-----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, FCwSSx1zNz/xeiLO5YbZYMOQa4OQd/CRxKXumXSmvIvWcG4pR4yTRW9fMnVOgtJX ccWHJyHkcQP57XtmmT4DLQ== 0000891618-99-002710.txt : 19990616 0000891618-99-002710.hdr.sgml : 19990616 ACCESSION NUMBER: 0000891618-99-002710 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19990615 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/A SEC ACT: SEC FILE NUMBER: 000-15086 FILM NUMBER: 99646954 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/A 1 AMENDMENT #1 TO FORM 10-K 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 1 TO FORM 10-K/A ------------------------ (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 PALO ALTO, CA 94303 (650) 960-1300 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE) INCLUDING AREA 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 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. 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. 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.
1 3
EXHIBIT NUMBER DESCRIPTION ------- ----------- 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. 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. 27* Financial Data Schedule.
- --------------- * Previously filed. (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. 2 4 (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. 3 5 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Amendment No. 1 to the Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized. SUN MICROSYSTEMS, INC. Registrant June 14, 1999 /s/ MICHAEL E. LEHMAN -------------------------------------- Michael E. Lehman Vice President, Corporate Resources and Chief Financial Officer 4 6 Pursuant to the requirements of the Securities Exchange Act of 1934, this Amendment No. 1 to the Annual 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 --------- ----- ---- * Chairman of the Board of Directors, June 14, 1999 - -------------------------------------- President and Chief Executive (Scott G. McNealy) Officer (Principal Executive Officer) /s/ MICHAEL E. LEHMAN Vice President, Corporate Resources June 14, 1999 - -------------------------------------- and Chief Financial Officer (Michael E. Lehman) (Principal Financial Officer) /s/ MICHAEL L. POPOV Vice President and Corporate June 14, 1999 - -------------------------------------- Controller (Principal Accounting (Michael L. Popov) Officer) * Director June 14, 1999 - -------------------------------------- (L. John Doerr) * Director June 14, 1999 - -------------------------------------- (Judith L. Estrin) * Director June 14, 1999 - -------------------------------------- (Robert J. Fisher) * Director June 14, 1999 - -------------------------------------- (Robert L. Long) * Director June 14, 1999 - -------------------------------------- (M. Kenneth Oshman) * Director June 14, 1999 - -------------------------------------- (A. Michael Spence) * /s/ MICHAEL E. LEHMAN - -------------------------------------- Michael E. Lehman (Power of Attorney)
5 7 INDEX TO 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. 10.85(7) Registrant's Section 162 (m) Executive Officer Performance-Based Bonus Plan dated August 9, 1995.
8
EXHIBIT NUMBER DESCRIPTION ------- ----------- 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. 27* Financial Data Schedule.
- --------------- * Previously filed. (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-13.0 2 REGISTRANT'S 1998 ANNUAL REPORT TO STOCKHOLDERS 1 EXHIBIT 13 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, --------------------------------------------------------------------- 1998 1997 1996 1995 --------------- --------------- --------------- --------------- DOLLARS % DOLLARS % DOLLARS % DOLLARS % ------- ----- ------- ----- ------- ----- ------- ----- (IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 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 -------- -------- -------- --------
F-1 3 HISTORICAL FINANCIAL REVIEW OF SUN MICROSYSTEMS, INC. SUMMARY CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED JUNE 30, ------------------------------------------------------------- 1994 1993 1992 1991 --------------- --------------- --------------- ------- DOLLARS % DOLLARS % DOLLARS % DOLLARS ------- ----- ------- ----- ------- ----- ------- (IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Net revenues.................. $4,690 100.0 $4,309 100.0 $3,589 100.0 $3,221 ------ ----- ------ ----- ------ ----- ------ Costs and expenses: Cost of sales............... 2,753 58.7 2,518 58.4 1,963 54.7 1,758 Research and development.... 500 10.7 445 10.3 382 10.6 356 Selling, general and administrative............ 1,160 24.7 1,105 25.7 983 27.4 812 Purchased in-process research and development............... -- -- -- -- -- -- -- Total costs and expenses... 4,413 94.1 4,068 94.4 3,328 92.7 2,926 ------ ----- ------ ----- ------ ----- ------ Operating income.............. 277 5.9 241 5.6 261 7.3 295 Gain on sale of equity investment.................. -- -- -- -- -- -- -- Interest income (expense), net......................... 6 0.1 (2) -- (6) (0.2) (11) Litigation settlement......... -- -- (15) (0.4) -- -- -- Income before income taxes.... 283 6.0 224 5.2 255 7.1 284 Provision for income taxes.... 