-----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, HnMG+GNxRGPUPcFqN99DF8lDp1XWzxYkItqlu0/86gjNHOpwZx/w/R1/sMuVf99J 4hlFc3/ryG1TpVfHZZwM7g== 0000891618-99-004343.txt : 19990928 0000891618-99-004343.hdr.sgml : 19990928 ACCESSION NUMBER: 0000891618-99-004343 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990927 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SUN MICROSYSTEMS INC CENTRAL INDEX KEY: 0000709519 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRONIC COMPUTERS [3571] IRS NUMBER: 942805249 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-15086 FILM NUMBER: 99717715 BUSINESS ADDRESS: STREET 1: 901 SAN ANTONIO RD CITY: PALO ALTO STATE: CA ZIP: 94303 BUSINESS PHONE: 6509601300 MAIL ADDRESS: STREET 1: 901 SAN ANTONIO ROAD CITY: PALO ALTO STATE: CA ZIP: 94303 10-K 1 FORM 10-K FOR THE YEAR ENDED JUNE 30, 1999 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ------------------------ (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 1999 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO ____________ . COMMISSION FILE NUMBER: 0-15086 SUN MICROSYSTEMS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 94-2805249 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) 901 SAN ANTONIO ROAD (650) 960-1300 PALO ALTO, CA 94303 (ADDRESS OF PRINCIPAL EXECUTIVE (REGISTRANT'S TELEPHONE NUMBER, 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 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 14, 1999, was approximately $65,196,694,478 based upon the last sale price reported for such date on The Nasdaq Stock 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 14, 1999 was 780,552,918. DOCUMENTS INCORPORATED BY REFERENCE Parts of the Annual Report to Stockholders for the fiscal year ended June 30, 1999 are incorporated by reference into Items 1, 5, 6, 7, 8 and 14 hereof. Parts of the Proxy Statement for the 1999 Annual Meeting of Stockholders are incorporated by reference into Items 10, 11, 12 and 13 hereof. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 PART I ITEM 1. BUSINESS This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, particularly statements regarding economic trends in geographic markets, trends relating to customer buying patterns, trends and growth in the Internet marketplace, and our expectations relating to future research and development and selling, general and administrative expenses. These forward-looking statements involve risks and uncertainties, and the cautionary statements set forth below and 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 our 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 our efforts to comply with Year 2000 requirements and other factors. GENERAL We are a leading worldwide provider of products, services and support solutions for building and maintaining network computing environments. We sell scalable computer systems, high-speed microprocessors, and a complete line of high performance software for operating network computing equipment and storage products. We also provide a full range of services, including support, education, and professional services. Our products and services command a significant share of the rapidly growing network computing market, which includes the Internet and corporate intranets. Our products are used for many demanding commercial and technical applications in various industries including telecommunications, manufacturing, financial services, education, retail, government, energy and healthcare. We owe much of our success to our adherence to open industry standards, the Solaris(TM)Operating Environment, the UNIX(R) platform, and the UltraSPARC(TM) (Ultra Scalable Processor Architecture) microprocessor architecture. In addition we are committed to investment in and ownership of intellectual property, leveraging our partnerships with industry leaders and enabling the Internet and the "Net Economy." For the latest fiscal year ended June 30, 1999, we had annual revenues of more than $11.7 billion, over 29,000 employees, and we conducted business in over 170 countries. We were incorporated in California in February, 1982 and reincorporated in Delaware in July, 1987. BUSINESS STRATEGY Our objective is to expand our position as a leading global provider of network computing products and services. The key elements of our strategy include: - developing network computing products and technologies that enable the Internet and the Net Economy - providing competitive solutions based on open industry standards - extending our technology leadership and innovation - investing in support, education and professional services - leveraging strong industry relationships DEVELOPING NETWORK COMPUTING PRODUCTS AND TECHNOLOGIES THAT ENABLE THE INTERNET AND THE NET ECONOMY We were founded on the notion that computer networks are greater than the sum of their parts and that communication and information access should be uninhibited by the boundaries of proprietary software and 1 3 hardware architectures. To help us explain this vision we coined the phrase, "The Network is the Computer(TM)," and built networking technologies into every product. From the Solaris(TM) Operating Environment to UltraSPARC microprocessors, from scalable servers to the Java(TM) and Jini(TM) platforms, we are focused on providing customers with a single, high performance, highly reliable network computing architecture. This single focus provides customers with investment protection for their legacy computing environments, a single operating environment that is both backward compatible and scalable across our entire product line (binary compatibility) and an upgrade path for their entire network. The Internet has grown to encompass much more than simple information sharing. Increasingly, the Internet is enabling a whole new paradigm of business commerce that brings customers closer to suppliers and streamlines the delivery of goods and services. This new paradigm is commonly referred to as the Net Economy and is changing the fundamentals of most every business and industry across the globe. Through our products and technologies, we are helping customers participate in the Net Economy by implementing new processes and practices to take advantage of the opportunities that the Internet can provide. PROVIDING COMPETITIVE SOLUTIONS BASED ON OPEN INDUSTRY STANDARDS From inception, we have focused on developing products and technologies based upon open industry standards to provide customers with flexibility for their networking environments. Through our commitment to open, industry standards, we have created technologies, such as Network File System (NFS(TM)), Scalable Processor Architecture (SPARC(TM)) and most recently Java(TM) and Jini(TM), that have facilitated industry growth. Through the Internet, we are realizing our long-standing vision of a network where information can be accessed at anytime, from anywhere, by anyone and from any device. The Internet is growing and expanding to be more than just a repository of information. Increasingly, businesses are looking to the Internet to enable more effective and efficient methods of electronic commerce and communication, to streamline business practices, increase productivity and reduce both costs and complexity. By harnessing the power of the Internet, businesses are transforming traditional practices and promoting the Net Economy. We support this transformation by leveraging the power of our computing technologies in order to provide our customers with the solutions they need to effectively utilize the power of the Internet. EXTENDING OUR TECHNOLOGY LEADERSHIP AND INNOVATION We believe that in order to be a leading developer of enterprise and Internet-based products and technologies, we must continue to invest and innovate. Through our research and development investments, which have typically been approximately 10% of annual revenues, we are continually focusing on raising the bar of technological innovation. Over the past few years, we have made significant investments in several of our product technologies, including our highly scalable UltraSPARC processor architecture, our highly reliable and scalable Solaris Operating Environment, our cross-platform Java software development environment powering Internet-based applications, our Java-based Jini technology that allows a broad range of devices to connect and share information over the Internet and with one another, our scalable enterprise servers and workstations, and our network-based storage systems and software. Many of these technologies provide us with a competitive advantage and differentiation in the marketplace. We intend to continue our investments into new computing technologies and are focused on continuing to develop and deliver leading edge network computing products based upon our innovations. INVESTING IN SUPPORT, EDUCATION AND PROFESSIONAL SERVICES We are also investing in the expansion of our support, education and professional services. As the market for network computing and Internet products and technologies expands, the demand for services also increases. In recognition of this demand, we hired nearly 1,700 people in the last fiscal year ended June 30, 1999 into our Enterprise Services organization, which now employs over 7,500 professionals. With a shortage of computing professionals worldwide, our customers are increasingly demanding support for enterprise as well as Internet projects. They require key integration, training, support and development services to bring their 2 4 business processes and practices to the Internet. In addition, customers are looking for network computing suppliers to provide them with solutions to their enterprise and Internet computing needs. To meet the needs of our customers and partners, we will continue to invest in acquiring additional personnel to staff our rapidly growing support, education and professional services organization. LEVERAGING STRONG INDUSTRY RELATIONSHIPS While our product and service offerings are very broad, we recognize that no single supplier of computing solutions can meet all of the needs of all of its customers. We have established relationships with leading value-added resellers, OEMs, service providers, independent software vendors (ISV) and systems integrators to deliver solutions that customers demand. Through these relationships, we are able to provide the end-to-end solutions that customers require to compete in the Net Economy. We also have relationships with leading network and application service providers, and offer the products, technologies and services they require for highly reliable applications and networking services to their customers. These cooperative relationships provide an attractive business model for these partners and create an environment where Sun benefits as our partners' businesses grow. In order to foster strong relationships, we have also instituted sales force incentive and flexible financing programs that align our operations with the success of their business. BUSINESS ORGANIZATION To facilitate innovation and provide world class support for our global client base, we are structured as a group of businesses, each providing open, standard products and services for commercial and technical computing. We have focused our business on the following opportunities in the network computing industry: COMPUTER SYSTEMS AND STORAGE Computer Systems and Storage designs, develops, manufactures and sells a broad range of desktop systems, servers, storage and network switches, incorporating the UltraSPARC(TM) microprocessors and the Solaris Operating Environment. ENTERPRISE SERVICES Enterprise Services provides a full range of global services and support for heterogeneous network computing environments, including system/network management, systems integration, and support, education, and professional services. SOFTWARE PRODUCTS AND PLATFORMS Software Products and Platforms designs, develops and sells our Solaris Operating Environment, Java software and our core technologies for consumer and embedded markets which include Chorus OS(TM) (a real-time operating environment), Java implementations and Jini technologies, as well as our software tools and security products. In addition, this organization is also responsible for software marketing, a software technology OEM sales group and an expanded and integrated ISV/developer relations and market development group. MICROELECTRONICS Microelectronics designs, develops and markets high performance SPARC and Java microprocessors, board reference platforms, processor modules, chips sets and logic products for Sun products and third-party customers. NETWORK SERVICE PROVIDER Network Service Provider sells real-time network platforms and carrier-grade, fault tolerant products that are designed to be extremely reliable. Our Network Service Provider business focuses on the needs of 3 5 network-based telecommunications companies, cable operators, and the network equipment suppliers who develop products and technologies for the broader service provider industry. In addition, through our recent alliance with America Online, Inc. (AOL), the Sun-Netscape Alliance, we develop, market and sell enterprise and E-commerce software for consumers and businesses. These software products and technologies, commonly referred to as middleware, complement our enterprise servers, storage and workstation products. Combined, these products provide customers with comprehensive solutions to their enterprise and Internet computing needs. PRODUCTS Our products and technologies, from our microprocessors to our Solaris Operating Environment to high-end enterprise scalable servers, were designed, developed and produced for the network computing environment. WORKSTATIONS Our workstation products include the Ultra(TM) 5, Ultra 10 and Ultra 60 models. The Ultra 5 is used for business application and software development, offering high performance at a low cost. The Ultra 10 offers value and performance for 3-D graphics applications and is designed for applications such as drafting and design, animation and rendering, modeling and analysis. Finally, the Ultra 60 is Sun's highest performance workstation, in both single and dual processor configurations, and is suited for modeling and virtual prototyping, medical imaging, animation and geosciences. ENTERPRISE SERVERS Our enterprise servers consist of workgroup servers, mid-range servers and data center/high-performance computing servers. These products run enterprise mission critical application environments, directories, databases, websites and many other applications. They offer significant scalability, reliability, availability, serviceability and performance. In addition, all enterprise servers share common components and offer binary compatibility for all application environments because they all run the Solaris Operating Environment on the UltraSPARC architecture. The primary competitive differentiators for these products in the marketplace are their performance, scalability and reliability. Scalability refers to a system's ability to add resources such as additional microprocessors, memory or input/output to increase performance without adding complexity. Reliability refers to the system's ability to run continuously without interruption. These two important attributes in our enterprise server products help our customers avoid costly architecture migrations and downtime that can result from increasing business demands. WORKGROUP SERVERS. We offer two products in the Workgroup Server group: the Sun Enterprise(TM) 250 and 450. The Sun Enterprise 250 can be configured with up to two microprocessors, six Ultra SCSI disks, fast ethernet, multiple independent data paths, and multiple redundancy to provide customers with high performance, high throughput, and high reliability for business critical applications. The Sun Enterprise 250 can host electronic mail, websites, directory databases and many other applications. The Sun Enterprise 450 servers provide the scalability, performance and reliability for critical business needs. The Sun Enterprise 450 server supports up to four microprocessors and utilizes high speed interconnect and offers 10 PCI slots, which allow the Sun Enterprise 450 to scale as application demand grows. The Sun Enterprise 450 provides the reliability, availability and scalability needed for demanding applications and solutions such as groupware, distributed database applications, clustering, enterprise resource planning as well as e-mail and Internet/intranet services. MID-RANGE SERVERS. Our mid-range servers offer scalability supporting up to eight processor configurations in the Sun Enterprise 3500 and up to thirty processor configurations in the Sun Enterprise 6500. The entry level Sun Enterprise 3500 is a powerful, scalable, versatile and upgradeable departmental server in a compact package. The Sun Enterprise 4500 is expandable up to 14 processors and is one of our most modular and powerful departmental servers, offering outstanding performance and the ability to scale system 4 6 performance and capacity as needs grow. The Sun Enterprise 5500 is also expandable up to 14 processors and is packaged in a rack configuration allowing the bundling of additional storage in a single enclosure. Finally, the Sun Enterprise 6500 provides customers the ability to deploy large scale, mission critical applications in a network-based environment. The Sun Enterprise 6500 offers the performance and availability required for mainframe-class mission-critical applications. Our mid-range servers are utilized for E-commerce, databases, decision support, data mining and warehousing, telecommunications, enterprise resource planning and network file system support. DATA CENTER/HIGH-PERFORMANCE COMPUTING SERVERS. In the data center/high-performance computing server group, we offer the Sun Enterprise 10000, which is the most scalable UNIX system in the marketplace and incorporates mainframe features. The Sun Enterprise 10000 is designed to offer greater performance and lower total cost of ownership than mainframe products. The Sun Enterprise 10000 is used for server consolidations, application migrations, data mining and warehousing, custom applications, on-line transaction support, enterprise resource planning and databases. TELECOMMUNICATIONS SERVERS For telecommunications, cable, wireless and network equipment providers, our Netra servers provide NEBS (Network Equipment Building Standard) compliant, carrier grade, high-availability solutions for mission critical applications. The Netra telecommunications servers are all based on the scalable SPARC/ Solaris architecture. At the entry level, the Netra(TM) t1 server offers high availability at low cost with features such as automatic server restart, hot-pluggable disks and lights-out management, which allow providers to remotely manage power status and monitor system health. The Netra t1 was specifically designed for network service providers offering a compact chassis that can be easily stacked into existing racks. The Netra t1120/t1125 are NEBS certified, carrier-grade servers which allow network service providers