 ----------------------------------------------------------
The fair value of the Company's borrowing arrangements and other financial instruments is as follows:
AT JUNE 30, 1998 AT JUNE 30, 1997 ASSET (LIABILITY) ASSET (LIABILITY) CARRYING FAIR CARRYING FAIR (In thousands) AMOUNT VALUE AMOUNT VALUE ------------------------------------------------------------------------------------------------ 10.18% mortgage loan $(40,000) $(41,495) $ (40,000) $ (42,541) Forward foreign exchange contracts 4,265 4,265 (2,861) (2,861) Foreign currency option contracts -- 7,531 -- 1,262 Short-term borrowings (7,169) (7,169) (100,930) (100,930) Interest-rate swap agreement -- 292 -- 196 ------------------------------------------------------------------------------------------------
4. DERIVATIVE FINANCIAL INSTRUMENTS Outstanding notional amounts for derivative financial instruments were as follows:
AT JUNE 30, (In thousands) 1998 1997 -------------------------------------------------------------- Swap hedging debt $ 40,000 $ 40,000 Forward foreign exchange contracts 930,155 856,979 Foreign currency option contracts 241,861 254,182 --------------------------------------------------------------
While the contract or notional amounts provide one measure of the volume of these transactions, they do not represent the amount of the Company's exposure to credit risk. The amounts potentially subject to credit risk (arising from the possible inability of counterparties to meet the terms of their contracts) are generally limited to the amounts, if any, by which the counterparties' obligations exceed the obligations of the Company. The Company controls credit risk through credit approvals, limits, and monitoring procedures. Credit rating criteria for off balance sheet transactions are similar to those for investments. See additional information at "Other financial instruments" contained in Footnote 1. At June 30, 1998 and 1997, the Company had forward foreign exchange contracts of less than three months duration, to exchange principally Japanese yen, British pounds sterling, French francs, and German marks for U.S. dollars in the total gross notional amounts of $930 million and $857 million, respectively. Of these notional amounts, forward contracts to purchase foreign currency represented $139 million and $128 million and forward contracts to sell foreign currency represented $791 million and $729 million, at June 30, 1998 and 1997, respectively. The Company also has purchased foreign currency options of less than two months duration, to exchange principally Japanese yen, British pounds sterling, French francs, and German marks for U.S. dollars. 5. BORROWING ARRANGEMENTS The Company has a $40 million mortgage loan which is secured by real property and a building and is included in note payable and other obligations at June 30, 1998 and 1997, respectively. Principal is due to the bank at maturity on May 18, 1999, with interest payable semiannually, in arrears. The loan agreement provides for interest at a fixed interest rate of 10.18%. However, the Company has an interest-rate swap agreement with a third party (receive fixed, pay variable) that results in the Company paying a rate based on three-month LIBOR, which was 5.625% at June 30, 1998. The interest-rate swap agreement matures with the loan agreement. 35 20 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In August 1997, the Company negotiated a $500 million unsecured revolving credit agreement with an international group of 20 banks. The agreement expires on August 28, 2002. Any borrowings under this agreement bear interest at a floating rate based on prime, certificates of deposit, or Eurodollar rates, at the Company's option. Under the agreement, Sun is required to maintain various financial ratios. Sun was in compliance with all covenants at June 30, 1998. There were no borrowings under this facility at June 30, 1998. At June 30, 1998, Sun's international subsidiaries had uncommitted lines of credit aggregating approximately $694 million, of which approximately $7 million, denominated in Japanese yen, had been drawn. The average interest rate at June 30, 1998 was 0.89%. 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 billion. 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. 6. INCOME TAXES Income before income taxes and the provision for income taxes consist of the following:
YEARS ENDED JUNE 30, (In thousands) 1998 1997 1996 -------------------------------------------------------------------------------------------------- Income before income taxes: United States $ 589,387 $ 566,554 $291,126 Foreign 586,779 554,653 417,748 -------------------------------------------------- Total income before income taxes $1,176,166 $1,121,207 $708,874 -------------------------------------------------- Provision for income taxes: Current: United States federal $ 349,095 $ 303,537 $146,351 State 47,270 46,894 16,192 Foreign 106,192 67,234 67,959 -------------------------------------------------- Total current income taxes 502,557 417,665 230,502 -------------------------------------------------- Deferred: United States federal (81,319) (66,027) (10,419) State (6,492) (5,231) 1,178 Foreign (1,442) 12,380 11,225 -------------------------------------------------- Total deferred income taxes (89,253) (58,878) 1,984 -------------------------------------------------- Provision for income taxes $ 413,304 $ 358,787 $232,486 --------------------------------------------------------------------------------------------------
36 21 Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets are as follows:
AT JUNE 30, (In thousands) 1998 1997 - ----------------------------------------------------------------------------------------------- Deferred tax assets: Inventory valuation $ 67,006 $ 66,057 Reserves and other accrued expenses 165,724 115,722 Fixed asset basis differences 81,926 63,717 Compensation not currently deductible 41,407 38,979 State income taxes 15,468 21,926 Other 68,687 33,901 -------------------------- Gross deferred tax assets 440,218 340,302 Deferred tax liabilities: Net undistributed profits of subsidiaries (124,777) (112,758) Other 428 (928) -------------------------- Gross deferred tax liabilities (124,349) (113,686) Net deferred tax assets $315,869 $226,616 - -----------------------------------------------------------------------------------------------
The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to income before income taxes. The sources and tax effects of the difference are as follows:
YEARS ENDED JUNE 30, (In thousands) 1998 1997 1996 - ----------------------------------------------------------------------------------------------------- Expected tax rate at 35% $411,658 $392,423 $ 248,106 State income taxes, net of federal tax benefit 26,506 27,081 11,291 Foreign earnings permanently reinvested in foreign operations (49,600) (63,550) (36,580) Acquired in-process research and development 25,194 -- 5,690 Other (454) 2,833 3,979 -------------------------------------------------- Provision for income taxes $413,304 $358,787 $232,486 - -----------------------------------------------------------------------------------------------------
As of June 30, 1998, the Company has unrecognized deferred tax liabilities of approximately $173 million related to cumulative net undistributed earnings of foreign subsidiaries of approximately $559 million. These earnings are considered to be permanently invested in operations outside the United States. 37 22 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The current federal and state provisions do not reflect the tax savings resulting from deductions associated with the Company's various stock option plans. These savings (in thousands) were $111,375, $59,799, and $53,000 in fiscal 1998, 1997 and 1996, respectively, and were credited to stockholders' equity. The Company's United States income tax returns for fiscal years ended June 30, 1988 through 1996, are under examination, and the Internal Revenue Services has proposed certain adjustments. Management believes that adequate amounts have been provided for any adjustments that may ultimately result from these examinations. 7. COMMITMENTS The Company leases certain facilities and equipment under noncancelable operating leases. The future minimum annual lease payments are approximately $132 million, $114 million, $86 million, $69 million, and $52 million for fiscal years 1999, 2000, 2001, 2002, and 2003, respectively, and approximately $175 million for years following fiscal 2003. Rent expense under the noncancelable operating leases was $139 million in 1998, $113 million in 1997, and $99 million in 1996. 