87 1.8 67 1.6 82 2.3 94 ------ ----- ------ ----- ------ ----- ------ Net income.................... $ 196 4.2 $ 157 3.6 $ 173 4.8 $ 190 Net income per common share -- diluted..................... $ 0.50 $ 0.37 $ 0.42 $ 0.45 ------ ------ ------ ------ Shares used in the calculation of net income per common share -- diluted............ 388 430 431 439 ------ ------ ------ ------ YEARS ENDED JUNE 30, ----------------------------------------- 1991 1990 1989 ----- --------------- --------------- % DOLLARS % DOLLARS % ----- ------- ----- ------- ----- (IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Net revenues.................. 100.0 $2,466 100.0 $1,765 100.0 ----- ------ ----- ------ ----- Costs and expenses: Cost of sales............... 54.6 1,399 56.7 1,010 57.2 Research and development.... 11.1 302 12.2 234 13.3 Selling, general and administrative............ 25.2 588 23.9 433 24.5 Purchased in-process research and development............... -- -- -- -- -- Total costs and expenses... 90.9 2,289 92.8 1,677 95.0 ----- ------ ----- ------ ----- Operating income.............. 9.1 177 7.2 88 5.0 Gain on sale of equity investment.................. -- -- -- -- -- Interest income (expense), net......................... (0.3) (23) (0.9) (10) (0.6) Litigation settlement......... -- -- -- -- -- Income before income taxes.... 8.8 154 6.3 78 4.4 Provision for income taxes.... 2.9 43 1.8 17 1.0 ----- ------ ----- ------ ----- Net income.................... 5.9 $ 111 4.5 $ 61 3.4 Net income per common share -- diluted..................... $ 0.30 $ 0.19 ------ ------ Shares used in the calculation of net income per common share -- diluted............ 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 -------- -------- -------- -------- -------- --------
F-2 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. F-3 5 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 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 F-4 6 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 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 IPRD Overview The following paragraphs contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, particularly statements regarding the Company's expectations, including percentage of completion, expected product release dates, dates for which the Company expects to begin generating benefits from projects, expected product capabilities and product life cycles, costs and efforts to complete projects, growth rates, projected revenue and expense information used by the Company to F-5 7 calculate discounted cash flows, and discount rates. These forward-looking statements involve risks and uncertainties, and the cautionary statements including those set forth below and in "Future Operating Results" identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statement. Such factors include but are not limited to, delays in the development of in-process technologies or the release of products into the market, the complexity of the technology, the Company's ability to successfully manage product introductions, lack of customer acceptance, competition and changes in technological trends, and market or general economic conditions. In addition, there can be no assurance that any of the new products discussed below will be completed, that such products will meet either technological or commercial success or that the Company will receive any economic benefit from such products as a result of delays in the development of the technology, the complexity of the technology, changes in customer needs, or for other reasons, including those described above. Purchased in-process research and development ("IPRD") of $176.4 million, $23 million, and $57.9 million in fiscal 1998, 1997, and 1996, respectively, represents the write-off of in-process technologies associated with the Company's acquisitions of Diba, Inc. ("Diba"), Integrity Arts, Inc. ("Integrity Arts"), Chorus Systems, S.A. ("Chorus"), Red Cape Software, Inc. ("Red Cape"), and the storage products business of Encore Computer Corporation ("Encore") in fiscal 1998, Long View Technologies, LLC ("Long View") in fiscal 1997 and Integrated Micro Products, plc and its wholly-owned subsidiaries, Integrated Micro Products (UK), Ltd. and Integrated Micro Products Inc. (collectively "IMP"), and Lighthouse Design, Ltd. ("Lighthouse") in fiscal 1996 (collectively the "Acquired Companies"). At the date of each acquisition noted above, the projects associated with the IPRD efforts had not yet reached technological feasibility and the R&D in progress had no alternative future uses. Accordingly, these amounts were expensed on the respective acquisition dates of each of the Acquired Companies. Also see Footnote 2 -- "Acquisitions". In response to recent actions and comments from the Securities and Exchange Commission regarding its views on the application of valuation methodologies to purchased IPRD, the Company has expanded its disclosures related to acquisitions involving IPRD charges for each of the Acquired Companies. The Company believes that it is in compliance with all of the rules and related guidance as they currently exist. Valuation of IPRD The following table summarizes the significant assumptions underlying the valuations in 1998, 1997, and 1996 related to the IPRD from each of the Acquired Companies (in millions, except percentages).