to deploy mission critical applications and services outside the central office. The Netra t1120 is for DC power environments, whereas the Netra t1125 is for AC power. The Netra t1120/t1125 are used by telecommunications and service provider customers for network policy management, directory, load balancing, security, voice messaging and many other applications. The Netra ft1800 is a fault tolerant server offering customers NEBS compliance and extreme reliability. It is specifically designed for central office and data networking environments for running mission critical applications. The Netra ft1800 has been designed to eliminate all single points of failure in order to provide continuous availability. The Netra ft1800 is used for network management and telecommunications applications. NETWORK STORAGE Our Network Storage systems and software also support our strategy of providing products and technologies to network computing environments. Through our broad product line, we are able to deliver not only storage connectivity, but also storage intelligence to the network across multiple operating environments, including NT. The Intelligent Storage Server(TM) A7000 offers seamless UNIX/mainframe/NT information sharing capabilities. It is designed to deliver high-end, heterogeneous storage supporting UNIX platforms, mainframes and NT platforms and as such it is well-suited for storage consolidation of multiple servers into a single storage unit. The A7000 also offers campus remote mirroring for disaster recovery or business continuance in the event of system failures. The A5000 storage array is an all fibre channel array for high performance data warehousing or high bandwidth applications due to the all fibre channel pipes from host to fibre channel disks. It offers cluster support for mission critical availability and performance. Both Solaris and NT platforms are supported. This highly reliable and scalable product is a building block disk for creating a new breed of intelligent storage networks. The A3500 array features a high-availability design and outstanding performance and capacity for OLTP (On-Line Transaction Processing) applications and departmental-level storage requirements. It also offers 5 7 cluster support for OLTP applications. This product scales from disks to dual controller, high performance, high availability storage. The A1000/D1000 products provide a building-block solution for workgroups and small departments. These products offer a high-performance, affordable, and versatile storage solution. These expandable RAID (Redundant Array of Independent Disks) systems allow customers to customize their storage environments as a stand-alone device offered with or without a controller and to provide optimum scalability as a rack-mounted solution. Our tape automation products provide the flexibility, scalable capacities, and high performance for enterprises of all sizes. Sun offers autoloaders using 8mm and digital data service (DDS-3) technology for workgroup environments. The complete family of Sun StorEdge(TM) enterprise tape libraries has been designed with digital linear tape (DLT) technology and one of the industry's leading robotics technology. Our storage software applications provide a high level of information protection. Remote Dual Copy of the Sun StorEdge A7000 is designed to offer continuous business operation in the event of a data center disaster, while the Sun StorEdge Enterprise NetBackup(TM) system provides backup/restore for thousands of users and high performance hot database backup for Oracle, Sybase, Informix and SAP databases. Solstice Backup(TM) is a workgroup and departmental solution, optimized for backups of local data. Sun StorEdge Volume Manager(TM), Sun StorEdge LibMON(TM), and Sun StorEdge Enterprise HSM products provide flexible, cost effective information management, allowing more effective utilization of storage resources. MICROELECTRONICS In addition to creating the microprocessors for Sun's workstation and server products, Microelectronics provides OEM customers with a wide range of reference platforms in multiple markets, including enterprise, communications, and consumer electronics. Our microelectronics products include board reference platforms, microprocessor modules, chip sets and logic solutions and microprocessors. The UltraSPARC architecture is one of the most scalable solutions on the market, providing the power behind our servers and workstation products. In addition, we also design Java-based processors for consumer electronics, telecommunications and embedded solutions. Our PCI, compact PCI, SBus, Java and ATX board platforms are also used in telecommunications, enterprise computing and consumer electronics solutions, providing OEM customers with a low-cost, scalable, highly reliable solution. Finally, our modules, chip sets and logic products provide customers with the performance and flexibility to create low cost, scalable, easy to integrate solutions. SYSTEM AND INTERNET SOFTWARE SOLARIS OPERATING ENVIRONMENT. The Solaris product line includes desktop, intranet, Internet Service Provider (ISP) and enterprise operating environments for SPARC and Intel platforms. The Solaris Operating Environment is a high performance, highly reliable, scalable and secure operating environment that is easy to install and use, optimized for the Java platform and supports more than 12,000 applications. The Solaris Operating Environment is optimized for enterprise computing, Internet/intranet business requirements, powerful databases and high performance technical computing environments. We also provide software solutions that focus on network management and network security that complement our server and storage product offerings. In addition, we provide Solaris and Java-based tools for software developers who create high performance applications for enterprises, telecommunications and the Internet. JAVA. Our Java application environment is one of the first widely accepted application environments to allow development of application software independent of the underlying platform. In fiscal 1999, Sun broadly expanded the definition and availability of the Java platform and extended it to the smallest devices, such as smart cards, personal digital assistants, and embedded controllers and set-top boxes with our MicroJava(TM) platform, as well as to the enterprise with our EnterpriseJava platform. These two new Java platforms address 6 8 very different markets, yet share a common core architecture and Application Programming Interface (API) set. These platforms complement our StandardJava platform which is intended for PC and workstation clients. The Java Development Kit enables developers to create and run applets (which are miniature applications written in the Java programming language) that run inside a compatible web browser, and full applications written using the Java programming language. JINI. Jini connection technology is based upon a single concept, that devices should work together and simply connect to the network. This means that there are no drivers to find, no complex proprietary software requirements, and no cables and connectors that can be difficult to match. There are three Jini System Software product offerings: the Jini System Software Starter Kit, the Jini Technology Core Platform Compatibility Kit, and the JavaSpaces(TM) Technology Kit. These products contain components of the Jini technology to assist developers in creation of new Jini services. ENTERPRISE SUPPORT, EDUCATION, AND PROFESSIONAL SERVICES Sun is one of the largest network computing systems providers worldwide, with over 1.2 million network systems supported by Sun's products and technologies and with support available in over 170 countries. The SunSpectrum(TM) support services product offerings allow customers the power and flexibility to customize their support services contracts. Customers can choose from four different support contract offerings that range from mission-critical to self-support options. Each contract type is specifically designed to provide our customers with the support they require to ensure high availability and continuous operation. Our education services provide customers with innovative education solutions, from technical instructor led courses, to education consulting services, to self-paced technology-based training. We specialize in UNIX and Java technology training to assist our customers with their network computing and Internet operations. Finally, our professional services specialize in providing customers with platform integration, enterprise management and operation, advanced Internet, Java technology and Enterprise Resource Planning services. These offerings are tailored to meet specific customer needs in training, integration and consulting services, providing technical knowledge and network computing/Internet expertise. THE SUN-NETSCAPE ALLIANCE In March 1999, we formed the Sun-Netscape Alliance, which is focused on providing software applications and professional services that provide enterprise customers and service providers with the ability to put their businesses on the Internet quickly and to scale to meet rapid increases in demand. With products such as i-Planet remote access, the Netscape browser, web server, application server, directory, mail and E-commerce applications, this alliance is uniquely positioned to provide technologies and products that better support enterprises and service providers. In addition, alliance products support the Solaris Operating Environment, NT, HP-UX, AIX and Linux. SALES, DISTRIBUTION AND MARKETING We maintain a presence in most major markets and sell computer systems, software and services to our customers worldwide through a combination of direct and indirect channels. We also offer off-the-shelf software and component products such as CPU chips, ASICs and embedded boards on an OEM basis to other hardware manufacturers, and supply after-market and peripheral products to their end-user installed base, both directly and through independent distributors and resellers. 7 9 Our direct sales force is organized into two primary sales forces: a sales force concentrating on enterprise systems, storage, and some software products and a sales force for software products and platforms. These sales forces sell to selected end-user named accounts and numerous indirect channels. Each sales force is compensated on a channel-neutral basis to reduce potential channel conflict between distribution partners. Our other distribution channels include: - systems integrators, both government and commercial, who serve the market for large commercial projects requiring substantial analysis, design, development, implementation and support of custom solutions; - master resellers who supply product and provide product marketing and technical support services to our smaller Value-Added Resellers (VARs); - VARs who provide added value in the form of software packages, proprietary software development, high-end networking integration, vertical integration, vertical industry expertise, training, installation and support; - OEMs who integrate our products with other hardware and software; and - independent distributors who primarily cover markets in which we do not have a direct presence. The growth and management of the reseller channels is very important to our future revenues and profitability. Channel partners account for more than 50% of our revenues and will continue to play a key role in providing the value, service and support critical to our long-term success. Our direct systems sales force serves educational institutions, software vendors, governments, businesses and other strategic accounts. We have approximately 100 sales and service offices in the United States and approximately 140 sales and service offices in 45 other countries. In addition, we use independent distributors in approximately 150 countries, sometimes with other resellers and direct sales operations. Our revenues from outside the United States, including those from end-users, resellers and distributors were approximately 49%, 48% and 49% of our total revenues in fiscal 1999, 1998, and 1997, respectively. If we are unable to continue generating substantial revenues from international sales our business could be substantially harmed. Our ability to sell our products internationally is subject to the following risks: - general economic and political conditions in each country could adversely affect demand for our products and services in these markets, as recently occurred in certain Asian and Latin American markets; - currency exchange rate fluctuations could result in lower demand for our products, as well as currency translation losses; - changes to and compliance with a variety of foreign laws and regulations may increase our cost of doing business in these jurisdictions; and - trade protection measures and import and export licensing requirements subject us to additional regulation and may prevent us from shipping products to a particular market and increase our operating costs. Direct sales we make in countries outside of the United States are generally priced in local currencies and can be subject to currency exchange fluctuations. The net impact of currency fluctuations on net revenues and operating results cannot be precisely measured as our product mix and pricing change over time in various markets, partially in response to currency movements. Our results of operations could be harmed by factors such as changes in foreign currency rates or real economic conditions in the foreign markets in which we distribute our products. We are primarily exposed to changes in exchange rates on the Japanese yen, British pound, French franc, and German deutsche mark. When the U.S. dollar strengthens against these currencies, the U.S. dollar value of non-U.S. dollar-based sales decreases. When the U.S. dollar weakens against these currencies, the dollar value of non-U.S. dollar-based sales increases. Correspondingly, the U.S. dollar value of non-U.S. dollar-based costs increases when the U.S. dollar weakens and decreases when the U.S. dollar 8 10 strengthens. Overall we are a net receiver of currencies other than the U.S. dollar and, as such, benefit from a weaker dollar, and are adversely affected by a stronger dollar relative to major currencies worldwide. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, may adversely affect our consolidated sales and operating margins as expressed in U.S. dollars. To minimize currency exposure gains and losses, we may borrow funds in local currencies, enter into forward exchange contracts, purchase foreign currency options and promote natural hedges by purchasing components and incurring expenses in local currencies, whenever feasible. Our sales to overseas customers are made under export licenses that must be obtained from the United States Department of Commerce. Protectionist trade legislation in either the United States or other countries, such as a change in the current tariff structures, export compliance laws or other trade policies, could adversely affect our ability to sell or to manufacture in international markets. Furthermore, revenues from outside the United States are subject to inherent risks, including the general economic and political conditions in each country. Sales to or through C. Itoh Technoscience Co. Ltd., Fujitsu, Ltd. and Toshiba Corporation together represent a significant portion of Sun's revenues in Japan. We remain cautious with regard to the Japanese market and do not expect the current Japanese macroeconomic trends to change significantly in the near term. If the economic trends in Japan significantly worsen in a quarter or decline over an extended period of time, our results of operations and cash flows could suffer. Although we have experienced U.S. dollar revenue growth in the European marketplace on a year over year basis, there can be no assurance that such trends will continue. In particular, if capital spending declines in certain countries or industries over an extended period of time our results of operations and cash flows could suffer. One of our customers accounted for more than 10% of our revenues in fiscal 1999 and 1998. No individual customer accounted for more than 10% of revenues in fiscal 1997. Sales to MRA Systems, Inc., an authorized reseller, were approximately 14% of our fiscal 1999 and 1998 revenues. Our business could suffer if this customer or another significant customer terminated its business relationship with us or significantly reduced the amount of business it did with us. Also see Note 10 of Notes to Consolidated Financial Statements incorporated by reference herein for additional information concerning sales to foreign customers and business segments. Our marketing activities include advertising in computer publications and the business press, direct mailings to customers and prospects, televised programs and attendance at trade shows. We maintain a customer resource program, Sunergy(SM), which includes live interactive satellite broadcasts and provides electronic access to newsletters and technical information. We also sponsor a series of seminars to specific resellers, university customers, end-users and government customers and prospects designed to familiarize attendees with the capabilities of the Sun product line. Our future operating results will continue to be subject to quarterly fluctuations based upon a variety of factors. Our operating results usually fluctuate downward in the first and third quarters of each fiscal year due to customer buying patterns for hardware and software products and services. Our operating expenses will continue to increase as we continue to expand our operations. Our operating results could suffer if our revenues do not increase at least as fast as our expenses. If, in the future, we acquire technologies, products or businesses, or we form alliances with companies requiring technology investments or revenue commitments (such as our recent alliance with AOL), we will face a number of risks to our business. The risks we may encounter include those associated with integrating or co-managing operations, personnel, and technologies acquired or licensed, and the potential for unknown liabilities of the acquired or combined business. Also, we will include amortization expense of acquired intangible assets in our financial statements for several years following these acquisitions. Our business and operating results on a quarterly basis could be harmed if our acquisition or alliance activities are not successful. Our order backlog at June 30, 1999 was approximately $825 million, compared with approximately $599 million at June 30, 1998. Our backlog includes only orders for which a delivery schedule within six months has been specified by the customer. Backlog levels vary with demand, product availability and our delivery lead times and are subject to significant decreases as a result of, among other things, customer order delays, changes or cancellations. As such, backlog levels are not a reliable indicator of future operating results. 