8. STOCKHOLDERS' EQUITY COMMON STOCK The Company has adopted a share purchase rights plan to protect stockholders' rights in the event of a proposed takeover of the Company. Under the plan, a preferred share purchase right (a "Right") is associated with each share of the Company's common stock (a "Common Share"). Upon becoming exercisable, each Right will entitle its holder to purchase 1/1000th of a share of Series A participating preferred stock of the Company, a designated series of preferred stock for which each 1/1000th of a share has economic attributes and voting rights equivalent to one Common Share at an exercise price of $300, subject to adjustment. The Rights are not exercisable or transferable apart from the Common Shares unless certain events occur, including a public announcement that a person or group (an "Acquiring Person") has acquired or obtained the right to acquire 10% or more (20% or more for an Acquiring Person who has filed a Schedule 13G in accordance with the Securities Act of 1934 ("13G Filer")) of the outstanding Common Shares or until the commencement or announcement of an intention to make a tender or exchange offer for 10% or more of the outstanding Common Shares. Unless the Rights are redeemed, in the event that an Acquiring Person acquires 10% or more (20% or more if the Acquiring Person is a 13G Filer) of the outstanding Common Shares, each Right not held by the Acquiring Person will entitle the holder to purchase for the exercise price that number of Common Shares having market value equal to two times the exercise price. In the event that (i) the Company is acquired in a merger or business combination in which the Company is not the surviving corporation or in which the Common Shares are exchanged for stock or assets of another entity, or (ii) 50% or more of the Company's consolidated assets or earning power is sold, each Right not held by an Acquiring Person will entitle the holder to purchase for the exercise price that number of shares of common stock of the acquiring company having a market value equal to two times the exercise price. The Rights are redeemable, in whole but not in part, at the Company's option, at $0.01 per Right at any time prior to becoming exercisable and in certain other circumstances. The Rights expire on February 11, 2008. STOCK OPTION AND INCENTIVE PLANS The Company's 1990 Long-Term Equity Incentive Plan ("1990 Incentive Plan") and other employee stock option plans provide the Board of Directors broad discretion in creating employee equity incentives and authorize it to grant incentive and non-statutory stock options as well as certain other awards. In addition, these plans provide for issuance to eligible employees of non-statutory stock options to purchase common stock at or below fair market value at the date of grant subject to certain limitations set forth in the 1990 Incentive Plan. Options expire up to ten years from the date of grant or up to three months following termination of employment or service on the Board, whichever occurs earlier, and are exercisable at specified times prior to such expiration. Under the 1990 Incentive Plan, common stock may also be issued pursuant to stock purchase agreements that grant Sun certain rights to repurchase the shares at their original issue price in the event that the employment of the employee is terminated prior to certain predetermined vesting dates. The above described plans provide that shares of common stock may be sold at less than fair market value, which results in compensation expense equal to the difference between the market value on the date of grant and the purchase price. This expense, which is immaterial, is recognized over the vesting period of the shares. Sun's 1988 Directors' Stock Option Plan provides for the automatic grant of stock options to non-employee directors at each annual meeting of stockholders and on the date each such person becomes a director. These options are granted at fair market value on the date of grant and have a term of five years. Finally, in connection with the fiscal 1996 acquisition of 38 23 Lighthouse Design, Ltd., former shareholders who are employees of the Company were entitled to receive up to approximately 650,000 shares of stock upon achievement of specific performance criteria over a three year period. Of this amount, approximately 325,000 shares have vested. Information with respect to stock option and stock purchase rights activity is as follows:
OUTSTANDING OPTIONS/RIGHTS SHARES WEIGHTED AVAILABLE NUMBER AVERAGE (In thousands, except per share amounts) FOR GRANT OF SHARES PRICE PER SHARE EXERCISE PRICE ---------------------------------------------------------------------------------------------------------- Balance at June 30, 1995 4,684 49,248 $0.0025 - $12.282 $ 6.84 Additional shares reserved 49,040 -- -- -- Grants (12,886) 12,886 $0.00034 - $30.125 $20.25 Exercises -- (9,762) $0.00034 - $19.5 $ 6.78 Cancellations 4,440 (4,616) $0.005 - $30.125 $ 7.64 ------------------------------------------------------------ Balance at June 30, 1996 45,278 47,756 $0.005 - $30.125 $10.84 Additional shares reserved 300 -- -- -- Grants (13,289) 13,289 $0.00067 - $33.9375 $26.90 Exercises -- (7,367) $0.01 - $30.125 $ 6.99 Cancellations 1,840 (2,319) $0.01 - $33.375 $13.32 ------------------------------------------------------------ Balance at June 30, 1997 34,129 51,359 $0.00067 - $33.9375 $15.44 Additional shares reserved 5,172 -- -- -- Grants (14,881) 14,881 $0.0006 - $47.3750 $37.81 Exercises -- (9,263) $0.0006 - $33.9375 $ 8.53 Cancellations 1,991 (1,991) $1.350 - $47.3750 $21.25 ------------------------------------------------------------ Balance at June 30, 1998 26,411 54,986 $ 0.00067 - $47.3750 $22.28 ----------------------------------------------------------------------------------------------------------
The following table summarizes significant ranges of outstanding and exercisable options at June 30, 1998:
OUTSTANDING OPTIONS OPTIONS EXERCISABLE WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE REMAINING EXERCISE EXERCISE SHARES LIFE IN YEARS PRICE SHARES PRICE - ------------------------------------------------------------------------------------------------- $0.0007 - $ 5.00 2,247,449 5.4 $ 4.4713 1,407,509 $ 4.6831 $5.0001 - $10.00 16,491,580 4.6 $ 7.4620 8,415,847 $ 7.2509 $10.0001 - $15.00 2,222,150 5.0 $11.5499 581,070 $11.6474 $15.0001 - $20.00 1,699,320 5.4 $19.5000 485,520 $19.5000 $20.0001 - $25.00 7,245,162 6.2 $23.6803 1,864,404 $23.5609 $25.0001 - $30.00 9,075,495 6.6 $27.1952 1,641,853 $27.1933 $30.0001 - $40.00 5,040,863 7.3 $32.9105 559,492 $31.9555 $40.0001 - $45.00 10,302,247 8.1 $40.5786 -- $ -- $45.0001 - $47.3750 661,500 7.2 $46.8873 4,240 $47.3750 --------------------------------------------------------------------- 54,985,766 6.1 $22.2831 14,959,935 $12.7343 - -------------------------------------------------------------------------------------------------
39 24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS At June 30, 1998, options to purchase approximately 14,960,000 shares were exercisable at prices from $0.8496 to $47.3750 with a weighted average and aggregate exercise price of $12.7343 and $190,505,000, respectively, (11,143,000 shares at an aggregate price of $101,264,000 at June 30, 1997). At June 30, 1998, the Company retains repurchase rights to 1,003,536 shares issued pursuant to stock purchase agreements and other stock plans. The weighted average fair value at date of grant for options granted during 1998, 1997, and 1996 were $26.179, $17.873, and $11.517 per option, respectively. EMPLOYEE STOCK PURCHASE PLAN To provide employees with an opportunity to purchase common stock of Sun through payroll deductions, Sun established the 1990 Employee Stock Purchase Plan. Under this plan, Sun's employees, subject to certain restrictions, may purchase shares of common stock at 85% of the fair market value at either the date of enrollment or the date of purchase, whichever is less. Pursuant to this plan, the Company issued approximately 3,505,046, 2,928,689, and 4,714,000 shares of common stock in fiscal 1998, 1997, and 1996, respectively. At June 30, 1998, approximately 19,730,799 shares remained available for future issuance. COMMON STOCK REPURCHASE PROGRAMS In December 1990, the Board of Directors approved a systematic common stock repurchase program related to the 1990 Employee Stock Purchase Plan. In fiscal 1998, the Company repurchased 2,941,640 shares at a cost of approximately $127 million under this program (2,919,632 shares at a cost of approximately $88 million in 1997). In June 1995, the Board of Directors approved a plan to repurchase approximately 48 million shares of the Company's common stock. In July and August 1996, the Company repurchased 8,904,258 shares at a cost of approximately $236 million under this program. In August 1996, the Board of Directors approved a systematic common stock repurchase program related to the 1990 Long-Term Equity Incentive Plan. In fiscal 1998, the Company repurchased 3,654,230 shares at a cost of approximately $157 million under this program (4,248,729 shares at a cost of approximately $132 million in 1997). When the treasury