ACQUISITION ASSUMPTIONS -------------------------------------------------------------- ESTIMATED COST TO COMPLETE RISK ADJUSTED TECHNOLOGY AT TIME DISCOUNT RATE ENTITY/PROJECT OF ACQUISITION LICENSE RATE(1) ON IN-PROCESS R&D -------------- ------------------ ------------------- ----------------- Red Cape............................ $ 7.4 n/a 25% Encore.............................. $ 30.0 12% in 1999 30% 10% in 2000 6% for 2001-2005 Chorus -- JaZZr1.1.................. $ 0.2 21% in 1999 25% 19% in 2000 17% in 2001 15% for 2002-2005 Chorus -- Other IPRD................ $ 3.0 n/a 25% Integrity Arts...................... $ 16.0 n/a 38% Diba................................ $105.0 n/a 36% Long View........................... $ 8.1 6.5% 33% Lighthouse.......................... $ 13.0 n/a 25% IMP................................. $ 15.0 n/a 22%
- --------------- (1) Represents the license rate (as a percentage of revenue) that a third party would have paid and therefore would avoid paying, as the result of acquiring the related technology n/a = not applicable based upon valuation method utilized F-6 8 The following table provides information regarding the status of IPRD projects upon acquisition and as of June 30, 1998:
ACTUAL OR PERCENTAGE COMPLETE EXPECTED AT TIME OF PRODUCT RELEASE ACQUISITION DATE ------------------- ----------------- Red Cape....................................... 15% Q4 Fiscal 1999 Encore......................................... 60% Fiscal 1999 Chorus -- JaZZr1.1............................. 50% Q4 Fiscal 1998(1) Chorus -- Other IPRD........................... 20% Q4 Fiscal 1999 Integrity Arts................................. 5% Q3 Fiscal 1998(2) Diba........................................... 10% Q4 Fiscal 1999 Long View...................................... 25% Q4 Fiscal 1998(3) Lighthouse..................................... 80% Q1 Fiscal 1998(4) IMP............................................ 10% Q3 Fiscal 1999
- --------------- (1) Revised expected release date is Q3 Fiscal 1999. (2) Revised expected release date is Q4 Fiscal 1999. (3) Revised expected release date is Q2 Fiscal 1999. (4) Project was abandoned in Q3 of Fiscal 1997. See additional discussion at "Overall Status of IPRD". The Company calculated amounts allocated to IPRD using established valuation techniques in the high technology industry and expensed such amounts in the quarter that each such acquisition was consummated because technological feasibility had not been achieved and no alternative future uses had been established. The income approach used gave consideration to relevant market sizes and growth factors, expected industry trends, the anticipated nature and timing of new product introductions by Sun and its competitors, individual product sales cycles, and the estimated life of each product's underlying technology. The values assigned to developed technologies related to each acquisition were based upon future discounted cash flows related to each of the existing product's projected income stream. The discount rates used in the present value calculations were generally derived from a weighted average cost of capital, adjusted upward to reflect the additional risks inherent in the development life cycle, including the useful life of the technology, profitability levels of the technology, and the uncertainty of technology advances that are known at the date of each acquisition. The Company does not expect to achieve a material amount of expense reductions or synergies, therefore the valuation assumptions do not include significant anticipated cost savings. Overall Status of IPRD With respect to the Company's acquisitions completed in the three years ended June 30, 1998, with the exception of Encore and IMP which are discussed separately below, management believes that the projections the Company used in performing its valuations with respect to each acquisitions are still valid, in all material respects, however, there can be no assurance that the projected results will be achieved. Management expects to continue the development of each project and believes that there is a reasonable chance of successfully completing such development efforts, except for IPRD technology acquired from Lighthouse which is discussed below. However, there is risk associated with the completion of the in-process projects and there can be no assurance that any project will meet with either technological or commercial success. Failure to successfully develop and commercialize these in-process projects would result in the loss of the expected economic return inherent in the fair value allocation. Additionally, the value of other intangible assets acquired may become impaired. Although there have been delays in the development efforts related to certain acquired IPRD technologies, as of June 30, 1998 and for each of the three fiscal years then ended, the impact upon the Company's consolidated results of operations or financial position with respect to the success or lack thereof related to any acquisition, individually or in aggregate, is not considered material. F-7 9 The Company terminated its development efforts with respect to the IPRD technology acquired through the acquisition of Lighthouse, a company conducting development and engineering associated with the completion of a suite of software products using the NEXTSTEP and OpenStep operating environments for Solaris and Windows NT systems (collectively the "Lighthouse Software Products"). During fiscal 1997 Sun's commitment to OpenStep was scaled back thereby impacting development decisions related to the Lighthouse Software Products. The decision to abandon the in-process technologies acquired from Lighthouse was based upon a change in the long term strategy