9 11 CUSTOMER SERVICE AND SUPPORT We provide expertise in heterogeneous network computing through a full range of global services, including support services (systems support for hardware and software), education services (education consulting, skills migration and training) and professional services (IT consulting, systems integration and system/network management). Sun assists both technical and commercial customers, supporting more than 1 million systems in more than 170 countries, training more than 75,000 students annually, and providing consulting, integration and operations assistance to IT organizations worldwide. In support services, we have increased resources in the field for direct service delivery, especially software support engineers based in solution centers and field offices. Higher levels of field resources are critical to the overall investments being made in mission critical support capability. Our direct services are complemented by third-party service providers who primarily deliver hardware support services. Software support continues to be primarily delivered by our software support engineers. Third-party service providers provide necessary leverage on critical field resources such as parts inventories and staff to meet the service requirements of the growing installed base. Investments by these third-party service providers help us expand geographic coverage without additional fixed cost investment on our part. We offer a warranty for parts and labor on hardware products, generally for one year from date of sale and a limited warranty on software, generally for 90 days from date of sale. We service products during the warranty period and provide contract service after the initial product warranty has expired. Post-warranty support services are primarily offered through a tiered support offering called SunSpectrum(SM). SunSpectrum offers four levels of differentiated support that package hardware, software and peripherals in a single price support service. Warranty and post-warranty services are provided through 36 solution centers worldwide. Our education services offer comprehensive skills migration, enterprise consulting and courseware. Consultants can perform needs analysis, skills assessment and migration, curriculum design and course customization. Instructor-led courseware addresses the education needs of many customers including managers, operators, developers, system administrators, and end-users. As an alternative to the classroom, our customers may select technology-based training options including our web-based learning solution which is available to those having Internet access, built on the Java platform, and provides modular courses on Jini technologies. Additionally, we provide interactive training products on CD-ROM which can be geared for various levels of expertise. In professional services, we provide the people, processes and technology to deliver single point-of-contact solutions tailored to meet customer needs. Our technical and project management experts help customers plan, implement, and manage heterogeneous computing environments. Our consultants also help design IT architectures and plan migrations from legacy systems to network computing. To implement solutions, integration experts help customers develop and deploy distributed computing environments for new applications. To keep the environment operating at peak performance, operations experts help customers manage the complexity of the heterogeneous systems and networks. In addition, we help with all phases of creating and implementing Internet solutions. Investments have been made in competencies in Internet/Java technologies, business applications and systems and network management. Certain complex systems we sell require a high level of implementation support and consequently, a customer's acceptance of such systems may be delayed in the event Sun does not provide a sufficient level of such service. Delays in customer acceptance could seriously harm our business. PRODUCT DEVELOPMENT Our research and product development programs are intended to sustain and enhance our competitive position by incorporating the latest worldwide advances in hardware, software, graphics, networking, data communications and storage technologies. The product development efforts conducted within each of our businesses are focused on enhancing the performance, reliability, availability, and serviceability of our hardware and systems software. Additionally, we remain focused on system software platforms for Internet 10 12 and intranet applications, developing advanced workstation and server architectures, as well as designing application-specific integrated circuits and software for networking and distributed computing. Sun's product development continues to focus on the high-performance implementation of existing standards and the development of new technology standards. We conduct research and development worldwide principally in the United States, France, United Kingdom, Ireland, Japan, and Israel. Research and development expenses were approximately $1,263 million, $1,014 million and $826 million in fiscal 1999, 1998 and 1997, respectively. In recent years, our research and development efforts have focused increasingly on the Java architecture, Solaris software and SPARC microprocessors. We believe that software development provides and will continue to provide significant competitive differentiation. Therefore, we devote substantial resources to the development of workgroup software, networking and data communications, video, graphics, disk array, object technology and the software development environment. The products we make are very complex and if we are unable to rapidly and successfully develop and introduce new products, we will not be able to satisfy customer demand. We operate in a highly competitive, quickly changing environment, and our future success depends on our ability to develop and introduce new products that our customers choose to buy. If we are unable to develop new products, our business and operating results would be seriously harmed. We must quickly develop, introduce and deliver in quantity new, complex systems, software, and hardware products and components, including our UltraSPARC(TM) microprocessors, the Solaris operating environment, our intelligent storage products and other software products, such as those products under development or to be developed under our recent alliance with AOL. The development process for these complicated products is very uncertain. It requires high levels of innovation from both our product designers and our suppliers of the components used in our products. The development process is also lengthy and costly. If we fail to accurately anticipate our customers' needs and technological trends or are otherwise unable to complete the development of a product on a timely basis, we will be unable to introduce new products into the market on a timely basis, if at all, and our business and operating results would be adversely affected. In addition, the successful development of software products under our alliance with AOL depends on many factors, including our ability to work effectively within the alliance on complex product development and any encumbrances that may arise from time to time that may prevent us from developing, marketing or selling these alliance software products. If we are unable to successfully develop or market or sell the alliance software products, or other software products, our business and operating results could be seriously harmed. Software and hardware products such as ours may contain known as well as undetected errors and these defects may be found following introduction and shipment of new products or enhancements to existing products. Although we attempt to fix errors that we believe would be considered serious by our customers prior to shipment, we may not be able to detect or fix all such errors, and this could result in lost revenues and delays in customer acceptance, and could be detrimental to our business and reputation. Delays in product development or customer acceptance and implementation of new products and technologies could seriously harm our business. Delays in the development and introduction of our products may occur for various reasons. For example, delays in software development could delay shipments of related new hardware products. Generally, the computer systems that we sell to customers incorporate many of our hardware and software products, such as the UltraSPARC microprocessor, the Solaris operating environment and intelligent storage products. Any delay in the development of the software and hardware included in our systems could delay our shipment of these systems. In addition, if customers decided to delay the adoption and implementation of new releases of our Solaris operating environment this could also delay customer acceptance of new hardware products tied to that release. Adopting a new release of an operating system requires a great deal of time and money for a customer to convert its systems to the new release. The customer must also work with software vendors who port their software applications to the new operating system and make sure these applications will run on the new operating system. As a result, customers may decide to delay their adoption of a new release of an operating system because of the cost of a new system and the effort involved to implement it. Also, customers may wait 11 13 to implement new systems until after January 1, 2000 so that there is less likelihood of Year 2000 computer problems. MANUFACTURING AND SUPPLY Our manufacturing operations consist primarily of final assembly, test and quality control of systems, materials and components. We manufacture in California, Oregon, and Scotland, and distribute in California, the Netherlands and Japan. We have continued efforts to simplify the manufacturing process by reducing the diversity of system configurations offered, increasing the standardization of components across product types and establishing local sources of supply in major geographies. Our reliance on single source suppliers could delay product shipments and increase our costs. We depend on many suppliers for the necessary parts and components to manufacture our products. There are a number of vendors producing the parts and components that we need. However, there are some components that can only be purchased from a single vendor due to price, quality or technology reasons. For example, we depend on Sony for various monitors and on Texas Instruments for our SPARC microprocessors. If we were unable to purchase the necessary parts and components from a particular vendor and we had to find a new supplier for such parts and components, our new and existing product shipments could be delayed, severely affecting our business and operating results. Our future operating results depend on our ability to purchase a sufficient amount of components to meet the demands of our customers. We depend heavily on our suppliers to timely design, manufacture and deliver the necessary components for our products. While many of the components we purchase are standard, we do purchase some components, specifically color monitors and custom memory integrated circuits such as SRAMS and VRAMS, that require long lead times to manufacture and deliver. Long lead times make it difficult for us to plan component inventory levels in order to meet the customer demand for our products. In addition, in the past, we have experienced shortages in certain of our components (specifically DRAMS and SRAMS). If a component delivery from a supplier is delayed, if we experience a shortage in one or more components or if we are unable to provide for adequate levels of component inventory our new and existing product shipments could be delayed and our business and operating results could suffer. Since we order our components (and in some cases commit to their purchase) from suppliers in advance of receipt of customer orders for our products that include these components, we face a substantial inventory risk. As part of our component inventory planning, we frequently pay certain suppliers well in advance of receipt of customer orders. For example, we often enter into noncancelable purchase commitments with vendors early in the manufacturing process of our microprocessors to make sure we have enough of these components for our new products to meet customer demand. Because the design and manufacturing process for these components is very complicated it is possible that we could experience a design or manufacturing flaw that could delay or even prevent the production of the components for which we have previously committed to pay. We also face the risk of ordering too many components, or conversely, not enough components, since the orders are based on the forecasts of customer orders rather than actual orders. If we cannot change or be released from the noncancelable purchase commitments, we could incur significant costs from the purchase of unusable components, due to a delay in the production of the components or as a result of inaccurately predicting component orders in advance of customer orders. Our business and operating results could be seriously harmed as a result of these increased costs. The manufacture and introduction of our new hardware and software products is also a complicated process. Once we have developed a new product we face the following challenges in the manufacturing process: - we must be able to manufacture new products in high enough volumes so that we can have an adequate supply of new products to meet customer demand; - we must be able to manufacture the new products at acceptable costs. This requires us to be able to accurately forecast customer demand so that we can procure the appropriate components at optimal 12 14 costs. Forecasting demand requires us to predict order volumes, the correct mixes of our software and hardware products and the correct configurations of these products; - we must manage new product introductions so that we can minimize the impact of customers delaying purchases of existing products in anticipation of the new product release. We must also try to reduce the levels of older product and component inventories to minimize inventory write-offs; and - we may also decide to adjust prices of our existing products during this process in order to try to increase customer demand for these products. If we are introducing new products at the same time or shortly after the price adjustment, this will complicate our ability to anticipate customer demand for our new products. If we were unable to timely develop, manufacture and introduce new products in sufficient quantity to meet customer demand at acceptable costs or if we were unable to correctly anticipate customer demand for our new products, our business and operating results could be significantly harmed. COMPETITION If we are unable to compete effectively with existing or new competitors, our resulting loss of competitive position could result in price reductions, fewer customer orders, reduced revenues, reduced margins, reduced levels of profitability and loss of market share. We compete in the hardware and software products and services markets. These markets are intensely competitive. If we fail to compete successfully in these markets, the demand for our products would decrease. Any reduction in demand could lead to a decrease in the prices of our products, fewer customer orders, reduced revenues, reduced margins, reduced levels of profitability, and loss of market share. These competitive pressures could seriously harm our business and operating results. Our competitors are some of the largest, most successful companies in the world. They include Hewlett Packard Company (HP), International Business Machines Corporation (IBM), Compaq Computer Corporation (Compaq) and EMC Corporation (EMC). Our future competitive performance depends on a number of factors, including our ability to perform the following: - continually develop and introduce new products and services with better prices and performance than offered by our competitors; - offer a wide range of products and solutions from small single-processor systems to large complex enterprise-level systems; - offer solutions to customers that operate effectively within a computing environment that includes hardware and software from multiple vendors; - offer products that are reliable and that ensure the security of data and information; - create products for which third party software vendors will develop a wide range of applications; and - offer high quality products and services. We also compete with systems manufacturers and resellers of systems based on microprocessors from Intel Corporation (Intel) and Windows NT operating system software from Microsoft Corporation (Microsoft). These competitors include Dell Computer Corporation, HP and Compaq, in addition to Intel and Microsoft. This competition creates increased pressure, including pricing pressure, on our workstation and lower-end server product lines. We expect this competitive pressure to intensify considerably during our fiscal year 2000 with the anticipated releases of new software products from Microsoft and new microprocessors from Intel. The computer systems that we sell are made up of many products and components, including workstations, servers, storage products, microprocessors, the Solaris(TM) operating environment and other software products. In addition, we sell some of these components separately and as add-ons to installed systems. If we are unable to offer products and services that compete successfully with the products and services offered by our competitors or that meet the complex needs of our customers, our business and 13 15 operating results could be seriously harmed. In addition, if in responding to competitive pressures, we are forced to lower the prices of our products and services and we are unable to reduce our component costs or improve operating efficiencies, our business and operating results would be seriously harmed. Over the last two years, we have invested significantly in our storage products business with a view to increasing the sales of these products both on a stand-alone basis to customers using the systems of our competitors and as part of the systems that we sell. The intelligent storage products business is intensely competitive. EMC is currently the leader in this market. To the extent we are unable to penetrate this market and compete effectively, our business and operating results could be seriously harmed. In addition, we will be making significant investments over the next few years to develop, market and sell software products under our recent alliance with AOL and have agreed to significant minimum revenue commitments. These alliance products are targeted at the E-commerce market and are strategic to our ability to successfully compete in this market. If we are unable to successfully compete in this market, our business and operating results could be seriously harmed. We have encouraged the use of SPARC technology as a standard in the computer marketplace by licensing much of the technology and promoting open interfaces to the Solaris Operating Environment, as well as by offering microprocessors and enabling technologies to third party customers. As a result, several licensees also offer SPARC/Solaris based products that compete directly with our products, primarily in the desktop markets. We have also worked to make our Java technology a programming standard for complex networks. We develop applications, tools and systems platforms, as well as work with third-parties to create products and technologies, in order to continue to enhance the Java platform's capabilities. As part of this effort, we license Java technology widely to encourage competitors of Sun to also develop products competing with these applications, tools and platforms. PATENTS AND LICENSES We hold a number of U.S. and foreign patents relating to various aspects of our products and technology. While we believe that patent protection is important, we also believe that patents are of less competitive significance than factors such as innovative skills and technological expertise. We have from time to time been notified that we may be infringing certain patents or other intellectual property rights of others, although no material litigation has arisen out of any of these claims. Several pending claims are in various stages of evaluation. We are evaluating the desirability of entering into licensing agreements in certain of these cases. Based on industry practice, we believe that any necessary licenses or other rights could be obtained on commercially reasonable terms. However, no assurance can be given that licenses can be obtained on acceptable terms or that litigation will not occur. The failure to obtain necessary licenses or other rights, or litigation arising out of such claims, could harm our business. EMPLOYEES As of June 30, 1999, we had approximately 29,700 employees. We depend on key employees and face competition in hiring and retaining qualified employees. Our employees are vital to our success, and our key management, engineering and other employees are difficult to replace. We expect to continue to increase the number of our employees to support our growth. We generally do not have employment contracts with our key employees. Further, we do not maintain key person life insurance on any of our employees. The expansion of high technology companies in Silicon Valley and Colorado, as well as many other cities, has increased demand and competition for qualified personnel. We may not be able to attract, assimilate or retain additional highly qualified employees in the future and this could harm our business. 