shares are reissued, any excess of the average acquisition cost of the shares over the proceeds from reissuance is charged to retained earnings. STOCK-BASED COMPENSATION The Company has elected to follow Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, which require compensation expense for options to be recognized when the market price of the underlying stock exceeds the exercise price on the date of grant. Financial Accounting Standards No. 123 (FAS 123), "Accounting for Stock-Based Compensation," permits companies to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. In management's opinion, the existing stock option valuation models do not necessarily provide a reliable single measure of the fair value of stock-based awards. Therefore, as permitted, the Company will continue to apply the existing accounting rules under APB No. 25 and provide pro forma net income and pro forma net income per common share disclosures for stock-based awards made during the year as if the fair-value-based method defined in FAS No. 123 had been applied. For employee stock options, the fair value of the stock options was estimated as of the date of grant using the Black-Scholes option pricing model. Input variables used in the model include a weighted average risk-free interest rate using the 7.75 year Treasury Yield as of the date of grant, ranging from 5.38% to 6.37% for fiscal year 1998. 40 25 The fair value of options at the date of grant was estimated using the Black-Scholes model with the following weighted average assumptions:
YEARS ENDED JUNE 30, 1998 1997 1996 ---------------------------------------------------------------------------------- Expected life 7.8 8.1 7.7 Interest rate 5.73% 6.06% 6.36% Volatility 49.60% 46.60% 57.99% Dividend yield -- -- -- ----------------------------------------------------------------------------------
For the Employee Stock Purchase Plan, the fair value of the stock was calculated using actuals for the plans expiring during the year. For plans expiring after year end, the fair value was calculated using estimated shares to be purchased and estimated purchase price. Stock based compensation costs would have reduced pretax income by $132,985,000, $76,033,000, and $35,116,000 in 1998, 1997, and 1996, respectively, ($89,374,000, $51,703,000, and $23,879,000 after tax, and $.17, $.08, and $.05 per diluted share) if the fair values of the options granted in that year had been recognized as compensation expense on a straight line basis over the vesting period of the grant. The pro forma effect on net income for 1998, 1997, and 1996 is not representative of the pro forma effect on net income in the future years because it does not take into consideration pro forma compensation expense related to grants made prior to 1996. Pro forma net income and net income per common share are as follows:
YEARS ENDED JUNE 30, (In thousands, except per share amounts) 1998 1997 1996 ------------------------------------------------------------------------------------------------- Pro forma net income $673,488 $710,717 $452,509 ----------------------------------------------- Basic: Pro forma shares used in the calculation of pro forma net income per common share 373,728 368,426 371,134 ----------------------------------------------- Pro forma net income per common share $ 1.80 $ 1.93 $ 1.22 ----------------------------------------------- Diluted: Pro forma shares used in the calculation of pro forma net income per common share 383,377 377,288 390,390 ----------------------------------------------- Pro forma net income per common share $ 1.76 $ 1.88 $ 1.16 -------------------------------------------------------------------------------------------------
9. INDUSTRY SEGMENT, GEOGRAPHIC, AND CUSTOMER INFORMATION Sun, which operates in a single industry segment, designs, manufactures, markets, and services network computing systems and software solutions that feature networked desktops and servers. In fiscal 1998, one customer accounted for 14% of revenues. No customer accounted for 10% or more of revenues in fiscal 1997 or 1996. Operations of Sun's overseas subsidiaries consist of sales, service, distribution, and manufacturing. Intercompany transfers between geographic areas are accounted for at prices that approximate arm's length 41 26 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS transactions. In addition, United States export sales approximated 2.3%, 3.0%, and 3.8% of net revenues during fiscal 1998, 1997, and 1996, respectively. Information regarding geographic areas at June 30, 1998, 1997, and 1996, and for each of the years then ended, is as follows:
GEOGRAPHIC AREA UNITED REST OF (In thousands) STATES EUROPE JAPAN WORLD ELIMINATIONS TOTAL - ---------------------------------------------------------------------------------------------------------------------------------- June 30, 1998, and for the year then ended: Sales to unaffiliated customers $5,349,634 $2,708,514 $ 899,029 $833,663 $ -- $9,790,840 Intercompany transfers 969,752 1,938,940 17,609 45,652 (2,971,953) -- --------------------------------------------------------------------------------------------- Net revenues $6,319,386 $4,647,454 $ 916,638 $879,315 $(2,971,953) $9,790,840 --------------------------------------------------------------------------------------------- Operating income $ 642,685 $ 510,919 $ 25,225 $ 16,480 $ (65,235) $1,130,074 --------------------------------------------------------------------------------------------- Identifiable assets $4,005,490 $2,939,584 $ 352,529 $556,087 $(2,142,628) $5,711,062 --------------------------------------------------------------- ----------------------------- Liabilities $1,763,617 $1,484,335 $ 345,115 $543,080 $(1,938,713) $2,197,434 --------------------------------------------------------------------------------------------- June 30, 1997, and for the year then ended: Sales to unaffiliated customers $4,709,343 $2,177,319 $ 958,753 $752,931 $ -- $8,598,346 Intercompany transfers 978,981 2,018,531 17,973 61,724 (3,077,209) -- --------------------------------------------------------------------------------------------- Net revenues $5,688,324 $4,195,850 $ 976,726 $814,655 $(3,077,209) $8,598,346 --------------------------------------------------------------------------------------------- Operating income $ 477,136 $ 522,575 $ 13,958 $ 8,116 $ 4,733 $1,026,518 --------------------------------------------------------------------------------------------- Identifiable assets $4,079,585 $2,408,106 $ 360,814 $385,763 $(2,536,994) $4,697,274 --------------------------------------------------------------------------------------------- Liabilities $2,351,239 $1,284,970 $ 350,076 $369,868 $(2,400,816) $1,955,337 --------------------------------------------------------------------------------------------- June 30, 1996, and for the year then ended: Sales to unaffiliated customers $3,791,154 $1,778,712 $ 991,044 $533,841 $ -- $7,094,751 Intercompany transfers 944,785 1,586,615 16,847 50,868 (2,599,115) -- --------------------------------------------------------------------------------------------- Net revenues $4,735,939 $3,365,327 $1,007,891 $584,709 $(2,599,115) $7,094,751 -------------------------------------------------------------- ----------------------------- Operating income $ 280,296 $ 370,034 $ 23,690 $ 6,497 $ (5,505) $ 675,012 --------------------------------------------------------------------------------------------- Identifiable assets $3,721,745 $1,542,890 $ 325,417 $319,262 $(2,108,405) $3,800,909 --------------------------------------------------------------------------------------------- Liabilities $2,023,047 $ 891,360 $ 305,045 $318,834 $(1,988,863) $1,549,423 - ----------------------------------------------------------------------------------------------------------------------------------
10. CONTINGENCIES In March 1990 Sun received a letter from Texas Instruments Incorporated (TI) alleging that a substantial number of Sun's products infringe certain of TI's patents. Based on discussions with TI, Sun believes that it will be able to negotiate a license agreement with TI and that the outcome of this matter will not have a material adverse impact on Sun's financial position or its results of operations or cash flows in any given fiscal year. Such a negotiated license may or may not have a material adverse impact on Sun's results of operations or cash flows in a given fiscal quarter depending upon various 42 27 factors, including but not limited to the structure and amount of royalty payments, offsetting consideration from TI, if any, and allocation of royalties between past and future product shipments, none of which can be forecast with reasonable certainty at this time. In the normal course of business, the Company receives and makes inquiries with regard to other possible patent infringements. Where deemed advisable, the Company may seek or extend licenses or negotiate settlements. The estimate of the potential impact on the Company's financial position or overall results of operations for the above legal proceedings could change in the future. 11. QUARTERLY FINANCIAL DATA (UNAUDITED)