for certain of Sun's products, the impact of which was not material to the consolidated results of operations or financial position of Sun. Included below are further details regarding the nature of technology acquired, the valuation assumptions and the status of the IPRD related to Encore and IMP, the Company's two largest acquisitions in the three years ended June 30, 1998. ENCORE IPRD Overview -- Encore At the time of the acquisition (November 24, 1997), Encore was conducting development and engineering activities associated with its Intershare and DASD-NET products (the "Encore Products"). It is anticipated that completion of the Encore Products would help the Company establish a viable position in the computer mainframe/open systems storage market. In addition, Encore's current products and technology would help facilitate efforts to develop a high end "intelligent" storage product, which can also be modified to address the low-end storage market. As of the date of the acquisition, the release of the Encore products was expected to commence in fiscal 1999, at which time the Company expected to generate economic benefits from the value of the development associated with the IPRD. At the acquisition date, Encore needed to perform substantial development efforts before reaching technological feasibility. These efforts include converting the box-system architecture to a storage-area-network, developing an alternative to the interconnect technology used by Encore which will provide the price and performance required to compete within the market place, and resolving several design issues during the porting phase of development. Valuation of IPRD -- Encore At the acquisition date, the Company estimated that total revenue related to the IPRD technology would increase at a compound annual growth rate of approximately 55% from fiscal 1999 to 2002. The Company projected that revenues would peak in fiscal 2002 and decline thereafter as new product technologies were expected to be introduced by the Company. These projections were based on management's estimates of market size and growth, expected trends in technology, and the expected timing of new product introductions. The product life cycle utilized by the Company resulted in the use of estimated licensing rates of 12% in 1999, 10% in 2000 and 6% for 2001-2005 of the analysis. The 12% rate was based upon a 25% operating margin related to the storage product and with 80% of the value of the product being related to software and 60% of the software being related to the acquired technology. The rate decline is attributable to proportionately lower levels of acquired technology in advancing products. The Company selected a discount rate of 30%. In the selection of the appropriate discount rate, consideration was given to the Company's weighted average cost of capital ("WACC"), as well as other factors including the useful life of the technology, profitability levels of the technology, the uncertainty of technology advances that are known at the acquisition date, and the stage of completion of the technology. The discount rate chosen was greater than the Company's WACC as the technology had not yet reached technological feasibility as of the date of the valuation. The value assigned to the IPRD reflects the Company's determination of the relative value and contribution of the acquired research and development. The Company arrived at the value of the IPRD by giving consideration to the R&D's stage of completion, the complexity of the work completed to date, the F-8 10 difficulty in completing the remaining development, costs already incurred, and the projected costs to complete the project. Comparison to Actual Results -- Encore At June 30, 1998, the Company had made progress on the development efforts related to the Encore Products that was underway as of the acquisition date. Approximately $5 million of the estimated total cost to complete of $30 million had been incurred as of June 30, 1998. Although the research and development effort was approximately twelve months behind schedule at June 30, 1998, the total expected cost to complete the IPRD technology acquired from Encore has not increased nor is it expected to exceed the original anticipated cost to complete the development efforts. Based upon a planned introduction date of late fiscal 1999, the impact of this delay to the consolidated results of operations or financial position of Sun was not considered material for fiscal 1998. Given the uncertainties of the development process, no assurance can be given that deviations from these estimates will not occur. Management expects to continue the development of each project and believes that there is a reasonable chance of successfully completing such development. However, as there is risk associated with the completion of the in-process projects due to the remaining efforts to achieve technological feasibility, rapidly changing customer needs, complexity of technology and growing competitive pressures, there can be no assurance that any project will meet with either technological or commercial success. Failure to successfully develop and commercialize these in-process projects would result in the loss of the expected economic return inherent in the fair value allocation. Additionally, the value of other intangible assets acquired may become impaired. INTEGRATED MICRO PRODUCTS IPRD Overview -- IMP At the time of the acquisition (April 23, 1996), IMP was conducting development and engineering activities associated with a next generation fault-tolerant computer based on Sun's UltraSPARC(TM) microprocessor. The UltraSPARC-based system will incorporate scalability to multiple processors, performance improvements, and a new standard bus