14 16 ADDITIONAL FACTORS AFFECTING OUR BUSINESS Our failure or the failure of our business partners and customers to be Year 2000 compliant could harm our business. 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 be able to distinguish years beginning with "19" from those beginning with "20." As a result, in less than six months, computer systems and/or software products used by many companies may need to be upgraded to comply with such Year 2000 requirements. We are currently expending resources to review our products and services, as well as our internal use software in order to identify and modify those products, services and systems that are not Year 2000 compliant. We believe that the vast majority of these costs are not incremental to us but represent a reallocation of existing resources and include regularly scheduled systems upgrades and maintenance. In addition, we have made custom coding enhancements to our mission critical internal business systems and we believe that such internal systems are now Year 2000 compliant. We are working to make our remaining internal systems Year 2000 compliant by September 30, 1999. Although we believe that the costs associated with the aforementioned Year 2000 efforts are not material, we currently estimate that such costs will be between $40 to $45 million, of which approximately $25 million had been spent through June 30, 1999. The aforementioned costs are estimates due in large part to the fact that we do not separately track the internal labor costs associated with Year 2000 compliance, unless such costs are incurred by individuals devoted primarily to Year 2000 compliance efforts. These cost estimates do not include any potential costs related to any customer or other claim. In addition, these cost estimates are based on the current assessment of the ongoing activities described above, and are subject to change as we continuously monitor these activities. We believe any modifications deemed necessary will be made on a timely basis and we do not believe that the cost of such modifications will seriously harm our business. We currently expect the aforementioned evaluation of our products, services and systems and any remediation necessary will be completed by September 30, 1999. As of June 30, 1999, we had not identified any items or areas which would require material remediation efforts. Our expectations as to the extent and timeliness of any modifications required in order to achieve Year 2000 compliance and the costs related thereto are forward- looking statements 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 section. We cannot be sure, however, that we will be able to successfully modify on a timely basis such products, services and systems to comply with Year 2000 requirements. Our business could suffer if we fail to make our products, services and systems Year 2000 compliant in time. We have established a program to assess whether certain of our products are Year 2000 compliant. Under this program, we are in the process of performing tests on Sun products listed on our price lists. To monitor this program and to help customers evaluate their Year 2000 issues we have created a Web site at http://sun.com/y2000/cpl.html which identifies the following categories: products that were released Year 2000 compliant; products that require modifications to be Year 2000 compliant; products under review; products that are not Year 2000 compliant and need to be replaced with a Year 2000 compliant product; source code products that could be modified and implemented without our review; and products that do not process or manipulate date data or have no date-related technology. We update this list periodically as our analysis of additional products is completed. Based on our assessment to date, most of our newly introduced products and services are Year 2000 compliant, however, we cannot be sure that our current products do not contain undetected errors or defects associated with Year 2000 functions that may result in material costs to us. In addition, some of our customers are running products that are not Year 2000 compliant and will require an upgrade or other remediation to become Year 2000 compliant. We provide limited warranties as to Year 2000 compliance on certain of our products and services. Except as specifically provided for in the limited warranties, we do not believe that we are legally responsible for costs incurred by customers to achieve Year 2000 compliance. We have been taking steps to identify affected customers, raise customer awareness related to noncompliance of our older products and encourage such customers to migrate to current products or product versions. It is possible that we may 15 17 experience increased expenses if we need to upgrade or perform other remediation on products that our customers are using that are not Year 2000 compliant. Our business may also materially suffer if customers become concerned about or are dissatisfied with our products and services as a result of Year 2000 issues. We also face risks to the extent that suppliers of products, services and systems purchased by us or the suppliers of others with whom we transact business cannot timely provide us with products, components, services or systems that meet Year 2000 requirements. To the extent that we are not able to test technology provided by third party hardware or software vendors, we are in the process of carrying out audits and obtaining Year 2000 compliance certifications from each of our major vendors that their products and internal systems, as applicable, are Year 2000 compliant. In the event any such third parties cannot timely provide us with products, services or systems that meet the Year 2000 requirements, our business could be harmed. Furthermore, a reasonably likely worst case scenario would be if one of our major vendors experienced a material disruption in business, which caused us to experience a material disruption in business. If either our internal systems or the internal systems, products or services of one or more of our major vendors (including banks, energy suppliers and transportation providers) fail to achieve Year 2000 compliance, our business could be seriously harmed. We are currently developing contingency plans to deal with potential Year 2000 problems related to our internal systems that are deemed to be high risk and with respect to products and services provided by outside vendors. We expect these plans to be complete by September 30, 1999. If these plans are not timely completed or if they are not successful or if new Year 2000 problems not covered by our contingency plans emerge, our business and operating results may be seriously harmed. Although we believe that the cost of Year 2000 modifications for both internal use software and systems, as well as Sun's products are not material, we cannot be sure that various factors relating to the Year 2000 compliance issues will not seriously harm our business or operating results. For example, a significant amount of litigation may arise out of Year 2000 compliance issues and we cannot be sure about the extent to which we may be affected by any of this litigation. Even though we do not believe that we are legally responsible for our customers' Year 2000 compliance obligations, it is unclear whether different governments or governmental agencies may decide to allocate liability relating to Year 2000 compliance to us without regard to specific warranties or warranty disclaimers. Our business could suffer in any given quarter if any liability is allocated to us. Furthermore, we do not know how customer spending patterns may be affected by Year 2000 issues. We believe, however, that customers will focus on preparing their businesses for the Year 2000 and that their capital budgets will be spent in large part on remediation efforts, potentially delaying the purchase and implementation of new systems, thereby creating less demand for our products and services. Our business could be harmed if customers delay purchasing our products during the first half of our fiscal Year 2000 because of Year 2000 concerns, or if our customers are unable to conduct their business or are prevented from placing orders or paying us because of their own Year 2000 problems. A significant disruption of our financial management and control systems or a lengthy interruption in our operations caused by a Year 2000 related issue could also result in a material adverse impact on our operating results and financial condition. OUR ACQUISITION AND ALLIANCE ACTIVITIES COULD DISRUPT OUR ONGOING BUSINESS. We intend to continue to make investments in companies, products and technologies, either through acquisitions or investment alliances. For example, we have purchased several companies in the past and formed alliances, including our recent alliance with AOL. Acquisitions and alliance activities often involve risks, including: - we may experience difficulty in assimilating the acquired operations and employees; - we may experience difficulty in managing product co-development activities with our alliance partners; - we may be unable to retain the key employees of the acquired operation; - the acquisition or investment may disrupt our ongoing business; - we may not be able to incorporate successfully the acquired technology and operations into our business and maintain uniform standards, controls, policies and procedures; and - we may lack the experience to enter into new markets, products or technologies. 16 18 Some of these factors are beyond our control. Failure to manage these alliance activities effectively and to integrate acquisitions would affect our operating results or financial condition. ITEM 2. PROPERTIES We conduct our worldwide operations using a combination of leased and owned facilities. While we believe we have sufficient facilities to conduct business during fiscal 2000, we will continue to lease and acquire facilities throughout the world as necessary. Our owned properties consist of an approximately 1,000,000 square foot facility on approximately 57 acres in Menlo Park, California; an approximately 700,000 square foot facility on approximately 58 acres in Newark, California; an approximately 540,000 square foot facility on approximately 158 acres in Burlington, Massachusetts; an approximately 530,000 square foot facility on approximately 120 acres in Broomfield, Colorado where an additional 200,000 square foot facility is under construction; an approximately 260,000 square foot facility on approximately 12 acres in Palo Alto, California; an approximately 230,000 square foot facility on approximately 24 acres in Linlithgow, Scotland; an approximately 180,000 square foot facility in Plantation, Florida; an approximately 140,000 square foot facility in Melbourne, Florida; an approximately 30,000 square foot facility on approximately 2.5 acres in Bagshot, England; an 82 acre site in Santa Clara, California where a 630,000 square foot facility is under construction; 40 acres in Farnborough, England where an approximately 240,000 square foot facility is under construction; and a parcel of land in Newark, California of approximately 85 acres. We also lease approximately 7.3 million square feet, including three million square feet is in the San Francisco Bay Area. The remaining leased space is located in 270 sales and service offices around the world. A substantial portion of our facilities, including our corporate headquarters and other critical business operations are located near major earthquake faults. We are uninsured and do not fund for earthquake-related losses. In addition, we face risks to the extent that our suppliers of products, services and systems and others with whom we do business on a worldwide basis are impacted by an earthquake. As a result, our business, financial condition or operating results could be materially adversely effected in the event of a major earthquake. ITEM 3. LEGAL PROCEEDINGS On October 7, 1997, we filed suit against Microsoft in the United States District Court for the Northern District of California alleging breach of contract, trademark infringement, false advertising, unfair competition, interference with prospective economic advantage and inducing breach of contract. We filed an amended complaint on October 14, 1997. Microsoft filed its answer, affirmative defenses and counterclaims to the amended complaint. The counterclaims include breach of contract, breach of the covenant of good faith and fair dealing, violation of the California Business & Professions Code and declaratory judgment. We believe that the counterclaims are without merit and/or that we have affirmative defenses and intend vigorously to defend ourselves with respect thereto. On March 24, 1998 the United States District Court judge ruled in our favor granting a preliminary injunction directing Microsoft to cease using our Java Compatible Logo(TM) on Microsoft products that failed to pass the applicable test suites from Sun. In addition, on May 12, 1998, we filed a second amended complaint alleging copyright infringement by Microsoft and motions requesting further preliminary injunctive relief directed against the planned release by Microsoft of additional products that failed to pass our applicable test suites. The Court held hearings and arguments on such motions on September 8, 9, and 10, 1998. On November 17, 1998, the District Court issued an Order granting, in substantial part, our request for preliminary injunctions. On December 15, 1998 Microsoft filed notice of its intent to appeal the District Court's Order and on December 18, 1998 Microsoft filed motions with the District Court to extend the time for compliance with the Order and to clarify or modify the Order. On January 13, 1999, Microsoft filed an appeal to the District Court's Order issued on November 17, 1998. On January 22, 1999, Sun and Microsoft filed numerous motions for summary judgment with the District Court. On May 24, 1999, the District Court issued tentative rulings on three pending motions for summary judgment which were argued on June 24, 1999. An appellate argument before the Ninth Circuit Court of Appeals relating to the November 1998 preliminary injunction granted in our favor occurred on June 16, 1999. On August 23, 1999, a three-judge panel of the Ninth Circuit Court of Appeals issued an opinion and ruling on Microsoft's appeal to that Court 17 19 of the November 1998 preliminary injunction issued by the District Court. The Ninth Circuit panel, in its ruling, found sufficient evidence in the record that Sun is likely to prevail on the merits of its breach of contract claims against Microsoft. However, the panel vacated the copyright infringement-based injunction that the District Court had entered and remanded the case back to the District Court for further consideration. The Remand Order and the lifting of the injunction took effect on September 13, 1999. The District Court has scheduled a hearing regarding the Remand Order for October 15, 1999. If the injunction is not reinstated, Microsoft may, during the pendency of the case, elect to offer products that fail to pass the applicable test suites from Sun. We believe that the outcome of this matter will not have a material adverse impact on our financial condition, results of operations or cash flows in any given fiscal year. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable EXECUTIVE OFFICERS OF THE REGISTRANT The following sets forth certain information regarding our Executive Officers as of September 14, 1999:
NAME AGE POSITION ---- --- -------- Scott G. McNealy............ 44 Chairman of the Board of Directors and Chief Executive Officer William T. Agnello.......... 50 Vice President, Workplace Resources Mel Friedman................ 61 President, Microelectronics Lawrence W. Hambly.......... 53 President, Enterprise Services H. William Howard........... 65 Vice President, Chief Information Officer Masood A. Jabbar............ 49 President, Computer Systems William N. Joy.............. 44 Founder and Chief Scientist James Judson................ 45 Vice President, Finance, Worldwide Operations Jon E. Kannegaard........... 49 Acting President, Software Products & Platforms Michael E. Lehman........... 49 Vice President, Corporate Resources and Chief Financial Officer Marc L. Loupe............... 45 Vice President, Finance and Planning, Worldwide Field Operations John E. Marselle............ 45 Vice President, The Americas John S. McFarlane........... 50 President, Network Service Provider Stephen T. McGowan.......... 51 Vice President, Finance, Computer Systems Michael H. Morris........... 51 Vice President, General Counsel and Secretary Michael A. Murray........... 43 Vice President, Finance and Administration, Enterprise Services Alton D. Page............... 43 Vice President, Operations, Sun-Netscape Alliance Gregory M. Papadopoulos..... 41 Vice President and Chief Technology Officer Marissa Peterson............ 37 Vice President, Worldwide Operations, Computer Systems Frank A. Pinto.............. 54 Vice President, Worldwide Sales, Computer Systems Michael L. Popov............ 53 Vice President, Corporate Controller George Reyes................ 45 Vice President, Treasurer Edward Saliba............... 50 Vice President, Human Resources Janpieter T. Scheerder...... 50 President, Network Storage John C. Shoemaker........... 56 Vice President and General Manager, Enterprise Desktop and Server Systems, Computer Systems Mark E. Tolliver............ 47 President and General Manager, Sun-Netscape Alliance Kevin Walsh................. 57 Vice President, Operations, Corporate Resources Edward J. Zander............ 52 President and Chief Operating Officer
Mr. McNealy is a Founder of Sun and has served as Chairman of the Board of Directors and Chief Executive Officer since April 1999, as Chairman of the Board of Directors, President and Chief Executive Officer from December 1984 to April 1999, as President and Chief Operating Officer from February 1984 to 18 20 December 1984 and as Vice President of Operations from February 1982 to February 1984. Mr. McNealy has served as a Director of Sun since the incorporation of Sun in February 1982. Mr. Agnello has served as Vice President, Workplace Resources of Sun since March 1994. Mr. Friedman has served as President, Microelectronics of Sun since March 1998 and as Vice President, Worldwide Operations of Sun Microsystems Computer Company ("SMCC") from April 1996 to March 1998. Prior to such time, since 1989, Mr. Friedman served Sun in various positions including Vice President Supply Management, Vice President California Operations and Vice President Workstations, Servers and Graphics. Mr. Hambly has served as President, Enterprise Services of Sun since April 1998, as President, SunService from July 1993 to April 1998, as Vice President, Marketing of SMCC from July 1991 to July 1993, as President of Sun Microsystems Federal, Inc. from July 1988 to July 1991 and in various sales management capacities of Sun, most recently as Vice President, Western Area Sales from April 1983 to July 1988. Mr. Howard has served as Vice President, Chief Information Officer of Sun since September 1998. From September 1990 to September 1998, he served as Corporate Vice President, Information Technology and Chief Information Officer for Inland Steel Industries, Inc. Mr. Jabbar has served as President, Computer Systems of Sun since April 1998 and as President of SMCC from February 1998 to April 1998. He served as Vice President and Chief Financial Officer of SMCC from June 1994 to February 1998, as Vice President, Finance and Planning, Worldwide Field Operations of SMCC from July 1992 to June 1994 and as Vice President, Finance and Administration, United States Field Operations for SMCC from July 1991 to June 1992. Mr. Jabbar served as Director, Finance Administration, United States Field Operations for Sun from October 1990 to June 1991, as Director of United States Field Market for Sun from October 1989 to October 1990, as United States Sales and Service Controller for Sun from April 1988 to October 1989 and as United States and Intercontinental Sales Controller for Sun from December 1986 to April 1988. Mr. Joy is a Founder of Sun and has served as Chief Scientist of Sun since September 1998. From January 1996 to September 1998 he served as Vice President of Research and from July 1991 to January 1996 he served as Vice President and Chief Executive Officer. Mr. Judson has served as Vice President, Finance, Worldwide Operations of Sun since May 1998. He served as SMCC Controller from May 1995 to May 1998 and as Assistant Controller for SMCC Worldwide Field Operations from November 1993 to May 1995. Mr. Judson served as Director of Financial Planning & Analysis, Worldwide Operations of Sun from February 1992 to November 1993, as Director of Finance, Product Development of Sun from November 1989 to August 1991, as Director and Division Controller, Sun Microsystems Federal, Inc. from July 1986 to November 1989 and as Plant Controller, Cost Accounting Manager, Financial Analyst of Sun from July 1983 to July 1986. Mr. Kannegaard has served as Acting President, Software Platforms & Products of Sun since August 1999, as Vice President, Java Products from October 1995 to August 1999 and President, SunSoft, Inc. from April 1995 to August 1995. From May 1992 to April 1995 he served as Vice President and General Manager of Developer Products and from May 1987 to May 1992 as Director of Engineering. Mr. Lehman has served as Vice President, Corporate Resources and Chief Financial Officer of Sun since January 1998. He has served as Vice President and Chief Financial Officer from February 1994 to January 1998, as Vice President and Corporate Controller from June 1990 to February 1994, as Director of Finance and Administration of Sun Microsystems of California, Ltd. from September 1989 to June 1990, as Assistant Corporate Controller of Sun from September 1988 to August 1989 and as External Reporting Manager from August 1987 to August 1988. Mr. Loupe has served as Vice President, Finance and Planning, Worldwide Field Operations, Computer Systems of Sun since May 1998. He served as Director, International Development from June 1997 to May 1998, as Director of Internal Audit from April 1994 to June 1997, as Director of Finance, Intercontinental 19 21 Operations (ICON) from April 1991 to April 1994 and as Vice President -- Finance & Operations, Sitka Corporation from July 1990 to April 1991. From July 1987 to July 1990, he served as Controller, Centram Systems West. Mr. Marselle has served as Vice President, The Americas of Sun since May 1999 and as President, Sun Federal, Inc., from June 1992 to May 1999. Mr. McFarlane has served as President, Network Service Provider of Sun since July 1999 and as President, Solaris Software of Sun from April 1998 to July 1999. He served as Vice President, Solaris and Network Software from December 1997 to April 1998 and as Vice President, Network Software Group from May 1997 to December 1997. Mr. McFarlane served as Vice President, Technology at Northern Telecom from 1993 to 1997. Mr. McGowan has served as Vice President, Finance, Computer Systems of Sun since March 1998. He served as Vice President, Finance, Worldwide Field Operations from June 1995 to March 1998 and as Vice President, Finance, North American Field Operations from October 1992 to June 1995. Mr. Morris has served as Vice President, General Counsel and Secretary of Sun since October 1987. Mr. Murray has served as Vice President, Finance and Administration, Enterprise Services of Sun since April 1998 and as Assistant Corporate Controller from August 1996 to April 1998. He served as Director, Finance, Sun Microsystems Australia Pty. Ltd. from August 1994 to August 1996 and as Director, Finance, Sun Microsystems of California, Ltd. from April 1992 to July 1994. Mr. Murray served as Director, Internal Audit of Sun from October 1989 to March 1992 and as Manager, Internal Audit from March 1989 to October 1989. Mr. Page has served as Vice President, Operations, Sun-Netscape Alliance since May 1999 and as Vice President, Treasurer of Sun from February 1996 to May 1999. Prior to that time, Mr. Page was a Partner of Ernst & Young, LLP. Mr. Papadopoulos has served as Vice President and Chief Technology Officer of Sun since April 1998. He served as Vice President and Chief Technology Officer of SMCC from March 1996 to April 1998, as Chief Technology Officer of SMCC from December 1995 to March 1996 and as Chief Scientist, Server Systems Engineering of Sun from September 1994 to December 1995. Mr. Papadopoulos served as Senior Architect and Director of Product Strategy, Thinking Machines Corporation from May 1993 to September 1994 and as Associate Professor, MIT from June 1991 to June 1995. Ms. Peterson has served as Vice President, Worldwide Operations, Computer Systems of Sun since April 1998. She served as Vice President, Worldwide Logistics from October 1996 to April 1998 and as Director, U.S. Manufacturing from April 1995 to October 1996. Mr. Pinto has served as Vice President, Worldwide Sales, Computer Systems of Sun since November 1998 and as Vice President, Sales, The Americas, Computer Systems of Sun from July 1998 to November 1998. He served as Vice President, North American Field Operations of SMCC from July 1995 to July 1998, as Vice President, Northeast Area for SMCC from January 1993 to June 1995, as Metro Regional Director of Sun from June 1989 to December 1992 and as Sun's District Manager, Northeast Major OEM District from November 1988 to June 1989. Mr. Popov has served as Vice President, Corporate Controller of Sun since April 1999 and as Vice President, COO Staff Operations of Sun from April 1998 to April 1999. He served as Vice President, Finance, SunService from June 1994 to April 1998 and as Assistant Corporate Controller of Sun from January 1992 to June 1994. Mr. Reyes has served as Vice President, Treasurer of Sun since April 1999 and as Vice President, Corporate Controller of Sun from April 1994 to April 1999. He served as Audit Director from April 1992 to March 1994, as Director of Finance for Sun's ICON operations from April 1991 to April 1992, as Assistant Controller from June 1989 to April 1991, as the Controller of Sun's General Systems Group from July 1988 to June 1989 and as Sun's Marketing Controller from March 1988 to June 1988. 20 22 Mr. Saliba has served as Vice President, Human Resources of Sun since June 1999 and Vice President, Finance, Solaris Software of Sun from May 1998 to June 1999. He served as Vice President, Finance, SunSoft, Inc. from February 1996 to May 1998, as Finance Director, Sun Microelectronics from May 1994 to February 1996, as Finance Director, SMCC Worldwide Operations from May 1993 to May 1994, as Finance Director, SMCC Engineering from June 1991 to May 1993 and as Finance Manager and Director, East Coast Operations from April 1989 to June 1991. Mr. Scheerder has served as President, Network Storage of Sun since April 1998. He served as President, SunSoft, Inc. from August 1995 to April 1998, as Vice President, Server Products, SMCC from April 1995 to August 1995, as Vice President, Solaris Products, SunSoft, Inc. from March 1992 to April 1995 and as Director of Marketing and Programming, SunSoft, Inc. from August 1991 to March 1992. Mr. Shoemaker has served as Vice President, General Manager, Enterprise Desktop and Server Systems, Computer Systems of Sun since April 1998. He served as Vice President, General Manager, Enterprise Server and Storage Group, SMCC from April 1996 to April 1998, as Vice President, Worldwide Operations, SMCC from July 1993 to April 1996, as Vice President, U.S. Operations, SMCC from June 1992 to July 1993, as Vice President, Finance and Planning, Worldwide Operations of Sun (on an acting basis since July 1992) from May 1990 to July 1993, and as Vice President (acting), Materials, Worldwide Operations from October 1991 to June 1992. Mr. Tolliver has served as President and General Manager, Sun-Netscape Alliance since March 1999 and President, Consumer and Embedded of Sun from April 1998 to March 1999. He served as Vice President, Market Development from July 1996 to April 1998 and as Vice President, Strategy from December 1995 to July 1996. Mr. Tolliver served as Vice President, Marketing, MasPar Computer Corporation from 1991 to 1994. Mr. Walsh has served as Vice President, Operations, Corporate Resources of Sun since May 1998. He served as Vice President, Worldwide Operations, Finance and Planning, from February 1993 to May 1998. Mr. Zander has served as President and Chief Operating Officer of Sun since April 1999 and Vice President, Chief Operating Officer of Sun from April 1998 to April 1999. He served as President, SMCC from February 1995 to April 1998, as President, SunSoft, Inc. from July 1991 to February 1995 and as Vice President, Corporate Marketing of Sun from October 1987 to July 1991. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information required by this item is incorporated by reference to the last page of our 1999 Annual Report to Stockholders. At September 14, 1999 there were 10,780 stockholders of record and the closing price of Sun's common stock was $45.3750 per share as reported by The Nasdaq Stock Market. 21 23 The following is a summary of all sales of Sun's common stock by the our directors and executive officers who are subject to Section 16 of the Securities Exchange Act of 1934, as amended, during the fiscal quarter ended June 30, 1999:
NUMBER OF OFFICER DATE PRICE SHARES SOLD ------- ------- -------- ----------- James Judson............................................... 5/12/99 $64.0000 2,500 John S. McFarlane.......................................... 5/11/99 $59.5630 1,000 Michael H. Morris.......................................... 4/21/99 $58.2500 23,600 Alton D. Page.............................................. 4/26/99 $63.8750 10,000 Gregory M. Papadopoulos.................................... 5/27/99 $58.6875 12,000 5/28/99 $60.0000 10,200 Michael L. Popov........................................... 4/23/99 $62.5000 22,400 George Reyes............................................... 4/22/99 $63.0000 42,400 Edward Saliba.............................................. 5/13/99 $66.0803 35,200 John C. Shoemaker.......................................... 4/26/99 $63.4961 36,000 5/12/99 $65.8973 28,000 Mark E. Tolliver........................................... 5/20/99 $64.0375 5,000 Edward J. Zander........................................... 5/19/99 $63.2397 25,000 5/19/99 $62.5000 25,000
ITEM 6. SELECTED FINANCIAL DATA The information required by this item is incorporated by reference to the information included under the caption "Financial Review" on page S11 of our 1999 Annual Report to Stockholders. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this item is incorporated by reference to the information included under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages S12 through S15 of our 1999 Annual Report to Stockholders. ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Our market risk disclosures pursuant to item 7A are not material and are therefore not required. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item, is incorporated by reference to the information included under the captions "Consolidated Statements of Income", "Consolidated Balance Sheets", "Consolidated Statements of Cash Flows", "Consolidated Statements of Stockholders' Equity", "Notes to Consolidated Financial Statements" and "Report of Ernst & Young LLP, Independent Auditors" on pages S16 through S22 of our 1999 Annual Report to Stockholders. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding our directors is incorporated by reference from the information contained under the caption "Election of Directors" in our 1999 Proxy Statement for the 1999 Annual Meeting of Stockholders. Information regarding current executive officers found under the caption "Executive Officers of the Registrant" in Part 1 hereof is also incorporated by reference into this Item 10. Information regarding 22 24 Section 16 reporting compliance is incorporated by reference from information contained under the caption "Executive Compensation -- Section 16(a) Beneficial Ownership Reporting Compliance" in our 1999 Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference from the information contained under the caption "Executive Compensation" in our 1999 Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference from the information contained under the caption "Security Ownership of Management" in our 1999 Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference from the information contained under the caption "Executive Compensation -- Summary Compensation Table", "-- Certain Transactions With Management" and "-- Employment Contracts and Change-In-Control Arrangements" in our 1999 Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: 1. Financial statements that are incorporated herein by reference to the following in our 1999 Annual Report to Stockholders. Consolidated Statements of Income for each of the three years in the period ended June 30, 1999 (page S16). Consolidated Balance Sheets at June 30, 1999 and 1998 (page S16). Consolidated Statements of Cash Flows for each of the three years in the period ended June 30, 1999 (page S17). Consolidated Statements of Stockholders' Equity for each of the three years in the period ended June 30, 1999 (page S17). Notes to Consolidated Financial Statements (pages S18 through S22). Report of Ernst & Young LLP, Independent Auditors (page S22). Our 1999 Annual Report to Stockholders is not deemed filed as part of this report except for those parts specifically incorporated herein by reference. 2. Financial Statement schedule:
PAGE SCHEDULE TITLE ---- -------- ----- S-1 II Valuation and Qualifying Accounts
All other schedules have been omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements, including the notes thereto. 23 25 3. Exhibits
EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1(11) Registrant's Restated Certificate of Incorporation, as amended March 17, 1999. 3.2 Registrant's Bylaws, as amended September 1, 1999. 3.3(3) Certificate of Amendment of Registrant's Restated Certificate of Incorporation filed March 17, 1999. 3.4(4) Amended Certificate of Designations filed March 17, 1999. 4.8(12) Second Amended and Restated Shares Rights Agreement dated as of February 11, 1998. 4.9(4) Amendment to Second Amended and Restated Share Rights Agreement dated April 14, 1999. 4.10(6) Indenture, dated August 1, 1999 (the "Indenture") between Registrant and The Bank of New York, as Trustee. 4.11(6) Form of Subordinated Indenture. 4.12(6) Officers' Certificate Pursuant to Section 301 of the Indenture, without exhibits, establishing the terms of Registrant's Senior Notes. 4.13(6) Form of Senior Notes. 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. 10.9(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. 10.21(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. 10.64 Registrant's 1988 Directors' Stock Option Plan, as amended on August 11, 1999. 10.65(10) Registrant's 1990 Employee Stock Purchase Plan, as amended on August 13, 1997. 10.66(14) Registrant's 1990 Long-Term Equity Incentive Plan, as amended on August 12, 1998. 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(3) Registrant's Non-Qualified Deferred Compensation Plan, as amended December 16, 1998.