FISCAL 1998 QUARTER ENDED, (In thousands, except per share amounts) JUNE 30 MARCH 29 DECEMBER 28 SEPTEMBER 28 ----------------------------------------------------------------------------------------------------- Net revenues $2,881,065 $2,360,928 $2,450,243 $2,098,604 Gross margin 1,488,429 1,259,292 1,278,613 1,071,170 Operating income 402,448 333,916 212,835 180,875 Net income 272,988 232,009 149,432 108,433 Net income per common share--diluted $ 0.69 $ 0.59 $ 0.38 $ 0.27 -----------------------------------------------------------------------------------------------------
FISCAL 1997 QUARTER ENDED, (In thousands, except per share amounts) JUNE 30 MARCH 30 DECEMBER 29 SEPTEMBER 29 ----------------------------------------------------------------------------------------------------- Net revenues $2,543,121 $2,114,618 $2,081,588 $1,859,019 Gross margin 1,281,358 1,061,424 1,048,186 886,918 Operating income 337,679 257,010 255,845 175,984 Net income 237,178 223,511 178,341 123,390 Net income per common share--diluted $ 0.61 $ 0.58 $ 0.46 $ 0.32 -----------------------------------------------------------------------------------------------------
12. SUBSEQUENT EVENTS (UNAUDITED) On August 28, 1998, the Company acquired all of the outstanding capital stock of NetDynamics, by means of a merger transaction pursuant to which all the shares of NetDynamics capital stock were converted into the right to receive shares of Sun common stock as described in Footnote 2. The transaction will be accounted for as a purchase, and the purchase price will be allocated to tangible and intangible assets and in-process research and development based upon an independent third-party valuation. On September 2, 1998, the Company signed a definitive agreement to acquire all the outstanding capital stock of iPlanet, Inc. by means of a merger transaction pursuant to which all of the shares of iPlanet, Inc. will be converted into the right to receive cash. Upon and subject to closing, the transaction will be accounted for as a purchase, and the purchase price will be allocated to tangible and intangible assets and in-process research and development based upon an independent third-party valuation. The closing of this acquisition is contingent upon the completion of various closing conditions. 43 28 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS THE BOARD OF DIRECTORS AND STOCKHOLDERS, SUN MICROSYSTEMS, INC. We have audited the accompanying consolidated balance sheets of Sun Microsystems, Inc. as of June 30, 1998 and 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended June 30, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sun Microsystems, Inc. at June 30, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 1998, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP Palo Alto, California July 15, 1998 44 29 ABOUT YOUR INVESTMENT STOCK SYMBOL SUNW STOCK MARKET The Company's stock trades on The Nasdaq Stock Market. STOCK TRADING The following table sets forth the per share high and low sales prices for each quarter shown, as well as the per share closing sales prices on the last trading day of each quarter. In addition, the table shows the average trading volume for each quarter listed.
CLOSING SALES DAILY AVERAGE HIGH LOW PRICES TRADING VOLUME - ---------------------------------------------------------------------------------------------------------- Fiscal year ended June 30, 1998 First quarter $ 53.3125 $ 35.9375 $ 46.8125 5,062,402 Second quarter 48.0469 30.3750 39.8750 7,340,261 Third quarter 50.0000 37.6250 41.7188 6,947,744 Fourth quarter 45.5625 38.1875 43.4375 4,633,556 Fiscal year ended June 30, 1997 First quarter $ 32.5625 $ 22.0000 $ 31.0625 9,502,834 Second quarter 35.1250 25.5000 25.6875 8,704,392 Third quarter 35.0000 26.2500 28.8750 5,834,969 Fourth quarter 38.7500 25.8750 37.2188 5,076,927 - ----------------------------------------------------------------------------------------------------------