architecture. The development of a fault-tolerant UltraSPARC product could enable the deployment of fault-tolerant functionality across a wide range of Sun's highly scaleable Ultra Enterprise(TM) Servers. At the acquisition date it was anticipated that the UltraSPARC product would require approximately one and one-half years of further development and engineering work. At the acquisition date, IMP was in the process of developing a fault-tolerant UltraSPARC product line and substantial development efforts remained, which included design, coding, testing and other implementation efforts. Valuation of IPRD -- IMP The Company estimated that total revenue related to the acquired technology would increase at a compound annual growth rate of approximately 40% from 1997 to 2002. These projections were based on management's estimates of market size and growth, expected trends in technology, and the expected timing of new product introductions. Management's assumptions with respect to operating expenses used in the valuation analysis include: (i) cost of goods sold, (ii) SG&A expenses, and (iii) R&D expenses. Selected operating expense assumptions were based on an evaluation of IMP's overall business model, including both historic and expected direct expense levels, and an assessment of general industry metrics. The Company projected cost of revenues (expressed as a percentage of revenues) for the IPRD to average 51% over the projection period. Management estimated SG&A for the IPRD to be 22% and 25% of revenues, respectively, in the first two years following acquisition, and an average of 13% over the remainder of the projection period. Management estimated that maintenance R&D related to the IPRD to be 5% and 3% of revenues, respectively, in the first two years following acquisition, and an average of 2% of revenues over the full projection period. F-9 11 The Company selected a discount rate for the IPRD of 22%. In the selection of the appropriate discount rate, consideration was given to Sun's WACC, as well as other factors including the useful life of the technology, profitability levels of the technology, the uncertainty of technology advances that were known at the acquisition date, and the stage of completion of the technology. The discount rate utilized for the IPRD was determined to be greater than Sun's WACC due to the fact that the technology had not yet reached technological feasibility as of the date of the valuation. The value of the IPRD reflects the Company's determination of the relative value and contribution of the acquired research and development. At the acquisition date, the UltraSPARC based technology was in the design stage of development. The nature and complexity to complete the product required hardware engineering, software development, the development and implementation of verification tests, and the building of engineering prototypes. Management expected the cost to complete the IPRD would total approximately $15 million, with an initial expected completion date during the second quarter of fiscal 1998. The remaining work required to complete the product is difficult and complex, and deviations from the current development plan could have a significant impact on both the completion date and the associated cost-to-complete. Comparison to Actual Results -- IMP Management's projections included a planned introduction date of late calendar 1997 for IMP's fault tolerant computers based on Sun's UltraSPARC microprocessors. Management expected the cost to complete the IPRD efforts to be incurred during fiscal 1997 and 1998 and to total approximately $15 million. As of June 30, 1998, the development efforts were behind schedule as a result of increased complexities surrounding the development efforts. As of June 30, 1998, the revised introduction date is expected to be during the third quarter of fiscal 1999. Since the expected introduction date was delayed by approximately one year, the total expected cost to complete the IPRD technology acquired from IMP has increased to approximately $25 million at June 30, 1998, and approximately $14 million had been incurred. The impact of the delayed release of the product based upon IMP's IPRD technology was not considered material to the consolidated results of operations or financial position of Sun for fiscal 1997 and fiscal 1998. Given the uncertainties of the development process, no assurance can be given that deviations from these estimates will not occur. Management expects to continue the development of each project and believes that there is a reasonable chance of successfully completing such development. However, as there is risk associated with the completion of the in-process projects due to the remaining efforts to achieve technological feasibility, rapidly changing customer needs, complexity of technology and growing competitive pressures, there can be no assurance that any project will meet with either technological or commercial success. Failure to successfully develop and commercialize these in-process projects would result in the loss of the expected economic return inherent in the fair value allocation. Additionally, the value of other intangible assets acquired may become impaired. 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 F-10 12 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 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 F-11 13 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. 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 F-12 14 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 F-13 15 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. 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 F-14 16 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. F-15 17 CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED JUNE 30, ----------------------------------------- 1998 1997 1996 ----------- ----------- ----------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 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. F-16 18 CONSOLIDATED BALANCE SHEETS ASSETS