24 26
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.85(7) Registrant's Section 162 (m) Executive Officer Performance-Based Bonus Plan dated August 9, 1995. 10.87(3) Registrant's Equity Compensation Acquisition Plan, as amended on November 11, 1998. 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. 10.93(13)+ Strategic Development and Marketing Agreement dated November 23, 1998 by and between America Online, Inc. and the Registrant. 13.0 Registrant's 1999 Annual Report to Stockholders (to be deemed filed only to the extent required by the instructions to exhibits for reports on Form 10-K). 21.0 Subsidiaries of Registrant. 23.1 Consent of Ernst & Young LLP, Independent Auditors. 24 Power of Attorney (See page 28). 27 Financial Data Schedule.
- --------------- + Portions of the exhibit have been omitted pursuant to an order granted by the Securities and Exchange Commission for confidential treatment. (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 the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 25, 1987. (3) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the Quarter ended March 28, 1999. (4) Incorporated by reference to Registrant's Registration Statement on Form 8-A/A, Amendment No. 7, filed on April 15, 1999. (5) Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1991. (6) Incorporated by reference to Registrant's Current Report on Form 8-K filed August 6, 1999. (7) Incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1995. (8) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the quarter ended December 29, 1996. (9) Incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1997. (10) Incorporated by reference 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 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. 7 filed on April 15, 1999. (13) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q/A, Amendment No. 2 for the Quarter ended December 27, 1998. (14) Incorporated by reference to Registrant's Registration Statement on Form S-8/A Amendment No. 1 filed on January 26, 1999. 25 27 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized. SUN MICROSYSTEMS, INC. Registrant September 23, 1999 By: /s/ MICHAEL E. LEHMAN ------------------------------------ Michael E. Lehman Vice President, Corporate Resources and Chief Financial Officer 26 28 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Scott G. McNealy and Michael E. Lehman jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, which include the Chief Executive Officer, the Chief Financial Officer and Corporate Controller and a majority of the Board of Directors, on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ SCOTT G. MCNEALY Chairman of the Board of Directors September 23, 1999 - ------------------------------------ and Chief Executive Officer (Scott G. McNealy) (Principal Executive Officer) /s/ MICHAEL E. LEHMAN Vice President, Corporate Resources September 23, 1999 - ------------------------------------ and Chief Financial Officer (Michael E. Lehman) (Principal Financial Officer) /s/ MICHAEL L. POPOV Vice President and Corporate September 23, 1999 - ------------------------------------ Controller (Michael L. Popov) (Principal Accounting Officer) /s/ JAMES L. BARKSDALE Director September 23, 1999 - ------------------------------------ (James L. Barksdale) /s/ L. JOHN DOERR Director September 23, 1999 - ------------------------------------ (L. John Doerr) /s/ JUDITH L. ESTRIN Director September 23, 1999 - ------------------------------------ (Judith L. Estrin ) /s/ ROBERT J. FISHER Director September 23, 1999 - ------------------------------------ (Robert J. Fisher) /s/ ROBERT L. LONG Director September 23, 1999 - ------------------------------------ (Robert L. Long) /s/ M. KENNETH OSHMAN Director September 23, 1999 - ------------------------------------ (M. Kenneth Oshman)
27 29 SCHEDULE II SUN MICROSYSTEMS, INC. VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND DEDUCTION/ END OF DESCRIPTION OF PERIOD EXPENSES WRITE-OFF PERIOD ----------- ---------- ---------- ---------- ---------- Year ended June 30, 1997: Accounts receivable allowances............... $100,730 $273,959 $178,598 $196,091 ======== ======== ======== ======== Year ended June 30, 1998: Accounts receivable allowances............... $196,091 $345,071 $305,599 $235,563 ======== ======== ======== ======== Year ended June 30, 1999: Accounts receivable allowances............... $235,563 $493,740 $390,532 $338,771 ======== ======== ======== ========
28 30 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1(11) Registrant's Restated Certificate of Incorporation, as amended March 17, 1999. 3.2 Registrant's Bylaws, as amended September 1, 1999. 3.3(3) Certificate of Amendment of Registrant's Restated Certificate of Incorporation filed March 17, 1999. 3.4(4) Amended Certificate of Designations filed March 17, 1999. 4.8(12) Second Amended and Restated Shares Rights Agreement dated as of February 11, 1998. 4.9(4) Amendment to Second Amended and Restated Share Rights Agreement dated April 14, 1999. 4.10(6) Indenture, dated August 1, 1999 (the "Indenture") between Registrant and The Bank of New York, as Trustee. 4.11(6) Form of Subordinated Indenture. 4.12(6) Officers' Certificate Pursuant to Section 301 of the Indenture, without exhibits, establishing the terms of Registrant's Senior Notes. 4.13(6) Form of Senior Notes. 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. 10.9(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. 10.21(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. 10.64 Registrant's 1988 Directors' Stock Option Plan, as amended on August 11, 1999. 10.65(10) Registrant's 1990 Employee Stock Purchase Plan, as amended on August 13, 1997. 10.66(14) Registrant's 1990 Long-Term Equity Incentive Plan, as amended on August 12, 1998. 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.
31
EXHIBIT NUMBER DESCRIPTION ------- ----------- 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(3) Registrant's Non-Qualified Deferred Compensation Plan, as amended December 16, 1998. 10.85(7) Registrant's Section 162 (m) Executive Officer Performance-Based Bonus Plan dated August 9, 1995. 10.87(3) Registrant's Equity Compensation Acquisition Plan, as amended on November 11, 1998. 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. 10.93(13)+ Strategic Development and Marketing Agreement dated November 23, 1998 by and between America Online, Inc. and the Registrant. 13.0 Registrant's 1999 Annual Report to Stockholders (to be deemed filed only to the extent required by the instructions to exhibits for reports on Form 10-K). 21.0 Subsidiaries of Registrant. 23.1 Consent of Ernst & Young LLP, Independent Auditors. 24 Power of Attorney (See page 28). 27 Financial Data Schedule.
- --------------- + Portions of the exhibit have been omitted pursuant to an order granted by the Securities and Exchange Commission for confidential treatment. (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 the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 25, 1987. (3) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the Quarter ended March 28, 1999. (4) Incorporated by reference to Registrant's Registration Statement on Form 8-A/A, Amendment No. 7, filed on April 15, 1999. (5) Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1991. (6) Incorporated by reference to Registrant's Current Report on Form 8-K filed August 6, 1999. (7) Incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1995. (8) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q for the quarter ended December 29, 1996. 32 (9) Incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1997. (10) Incorporated by reference to Registrant's Registration Statement on on Form S-8 file number 333-40677, filed with the Securities and Exchange Commission on November 20, 1997. (11) Incorporated by reference to Registrant's Quarterly Report on Form10-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. 7 filed on April 15, 1999. (13) Incorporated by reference to Registrant's Quarterly Report on Form 10-Q/A, Amendment No. 2 for the Quarter ended December 27, 1998. (14) Incorporated by reference to Registrant's Registration Statement on Form S-8/A Amendment No. 1 filed on January 26, 1999. EX-3.2 2 REGISTRANT'S BYLAWS 1 BYLAWS OF SUN MICROSYSTEMS, INC. (As adopted on December 14, 1990 and amended as of September 1, 1999) 1 2 TABLE OF CONTENTS
Page ---- ARTICLE I - CORPORATE OFFICES.......................................... 5 1.1 REGISTERED OFFICE........................................... 5 1.2 OTHER OFFICES............................................... 5 ARTICLE II - STOCKHOLDERS.............................................. 5 2.1 PLACE OF MEETINGS........................................... 5 2.2 ANNUAL MEETING.............................................. 5 2.3 SPECIAL MEETING............................................. 6 2.4 NOTICE OF STOCKHOLDERS' MEETINGS............................ 7 2.5 MANNER OF GIVING NOTICE; AFFIDAVIT OF NOTICE................ 7 2.6 QUORUM...................................................... 7 2.7 ADJOURNED MEETING; NOTICE................................... 8 2.8 CONDUCT OF BUSINESS......................................... 8 2.9 WAIVER OF NOTICE............................................ 8 2.10 STOCKHOLDER ACTION BY WRITTEN CONSENT WITHOUT A MEETING..................................................... 8 2.11 RECORD DATE FOR STOCKHOLDER NOTICE; VOTING; GIVING CONSENTS.................................................... 9 2.12 VOTING...................................................... 10 2.13 PROXIES..................................................... 10 2.14 LIST OF STOCKHOLDERS ENTITLED TO VOTE....................... 11 2.15 INSPECTORS OF ELECTION...................................... 11 ARTICLE III - DIRECTORS................................................ 11 3.1 POWERS...................................................... 11 3.2 NUMBER OF DIRECTORS......................................... 11 3.3 ELECTION, QUALIFICATION AND TERM OF OFFICE OF DIRECTORS..... 12 3.4 RESIGNATION AND VACANCIES................................... 12 3.5 PLACE OF MEETINGS; MEETINGS BY TELEPHONE.................... 13 3.6 REGULAR MEETINGS............................................ 13 3.7 SPECIAL MEETINGS; NOTICE.................................... 14 3.8 QUORUM...................................................... 14 3.9 WAIVER OF NOTICE............................................ 14 3.10 CONDUCT OF BUSINESS......................................... 14 3.11 BOARD ACTION BY WRITTEN CONSENT WITHOUT A MEETING........... 14 3.12 FEES AND COMPENSATION OF DIRECTORS.......................... 15 3.13 APPROVAL OF LOANS TO OFFICERS............................... 15 3.14 REMOVAL OF DIRECTORS........................................ 15 ARTICLE IV - COMMITTEES................................................ 15 4.1 COMMITTEES OF DIRECTORS..................................... 15
2 3 4.2 COMMITTEE MINUTES........................................... 16 4.3 MEETINGS AND ACTION OF COMMITTEES........................... 16 ARTICLE V - OFFICERS................................................... 16 5.1 GENERAL MATTERS............................................. 16 5.2 APPOINTMENT OF OFFICERS..................................... 17 5.3 SUBORDINATE OFFICERS........................................ 17 5.4 REMOVAL AND RESIGNATION OF OFFICERS......................... 17 5.5 VACANCIES IN OFFICES........................................ 17 5.6 CHAIRMAN OF THE BOARD....................................... 17 5.7 CHIEF EXECUTIVE OFFICER..................................... 17 5.8 PRESIDENT................................................... 18 5.9 VICE PRESIDENTS............................................. 18 5.10 SECRETARY................................................... 18 5.11 CHIEF FINANCIAL OFFICER..................................... 18 5.12 REPRESENTATION OF SHARES OF OTHER CORPORATIONS.............. 19 5.13 AUTHORITY AND DUTIES OF OFFICERS............................ 19 ARTICLE VI - INDEMNITY................................................. 19 6.1 THIRD PARTY ACTIONS......................................... 19 6.2 ACTIONS BY OR IN THE RIGHT OF THE CORPORATION............... 19 6.3 SUCCESSFUL DEFENSE.......................................... 20 6.4 DETERMINATION OF CONDUCT.................................... 20 6.5 PAYMENT OF EXPENSES IN ADVANCE.............................. 20 6.6 INDEMNITY NOT EXCLUSIVE..................................... 20 6.7 INSURANCE INDEMNIFICATION................................... 20 6.8 THE CORPORATION............................................. 21 6.9 EMPLOYEE BENEFIT PLANS...................................... 21 6.10 INDEMNITY FUND.............................................. 21 6.11 INDEMNIFICATION OF OTHER PERSONS............................ 21 6.12 SAVINGS CLAUSE.............................................. 21 6.13 CONTINUATION OF INDEMNIFICATION AND ADVANCEMENT OF EXPENSES.................................................... 22 ARTICLE VII - RECORDS AND REPORTS...................................... 22 7.1 MAINTENANCE AND INSPECTION OF RECORDS....................... 22 7.2 INSPECTION BY DIRECTORS..................................... 22 7.3 ANNUAL STATEMENT TO STOCKHOLDERS............................ 22 ARTICLE VIII - GENERAL MATTERS......................................... 23 8.1 CHECKS...................................................... 23 8.2 EXECUTION OF CORPORATE CONTRACTS AND INSTRUMENTS............ 23 8.3 STOCK CERTIFICATES; PARTLY PAID SHARES...................... 23 8.4 SPECIAL DESIGNATION ON CERTIFICATES......................... 23 8.5 LOST CERTIFICATES........................................... 24
3 4 8.6 CONSTRUCTION; DEFINITIONS.................................. 24 8.7 DIVIDENDS.................................................. 24 8.8 FISCAL YEAR................................................ 24 8.9 SEAL....................................................... 24 8.10 TRANSFER OF STOCK.......................................... 24 8.11 STOCK TRANSFER AGREEMENTS.................................. 25 8.12 REGISTERED STOCKHOLDERS.................................... 25 8.13 NOTICES.................................................... 25 ARTICLE I - AMENDMENTS................................................ 25