COMPARISON OF TWO-YEAR CUMULATIVE TOTAL RETURN $100 invested on June 30, 1995, in stock or applicable index assuming reinvestment of dividends. [PERFORMANCE GRAPH] 45 STOCK OWNERSHIP PROFILE (as of June 30, 1998) [GRAPHIC] EX-21.0 4 SUBSIDIARIES OF REGISTRANT 1 EXHIBIT 21.0 SUN MICROSYSTEMS, INC. Subsidiaries Belle Gate Investment B.V. Dakota Scientific Software, Inc. Diba, Inc. Diba Europe Ltd. Integrity Arts, Inc. Lighthouse Design, Ltd. Lighthouse Design R&D Corporation NetDynamics, Inc. Nihon Sun Microsystems K.K. Red Cape Software, Inc. Sarrus Software, Inc. Solaris Corporation Sun Microsystems (Barbados), Ltd. Sun Microsystems (Schweiz) A.G. Sun Microsystems AB Sun Microsystems AO Sun Microsystems AS Sun Microsystems Australia Pty. Ltd. Sun Microsystems Belgium N.V./S.A. Sun Microsystems Benelux B.V. Sun Microsystems Czech s.r.o. Sun Microsystems Distributions International, Inc. Sun Microsystems Europe Properties, Inc. Sun Microsystems Europe Properties B.V. Sun Microsystems Federal, Inc. Sun Microsystems France, S.A. Sun Microsystems GmbH Sun Microsystems (Hellas) S.A. Sun Microsystems Holdings Limited Sun Microsystems Hungary Computing Limited Liability Company Sun Microsystems Iberica, S.A. Sun Microsystems India Private Limited Sun Microsystems Intercontinental Operations Sun Microsystems International, Inc. Sun Microsystems International B.V. Sun Microsystems Ireland Ltd. Sun Microsystems Italia S.p.A. Sun Microsystems Korea, Ltd. 2 Sun Microsystems Limited Sun Microsystems Malaysia Sdn. Bhd. Sun Microsystems Management Services Corporation Sun Microsystems Nederland B.V. Sun Microsystems (NZ) Limited Sun Microsystems Oy Sun Microsystems Poland, Sp.z.o.o. Sun Microsystems (Portugal), Lta Sun Microsystems Properties, Inc. Sun Microsystems Pte. Ltd. Sun Microsystems Scotland B.V. Sun Microsystems Scotland Limited Sun Microsystems Slovakia, s.r.o. Sun Microsystems (South Africa)(Pty) Limited Sun Microsystems Superannuation Nominees Pty. Ltd. Sun Microsystems (Thailand) Limited Sun Microsystems de Chile, S.A. Sun Microsystems de Colombia, S.A. Sun Microsystems de Mexico, S.A. de C.V. Sun Microsystems de Venezuela, S.A. Sun Microsystems do Brasil Industria e Comercio Ltda. Sun Microsystems of California, Inc. Sun Microsystems of California, Ltd. Sun Microsystems of Canada Inc. Sun Microsystems China Ltd. Sun TSI Subsidiary, Inc. SunExpress International, Inc. SunSoft, Inc. SunSoft International, Inc. Solaris Indemnity, Ltd. Solaris Assurance, Inc. Sun Microsystems Risk Management, Inc. Sun Microsystems Taiwan Limited Sun Microsystems Israel Limited Sun Microsystems Technology Pty. Ltd. Sun Microsystems (China) Co., Ltd. Sun Microsystems de Argentina S.A. EX-23.1 5 CONSENT OF ERNST & YOUNG LLP 1 Exhibit 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report(Form 10-K) of Sun Microsystems, Inc. of our report dated July 15, 1998, included in the 1998 Annual Report to Stockholders of Sun Microsystems, Inc. Our audits also included the financial statement schedule of Sun Microsystems, Inc. listed in Item 14(a). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 33-9293, 33-11154, 33-15271, 33-18602, 33-25860, 33-28505, 33-33344, 33-38220, 33-51129, 33-56577, 333-01459, 333-09867, 333-34543, 333-34651 333-38163, 333-40675,33-40677,333-59503 and 333-62987 and Form S-3 No. 333-38021) pertaining to the 1982 Incentive Stock Option Plan, the Restricted Stock Plan, the 1984 Employee Stock Purchase Plan, the 1987 Stock Option Plan, the 1988 Directors' Stock Option Plan, the 1989 French Stock Option Plan, the 1990 Employee Stock Purchase Plan, the 1990 Long-Term Equity Incentive Plan, the Equity Compensation Acquisition Plan, the U.S. Non-Qualified Deferred Compensation Plan, the Integrity Arts, Inc. 1996 Stock Option Plan, the 1997 French Stock Option Plan, the Red Cape Software, Inc. 1996 Stock Option Plan, the NetDynamics, Inc. 1995 Stock Option Plan and the registration of $1,000,000,000 of debt securities and common stock in the related Prospectuses of our report dated July 15, 1998, with respect to the consolidated financial statements incorporated herein by reference and our report included in the preceding paragraph with respect to the financial statement schedule included in this Annual Report(Form 10-K) of Sun Microsystems, Inc. /s/ Ernst & Young LLP - ------------------------ Palo Alto, California September 22, 1998 EX-27 6 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS JUN-30-1998 JUL-01-1997 JUL-30-1998 822,267 476,185 1,845,765 235,563 346,446 4,147,525 2,257,228 956,616 5,711,062 2,122,871 0 0 0 288 3,513,628 5,711,062 8,603,359 9,790,840 3,972,283 8,660,766 0 0 1,571 1,176,166 413,304 762,862 0 0 0 762,862 2.04 1.93
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