AT JUNE 30, ---------------------------- 1998 1997 ----------- ----------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) 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. F-17 19 CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, -------------------------------------- 1998 1997 1996 ----------- ---------- ----------- (IN THOUSANDS) 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. F-18 20 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY THREE YEARS ENDED JUNE 30, 1998
COMMON STOCK ADDITIONAL -------------------- PAID-IN RETAINED SHARES AMOUNT CAPITAL EARNINGS ----------- ------ ---------- ---------- (IN THOUSANDS, EXCEPT SHARE AMOUNTS) Balances at June 30, 1995............. 425,509,924 $ 72 $1,089,478 $1,205,483 Issuance of stock, net of employee repurchases......................... (40,468) -- -- (19,516) Issuance of restricted stock.......... 850,662 -- 19,012 -- Treasury stock purchased.............. -- -- -- -- Net income............................ -- -- -- 476,388 Tax benefit and other................. -- -- 55,859 -- Balances at June 30, 1996............. 426,320,118 72 1,164,349 1,662,355 Issuance of stock, net of employee repurchases......................... (10,000) -- -- (14,710) Treasury stock purchased.............. -- -- -- -- Exercise of warrants.................. 4,225,768 1 1,611 -- Net income............................ -- -- -- 762,420 Tax benefit and other................. -- -- 63,837 -- Issuance of common stock dividend..... -- 215 -- (215) Balances at June 30, 1997............. 430,535,886 288 1,229,797 2,409,850 Issuance of stock, net of employee repurchases......................... (224,445) -- (2) (21,777) Treasury stock purchased.............. -- -- -- -- Net income............................ -- -- -- 762,862 Tax benefit and other................. -- -- 115,713 -- Balances at June 30, 1998............. 430,311,441 $288 $1,345,508 $3,150,935 ----------- ---- ---------- ---------- TREASURY STOCK CURRENCY TOTAL ------------------------- TRANSLATION STOCKHOLDERS' SHARES AMOUNT ADJUSTMENT EQUITY ----------- ----------- ----------- ------------- (IN THOUSANDS, EXCEPT SHARE AMOUNTS) Balances at June 30, 1995............. (31,452,316) $ (206,067) $33,629 $2,122,595 Issuance of stock, net of employee repurchases......................... 14,561,928 131,493 -- 111,977 Issuance of restricted stock.......... -- -- -- 19,012 Treasury stock purchased.............. (37,465,488) (522,336) -- (522,336) Net income............................ -- -- -- 476,388 Tax benefit and other................. -- -- (12,009) 43,850 Balances at June 30, 1996............. (54,355,876) (596,910) 21,620 2,251,486 Issuance of stock, net of employee repurchases......................... 10,378,115 137,574 -- 122,864 Treasury stock purchased.............. (16,072,619) (456,090) -- (456,090) Exercise of warrants.................. -- -- -- 1,612 Net income............................ -- -- -- 762,420 Tax benefit and other................. -- -- (4,192) 59,645 Issuance of common stock dividend..... -- -- -- -- Balances at June 30, 1997............. (60,050,380) (915,426) 17,428 2,741,937 Issuance of stock, net of employee repurchases......................... 12,638,384 196,631 -- 174,852 Treasury stock purchased.............. (6,595,870) (284,396) -- (284,396) Net income............................ -- -- -- 762,862 Tax benefit and other................. -- -- 2,660 118,373 Balances at June 30, 1998............. (54,007,866) $(1,003,191) $20,088 $3,513,628 ----------- ----------- ------- ----------
See accompanying notes. F-19 21 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 F-20 22 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) backlog and forecast demand, and such differences may be material to the financial statements. Inventories consist of:
AT JUNE 30, ------------------- 1998 1997 -------- -------- (IN THOUSANDS) 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 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 F-21 23 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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. 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. F-22 24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JUNE 30, ----------------------------------------- 1998 1997 1996 ----------- ----------- ----------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 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 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 F-23 25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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 the three years ended June 30, 1998, the Company completed eight acquisitions which were accounted for under the purchase method of accounting. Pro forma results of operations have not been presented for any of the acquisitions because the effects of these acquisitions were not material to the Company on either an individual or an aggregate basis. The results of operations of each acquisition are included in the Company's consolidated statement of income from the date of each acquisition and were not material to the Company on either an individual or an aggregate basis. The Company completed five acquisitions in fiscal 1998. On May 29, 1998, the Company completed its acquisition of Red Cape Software, Inc. ("Red Cape"), a company which was conducting engineering and testing activities to further develop its Framework for Policy Management