4 5 BYLAWS OF SUN MICROSYSTEMS, INC. ARTICLE I CORPORATE OFFICES 1.1 REGISTERED OFFICE The registered office of the corporation shall be in the City of Wilmington, County of New Castle, State of Delaware. The name of the registered agent of the corporation at such location is The Corporation Trust Company. 1.2 OTHER OFFICES The board of directors may at any time establish other offices at any place or places where the corporation is qualified to do business. ARTICLE II STOCKHOLDERS 2.1 PLACE OF MEETINGS Meetings of stockholders shall be held at any place, within or outside the State of Delaware, designated by the board of directors. In the absence of any such designation, stockholders' meetings shall be held at the registered office of the corporation. 2.2 ANNUAL MEETING The annual meeting of the stockholders of this corporation shall be held each year on a date and at a time designated by the board of directors. At the meeting, directors shall be elected and any other proper business may be transacted. Nominations of persons for election to the board of directors of the corporation and the proposal of business to be considered by the stockholders may be made at an annual meeting of stockholders only (a) pursuant to the corporation's notice of meeting, (b) by or at the direction of the board of directors or (c) by any stockholder of the corporation who was a stockholder of record at the time of giving of notice provided for in these Bylaws, who is entitled to vote at the meeting and who complies with the notice procedures set forth in this Bylaw. For nominations or other business to be properly brought before an annual meeting by a stockholder pursuant to clause (c) of the preceding sentence, the stockholder must have given timely notice thereof in writing to the secretary of the corporation and such other business must otherwise be a proper matter for stockholder action. To be timely, a stockholder proposal to be presented at an annual meeting must be delivered to the secretary of the corporation at the corporation's principal executive offices not less than 60 or more than 90 calendar days prior to the first anniversary of the date that the corporation first mailed its proxy statement to stockholders in connection with the previous year's annual meeting of stockholders, except that if no annual meeting was held in the previous year or the date of the annual meeting has been 5 6 changed by more than 30 calendar days from the first anniversary date of the previous year's annual meeting, notice by the stockholder to be timely must be received no later than the close of business on the tenth day following the day on which public announcement of the date of such annual meeting is first made. In no event shall the public announcement of an adjournment of an annual meeting commence a new period for the giving of a stockholder's notice as described above. Such stockholder's notice shall set forth (a) as to each person whom the stockholder proposes to nominate for election or reelection as a director all information relating to such person that is required to be disclosed in solicitations of proxies for election of director in an election contest, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (or any successor thereto) (the "Exchange Act") and Rule 14a-11 thereunder (or any successor thereto) (including such person's written consent to being named in the proxy statement as a nominee and to serving as a director if elected); (b) as to any other business that the stockholder proposes to bring before the meeting, a brief description of the business desired to be brought before the meeting, the reasons for conducting such business at the meeting and any material interest in such business of such stockholder and the beneficial owner, if any, on whose behalf the proposal is made; and (c) as to the stockholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made (i) the name and address of such stockholder, as they appear on the corporation's books, and such beneficial owner, and (ii) the class and number of shares for the corporation which are owned beneficially and of record by such stockholder and such beneficial owner. Notwithstanding any provision herein to the contrary, no business shall be conducted at an annual meeting except in accordance with the procedures set forth in this Section 2.2. For purposes of Section 2.2 and 3.3 of these Bylaws "public announcement" shall mean disclosure in a press release reported by the Dow Jones News Service, Associated Press or a comparable national news service or in a document publicly filed by the corporation with the Securities and Exchange Commission pursuant to Section 13, 14 or 15(d) of the Exchange Act. 2.3 SPECIAL MEETING A special meeting of the stockholders may be called at any time by the board of directors, or by the chairman of the board, or by any executive officer of the corporation, or by one or more stockholders holding shares in the aggregate entitled to cast not less than ten percent of the votes at that meeting. If a special meeting is called by any person or persons other than the board of directors, the request shall be in writing to the secretary of the corporation, and shall set forth (a) as to each person whom such person or persons propose to nominate for election or reelection as a director at such meeting all information relating to such proposed nominee that is required to be disclosed in solicitations of proxies for election of directors in an election contest, or is otherwise required, in each case pursuant to Regulation 14A under the Exchange Act (or any successor thereto) and Rule 14a-11 thereunder (or any successor thereto)(including such proposed nominee's written consent to being named in the proxy statement as a nominee and to serving as a director if elected); (b) as to any other business to be taken the meeting, a brief description of such business, the reasons for conducting such business and any material interest in such business of the person 6 7 or persons calling such meeting and the beneficial owners, if any, on whose behalf such meeting is called; and (c) as to the person or persons calling such meeting and the beneficial owners, if any, on whose behalf the meeting is called (i) the name and address of such persons, as they appear on the corporation's books, and of such beneficial owners, and (ii) the class and number of shares of the corporation which are owned beneficially and of record by such persons and such beneficial owners. No business may be transacted at such special meeting otherwise than specified in such notice or by or at the direction of the corporation's board of directors. The corporation's secretary shall cause notice to be promptly given to the stockholders entitled to vote, in accordance with the provisions of Sections 2.4 and 2.5, that a meeting will be held at the time reasonably requested by the person or persons who called the meeting, not less than 60 nor more than 90 days after the receipt of the request. If the notice is not given within 20 days after the receipt of a valid request, the person or persons requesting the meeting may give the notice. Nothing contained in this paragraph 2.3 shall be construed as limiting, fixing or affecting the time when a meeting of stockholders called by action of the board of directors may be held. Only such business shall be conducted at a special meeting of stockholders called by action of the board of directors as shall have been brought before the meeting pursuant to the corporation's notice of meeting. This Section 2.3 may not be amended to eliminate the right of one or more stockholders holding shares in the aggregate entitled to cast not less than ten percent of the votes at a special meeting of stockholders to call such a special meeting of stockholders, unless holders of at least seventy-five percent of the shares entitled to vote thereon approve such an amendment. 2.4 NOTICE OF STOCKHOLDERS' MEETINGS All notices of meetings with stockholders shall be in writing and shall be sent or otherwise given in accordance with Section 2.5 of these Bylaws not less than ten (10) nor more than sixty (60) days before the date of the meeting to each stockholder entitled to vote at such meeting, except as otherwise provided herein or required by law (meaning, here and hereinafter, as required from time to time by the General Corporation Law of Delaware or the certificate of incorporation of the corporation). The notice shall specify the place, date, and hour of the meeting, and, in the case of a special meeting, the purpose or purposes for which the meeting is called. 2.5 MANNER OF GIVING NOTICE; AFFIDAVIT OF NOTICE Written notice of any meeting of stockholders, if mailed, is given when deposited in the United States mail, postage prepaid, directed to the stockholder at his address as it appears on the records of the corporation. An affidavit of the secretary or an assistant secretary or of the transfer agent of the corporation that the notice has been given shall, in the absence of fraud, be prima facie evidence of the facts stated therein. 2.6 QUORUM At any meeting of the stockholders, the holders of a majority of all of the shares of the stock entitled to vote at the meeting, present in person or by proxy, shall constitute a quorum for all purposes, unless or except to the extent that the presence of a larger number may be required by law. Where a separate vote by a class or classes is required, a majority of the shares of such 7 8 class or classes entitled to take action with respect to that vote on that matter, present in person or by proxy, shall constitute a quorum. If a quorum shall fail to attend any meeting, the chairman of the meeting may adjourn the meeting to another place, date or time. If a notice of any adjourned special meeting of stockholders is sent to all stockholders entitled to vote thereat, stating that it will be held with those present constituting a quorum, those present at such adjourned meeting shall constitute a quorum, and all matters shall be determined by a majority of the votes cast at such meeting, except as otherwise required by law. 2.7 ADJOURNED MEETING; NOTICE When a meeting is adjourned to another time or place, unless these Bylaws otherwise require, notice need not be given of the adjourned meeting if the time and place thereof are announced at the meeting at which the adjournment is taken. At the adjourned meeting the corporation may transact any business that might have been transacted at the original meeting. If the adjournment is for more than thirty (30) days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting. 2.8 CONDUCT OF BUSINESS Such person as the board of directors may have designated or, in the absence of such a person, any executive officer of the corporation, shall call to order any meeting of the stockholders and act as chairman of the meeting. In the absence of the secretary of the corporation, the secretary of the meeting shall be such person as the chairman appoints. The chairman of any meeting of stockholders shall determine the order of business and the procedure at the meeting, including such regulation of the manner of voting and the conduct of discussion as seem to him in order. The date and time of the opening and closing of the polls for each matter upon which the stockholders will vote at the meeting shall be announced at the meeting. 2.9 WAIVER OF NOTICE Whenever notice is required to be given under any provision of the General Corporation Law of Delaware or of the certificate of incorporation or these Bylaws, a written waiver thereof, signed by the person entitled to notice, whether before or after the time stated therein, shall be deemed equivalent to notice. Attendance of a person at a meeting shall constitute a waiver of notice of such meeting, except when the person attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the stockholders need be specified in any written waiver of notice unless so required by the certificate of incorporation or these Bylaws. 2.10 STOCKHOLDER ACTION BY WRITTEN CONSENT WITHOUT A MEETING Any action required or able to be taken at any annual or special meeting of stockholders may be taken without a meeting, without prior notice, and without a vote if a consent or consents in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted and shall be delivered to the corporation at its registered office in Delaware, its principal place of 8 9 business, or to an officer or agent of the corporation having custody of the book in which proceedings of meetings of stockholders are recorded. Delivery to the corporation's registered office shall be made by hand or by certified or registered mail, return receipt requested. Every written consent shall bear the date of signature of each stockholder who signs the consent and no written consent shall be effective to take the corporate action referred to therein unless, within sixty (60) days of the date the earliest dated consent is delivered to the corporation, a written consent or consents signed by a sufficient number of holders to take action are delivered to the corporation in the manner prescribed in the first paragraph of this section. Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented in writing. If the action which is consented to is such as would have required the filing of a certificate under any section of the General Corporation Law of Delaware if such action had been voted on by stockholders at a meeting thereof, then the certificate filed under such section shall state, in lieu of any statement required by such section concerning any vote of stockholders, that written notice and written consent have been given as provided in Section 228 of the General Corporation Law of Delaware. 2.11 RECORD DATE FOR STOCKHOLDER NOTICE; VOTING; GIVING CONSENTS In order that the corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the board of directors may fix a record date, which shall not be more than sixty (60) nor less than ten (10) days before the date of such meeting, nor more than sixty (60) days prior to any other action. If the board of directors does not so fix a record date: (i) The record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day next preceding the day on which notice is given, or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held. (ii) The record date for determining stockholders entitled to receive payment of any dividend or other distribution or allotment of rights or to exercise any rights of change, conversion or exchange of stock or for any other purpose shall be at the close of business on the day on which the board of directors adopts the resolution relating thereto. In order that the corporation may determine the stockholders entitled to consent to corporate action in writing without a meeting, the board of directors may fix a record date, which record date shall neither precede nor be more than ten (10) days after the date upon which such resolution is adopted by the board of directors. Any stockholder of record seeking to have the stockholders authorize or take action by written consent shall, by written notice to the secretary, request the board of directors to fix a record date. The board of directors shall promptly, but in 9 10 all events within ten (10) days after the date on which such noticed is received, adopt a resolution fixing the record date. If the board of directors has not fixed a record date within such time, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting, when no prior action by the board of directors is required by law, shall be the first date on which a signed written consent setting forth the action taken or proposed to be taken is delivered to the corporation in the manner prescribed in the first paragraph of Section 2.10 of these Bylaws. If the board of directors has not fixed a record date within such time and prior action by the board of directors is required by law, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting shall be at the close of business on the date on which the board of directors adopts the resolution taking such prior action. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the board of directors may fix a new record date for the adjourned meeting. 2.12 VOTING The stockholders entitled to vote at any meeting of stockholders shall be determined in accordance with the provisions of Section 2.11 of these Bylaws, subject to the provisions of Sections 217 and 218 of the General Corporation Law of Delaware (relating to voting rights of fiduciaries, pledgors and joint owners of stock and to voting trusts and other voting agreements). Each stockholder shall have one (1) vote for every share of stock entitled to vote that is registered in his or her name on the record date for the meeting (as determined in accordance with Section 2.11 of these Bylaws), except as otherwise provided herein or required by law. At a stockholders' meeting at which directors are to be elected, each stockholder shall be entitled to cumulate votes (i.e., cast for any candidate a number of votes greater than the number of votes which such stockholder normally is entitled to cast) if the candidates' names have been properly placed in nomination (in accordance with these Bylaws) prior to commencement of the voting and the stockholder requesting cumulative voting has given notice prior to commencement of the voting of the stockholder's intention to cumulate votes. If cumulative voting is properly requested, each holder of stock, or of any class or classes or of a series or series thereof, who elects to cumulate votes shall be entitled to as many votes as equals the number of votes which (absent this provision as to cumulative voting) he would be entitled to cast for the election of directors with respect to his shares of stock multiplied by the number of directors to be elected by him, and he may cast all of such votes for a single director or may distribute them among the number to be voted for, or for any two or more of them, as he may see fit. Every stock vote shall be taken by ballots, each of which shall state the name of the stockholder or proxy voting and such other information as may be required under the procedure established for the meeting. All elections shall be determined by a plurality of the votes cast, and except as otherwise required by law or provided herein, all other matters shall be determined by a majority of the votes cast affirmatively or negatively. 