Software, a Java(TM) technology- based, goal-oriented, policy-based storage management software that can be used across platforms. On November 24, 1997, the Company completed its acquisition of Encore Computer Corporation's Storage Products Business ("Encore"). Encore was conducting development and engineering activities associated with its Intershare and DASD-NET products (the "Encore Products") for the computer mainframe/open systems storage market. The acquired technology of the Encore Products will facilitate the Company's efforts to develop a high-end "intelligent" storage product, which can be modified to address the low-end storage market. On October 21, 1997 the Company completed its acquisition of Chorus Systems, S.A. ("Chorus"). Chorus was conducting development, engineering and testing activities associated with certain software products which will allow the Company to create a robust product line leveraging the Java programming language, including a tool set and flash file system, as well as embedded operating systems. On September 22, 1997, the Company completed its acquisition of Integrity Arts, Inc. ("Integrity Arts"), a company developing a smart card Application Programming Interface ("API"). An API defines the concepts, terms and structures of a software platform that can be followed by application designers and architects and describes application functionality, data management principles, communication principles, and network infrastructure. Integrity Arts was also developing the related smart card and terminal run-time software modules, software development tools, card application architectures, and data security software. On August 22, 1997, the Company completed its acquisition of Diba, Inc. ("Diba"). Diba was conducting development and engineering activities associated with the completion of a consumer information appliance which will offer improved performance F-24 26 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) and efficiency by allowing processing of software applications at either the local area network located in the consumer's home or at another location. The Company completed one acquisition, Long View Technologies, LLC ("Long View") during fiscal 1997. Long View was acquired on February 14, 1997 and at the time was conducting development and engineering activities associated with the completion of a virtual machine for the MS Windows '95 and NT operating systems which would contribute to the speed and robustness of the Sun Java platform's ability to operate in the network computing market. During fiscal 1996, the Company completed two acquisitions. On April 23, 1996, the Company completed its acquisition of Integrated Micro Products, Inc. ("IMP"), a company conducting development and engineering activities associated with the development of fault tolerant computers. On June 28, 1996, the Company completed its acquisition of Lighthouse Design, Ltd. ("Lighthouse") a company conducting development and engineering activities associated with the completion of a suite of software products for end-users and developers. These software products included spreadsheets, wordprocessors, database development and project management tools, as well as the objects used by software developers to build tools for enterprises using the NEXTSTEP or OpenStep operating environments for Solaris(TM) and Windows NT systems. A summary of the Company's purchase transactions which included in-process research and development ("IPRD") charges is included in the following table (in millions).
IPRD FORM OF CONSIDERATION ENTITY NAME CONSIDERATION DATE CHARGE & OTHER NOTES ----------- ------------- ---- ------ --------------------- Fiscal 1998 Acquisitions Red Cape................ $ 16.7 May 29, 1998 $14.1 Cash Encore.................. $186.2 Nov 29, 1997 $97.0 Cash; developed technology and goodwill and other intangibles of $56 and $6.7, respectively Chorus.................. $ 26.5 Oct 21, 1997 $13.1 Cash Integrity Arts.......... $ 30.2 Sep 22, 1997 $29.9 Cash Diba.................... $ 29.7 Aug 22, 1997 $22.3 $25.6 in cash and assumed liabilities of $4.1 Fiscal 1997 Acquisitions Long View............... $ 23.0 Feb 14, 1997 $23.0 Cash Fiscal 1996 Acquisitions Lighthouse.............. $ 22.8 Jun 28, 1996 $14.9 $19 in common stock; $3.2 in cash and assumed liabilities of $0.6 IMP..................... $106.5 Apr 23, 1996 $43.0 $96.1 in cash and assumed liabilities of $10.4; developed technology and goodwill and other intangibles of $36.5 and $12, respectively
The Company calculated amounts allocated to IPRD using established valuation techniques in the high technology industry and expensed such amounts in the quarter that each such acquisition was consummated because technological feasibility of the in-process technologies so acquired had not been achieved and no alternative future uses had been established. The income approach used gave consideration to relevant market sizes and growth factors, expected industry trends, the nature and timing of new product introductions by Sun and its competitors, individual product sales cycles, and the estimated life of each product's underlying technology. The excess purchase price over the estimated value of the net tangible assets acquired was allocated to various intangible assets, consisting primarily of developed technology and goodwill, as well as other goodwill-like assets, such as customer base and assembled workforce. The values assigned to developed technologies related to each acquisition were based upon future discounted cash flows related to the existing products' F-25 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) projected income streams. The values of the customer bases were determined based upon the value of existing relationships and the expected revenue stream. The values of the assembled workforces were based upon the cost to replace those workforces. Amounts allocated to goodwill and other intangibles are amortized on a straight-line basis over periods ranging from two to five years. 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." 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 COST GAINS LOSSES FAIR VALUE -------- ---------- ---------- ---------------- (IN THOUSANDS) 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 COST GAINS LOSSES FAIR VALUE -------- ---------- ---------- ---------------- (IN THOUSANDS) 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 ======== ==== ==== ========
F-26 28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The cost and estimated fair values of cash equivalents and short-term investments by contractual maturity are as follows:
AT JUNE 30, 1998 ---------------------- ESTIMATED CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS COST FAIR VALUE ------------------------------------------- -------- ---------- (IN THOUSANDS) 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 AMOUNT VALUE AMOUNT VALUE -------- -------- --------- --------- (IN THOUSANDS) 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, -------------------- 1998 1997 -------- -------- (IN THOUSANDS) 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. F-27 29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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. 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, ------------------------------------ 1998 1997 1996 ---------- ---------- -------- (IN THOUSANDS) 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 ========== ========== ========
F-28 30 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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, ---------------------- 1998 1997 --------- --------- (IN THOUSANDS) 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, -------------------------------- 1998 1997 1996 -------- -------- -------- (IN THOUSANDS) 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. 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 F-29 31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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 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. F-30 32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Information with respect to stock option and stock purchase rights activity is as follows:
OUTSTANDING OPTIONS/RIGHTS --------------------------------------------- SHARES WEIGHTED AVAILABLE NUMBER AVERAGE FOR GRANT OF SHARES PRICE PER SHARE EXERCISE PRICE --------- --------- ------------------- -------------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 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 ---------- --- -------- ---------- --------
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. F-31 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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. 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................................ -- -- -- ----- ----- -----
F-32 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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, --------------------------------- 1998 1997 1996 --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 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 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. F-33 35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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 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 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. F-34 36 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. QUARTERLY FINANCIAL DATA (UNAUDITED)
FISCAL 1998 QUARTER ENDED, -------------------------- JUNE 30 MARCH 29 DECEMBER 28 SEPTEMBER 28 ---------- ---------- ----------- ------------ (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 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, -------------------------- JUNE 30 MARCH 30 DECEMBER 29 SEPTEMBER 29 ---------- ---------- ----------- ------------ (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 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. 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. The closing of this acquisition is contingent upon the completion of various closing conditions. F-35 37 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 F-36 38 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 DAILY AVERAGE HIGH LOW SALES 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] STOCK OWNERSHIP PROFILE (AS OF JUNE 30, 1998) [GRAPHIC] F-37 EX-23.1 3 CONSENT OF ERNST & YOUNG LLP 1 EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the use of our report dated July 15, 1998 incorporated by reference in the Annual Report on Form 10-K of Sun Microsystems, Inc. for the year ended June 30, 1998, with respect to the consolidated financial statements, as amended, incorporated by reference in this Form 10-K/A. 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, 333-15179, 333-34543, 333-34651, 333-38163, 333-40675, 333-40677, 333-59503, 333-62987, 333-65531, 333-67183 and 333-72413 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, i-Planet, Inc. 1996 Stock Option/Stock Issuance Plan, Maxstrat 1994 Stock Option Plan and the registration of $1,000,000,000 of debt securities and common stock, and in the related Prospectuses of our report dated July 15, 1998, with respect to the consolidated financial statements incorporated herein by reference in this Annual Report (Form 10-K/A) of Sun Microsystems, Inc. Ernst & Young LLP Palo Alto, California June 14, 1999 F-38 -----END PRIVACY-ENHANCED MESSAGE-----