2.13 PROXIES Each stockholder entitled to vote at a meeting of stockholders or to express consent or 10 11 dissent to corporate action in writing without a meeting may authorize another person or persons to act for him by a written or electronic proxy, filed in accordance with the procedure established for the meeting or taking of action in writing, but no such proxy shall be voted or acted upon after three (3) years from its date, unless the proxy provides for a longer period. Any copy, facsimile telecommunication or other reliable reproduction of the writing or transmission created pursuant to this Section 2.13 may be substituted or used in lieu of the original writing or transmission for any and all purposes for which the original writing or transmission could be used, provided that such copy, facsimile telecommunication or other reproduction shall be a complete reproduction of the entire original writing or transmission. An electronic proxy (which may be transmitted via telephone, e-mail, the Internet or such other electronic means as the Board of Directors may determine from time to time) shall be deemed executed if the Company receives an appropriate electronic transmission from the stockholder or the stockholder's attorney-in-fact along with a pass code or other indentifier which reasonably establishes the stockholder or the stockholder's attorney-in-fact as the sender of such transmission. The revocability of a proxy that states on its face that it is irrevocable shall be governed by the provisions of Section 212(c) of the General Corporation Law of Delaware. 2.14 LIST OF STOCKHOLDERS ENTITLED TO VOTE The officer who has charge of the stock ledger of a corporation shall prepare and make, at least ten (10) days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten (10) days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present. Such list shall presumptively determine the identity of the stockholders entitled to vote at the meeting and the number of shares held by each of them. 2.15 INSPECTORS OF ELECTION The corporation may, and to the extent required by law, shall, in advance of any meeting of stockholders, appoint one or more inspectors to act at the meeting and make a written report thereof. The corporation may designate one or more persons as alternate inspectors to replace any inspector who fails to act. If no inspector or alternate is able to act at a meeting of stockholders, the person presiding at the meeting may, and to the extent required by law, shall, appoint one or more inspectors to act at the meeting. Each inspector, before entering upon the discharge of his duties, shall take and sign an oath faithfully to execute the duties of inspector with strict impartiality and according to the best of his ability. Every vote taken by ballots shall be counted by an inspector or inspectors appointed by the chairman of the meeting. 11 12 ARTICLE III DIRECTORS 3.1 POWERS Subject to the provisions of the General Corporation Law of Delaware and any limitations in the Certificate of Incorporation or these Bylaws relating to action required to be approved by the stockholders or by the outstanding shares, the business and affairs of the corporation shall be managed and all corporate powers shall be exercised by or under the direction of the board of directors. 3.2 NUMBER OF DIRECTORS The number of directors of the corporation shall be no less than five (5) or more than nine (9). The exact number of directors shall be seven (7), until changed, within the limits specified above, by a Bylaw amending this Section 3.2, duly adopted by the board of directors or by the shareholders. The indefinite number of directors may be changed, or a definite number fixed without provision for an indefinite number, by an adopted amendment to this Bylaw duly adopted by the vote or written consent of holders of a majority of the outstanding shares entitled to vote; provided, however, that an amendment reducing the number or the minimum number of directors to a number less than five (5) cannot be adopted if the votes cast against its adoption at a meeting of the shareholders, or the shares not consenting in the case of action by written consent, are equal to more than sixteen and two-thirds percent (16-2/3%) of the outstanding shares entitled to vote thereon. No amendment may change the stated maximum number of authorized directors to a number greater than two (2) times the stated number of directors minus one (1). No reduction of the authorized number of directors shall have the effect of removing any director before that director's term of office expires. 3.3 ELECTION, QUALIFICATION AND TERM OF OFFICE OF DIRECTORS Except as provided in Section 3.4 of these Bylaws, directors shall be elected at each annual meeting of stockholders to hold office until the next annual meeting. Directors need not be stockholders unless so required by the certificate of incorporation or these Bylaws, wherein other qualifications for directors may be prescribed. Each director, including a director elected to fill a vacancy, shall hold office until his successor is elected and qualified or until his earlier resignation or removal. Nominations for election to the board of directors of the corporation at an annual meeting of stockholders may be made by the board or on behalf of the board by a nominating committee appointed by the board, or by any stockholder of the corporation entitled to vote for the election of directors at such meeting. Such nominations, other than those made by or on behalf of the board, shall be made by notice in writing received by the secretary of the corporation at the corporation's principal executive offices not less than 60 or more than 90 calendar days prior to the first anniversary of the date that the corporation first mailed its proxy statement to stockholders in connection with the previous year's annual meeting of stockholders, except that if no annual meeting was held in the previous year or the date of the annual meeting has been changed by more than 30 calendar days from the first anniversary date of the previous year's annual meeting, notice by the stockholder to be timely must be received no later than the close of business on the tenth day following the day on which public announcement (as defined in Section 2.2) of the date of such annual meeting is first made. Such notice shall set forth as to each proposed nominee who is not an incumbent director (i) the name, age, business address and, if 12 13 known, residence address of each nominee proposed in such notice, (ii) the principal occupation or employment of such nominee, (iii) the number of shares of stock of the corporation beneficially owned by each such nominee and by the nominating stockholder, and (iv) any other information concerning the nominee that must be disclosed of nominees in proxy solicitations pursuant to Regulation 14A under the Securities Exchange Act of 1934. The chairman of the annual meeting may, if the facts warrant, determine and declare to the meeting that a nomination was not made in accordance with the foregoing procedure. If such determination and declaration is made, the defective nomination shall be disregarded. 3.4 RESIGNATION AND VACANCIES Any director may resign at any time upon written notice to the attention of the Secretary of the corporation. When one or more directors so resigns and the resignation is effective at a future date, only a majority of the directors then in office, including those who have so resigned, shall have power to fill such vacancy or vacancies, the vote thereon to take effect when such resignation or resignations shall become effective, and each director so chosen shall hold office as provided in this section in the filling of other vacancies. Unless otherwise provided in the certificate of incorporation or these Bylaws: (i) Vacancies and newly created directorships resulting from any increase in the authorized number of directors elected by all of the stockholders having the right to vote as a single class may be filled only by a majority of the directors then in office, although less than a quorum, or by a sole remaining director. (ii) Whenever the holders of any class or classes of stock or series thereof are entitled to elect one or more directors by the provisions of the certificate of incorporation, vacancies and newly created directorships of such class or classes or series may be filled only by a majority of the directors elected by such class or classes or series thereof then in office, or by a sole remaining director so elected. If at any time, by reason of death or resignation or other cause, the corporation should have no directors in office, then any officer or any stockholder or an executor, administrator, trustee or guardian of a stockholder, or other fiduciary entrusted with like responsibility for the person or estate of a stockholder, may call a special meeting of stockholders in accordance with the provisions of the certificate of incorporation or these Bylaws, or may apply to the Court of Chancery for a decree summarily ordering an election as provided in Section 211 of the General Corporation Law of Delaware. If, at the time of filling any vacancy or any newly created directorship, the directors then in office constitute less than a majority of the whole board (as constituted immediately prior to any such increase), then the Court of Chancery may, upon application of any stockholder or stockholders holding at least ten (10) percent of the total number of the shares at the time outstanding having the right to vote for such directors, summarily order an election to be held to fill any such vacancies or newly created directorships, or to replace the directors chosen by the directors then in office as aforesaid, which election shall be governed by the provisions of Section 13 14 211 of the General Corporation Law of Delaware as far as applicable. 3.5 PLACE OF MEETINGS; MEETINGS BY TELEPHONE The board of directors of the corporation may hold meetings, both regular and special, either within or outside the State of Delaware. Unless otherwise restricted by the certificate of incorporation or these Bylaws, members of the board of directors, or any committee designated by the board of directors, may participate in a meeting of the board of directors, or any committee, by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and such participation in a meeting shall constitute presence in person at the meeting. 3.6 REGULAR MEETINGS Regular meetings of the board of directors shall be held at such place or places, on such date or dates, and at such time or times as shall have been established by the board of directors and publicized among all directors. A notice of each regular meeting shall not be required. 3.7 SPECIAL MEETINGS; NOTICE Special meetings of the board of directors for any purpose or purposes may be called at any time by any executive officer of the corporation, or by one-third of the directors then in office (rounded up to the nearest whole number) and shall be held at a place, on a date and at a time as such officer or such directors shall fix. Notice of the place, date and time of special meetings, unless waived, shall be given to each director by mailing written notice not less than two (2) days before the meeting or by sending a facsimile transmission of the same not less than two (2) hours before the time of the holding of the meeting. If the circumstances warrant, notice may also be given personally or by telephone not less than two (2) hours before the time of the holding of the meeting. Oral notice given personally or by telephone may be communicated either to the director or to a person at the office of the director who the person giving the notice has reason to believe will promptly communicate it to the director. Unless otherwise indicated in the notice thereof, any and all business may be transacted at a special meeting. 3.8 QUORUM At all meetings of the board of directors, a majority of the authorized number of directors shall constitute a quorum for the transaction of business and the act of a majority of the directors present at any meeting at which there is a quorum shall be the act of the board of directors, except as may be otherwise specifically provided by statute or by the certificate of incorporation. If a quorum is not present at any meeting of the board of directors, then the directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum is present. A meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of directors, if any action taken is approved by at least a majority of the required quorum for that meeting. 3.9 WAIVER OF NOTICE Whenever notice is required to be given under any provision of the General Corporation Law of Delaware or of the certificate of incorporation or these Bylaws, a written waiver thereof, 14 15 signed by the person entitled to notice, whether before or after the time stated therein, shall be deemed equivalent to notice. Attendance of a person at a meeting shall constitute a waiver of notice of such meeting, except when the person attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the directors, or members of a committee of directors, need be specified in any written waiver of notice unless so required by the certificate of incorporation or these Bylaws. 3.10 CONDUCT OF BUSINESS At any meeting of the board of directors, business shall be transacted in such order and manner as the board may from time to time determine, and all matters shall be determined by the vote of a majority of the directors present, except as otherwise provided herein or required by law. 3.11 BOARD ACTION BY WRITTEN CONSENT WITHOUT A MEETING Unless otherwise restricted by the certificate of incorporation or these Bylaws, any action required or permitted to be taken at any meeting of the board of directors, or of any committee thereof, may be taken without a meeting if all members of the board or committee, as the case may be, consent thereto in writing and the writing or writings are filed with the minutes of proceedings of the board or committee. 3.12 FEES AND COMPENSATION OF DIRECTORS Unless otherwise restricted by the certificate of incorporation or these Bylaws, the board of directors shall have the authority to fix the compensation of directors. 3.13 APPROVAL OF LOANS TO OFFICERS The corporation may lend money to, or guarantee any obligation of, or otherwise assist any officer or other employee of the corporation or of its subsidiary, including any officer or employee who is a director of the corporation or its subsidiary, whenever, in the judgment of the directors, such loan, guaranty or assistance may reasonably be expected to benefit the corporation. The loan, guaranty or other assistance may be with or without interest and may be unsecured, or secured in such manner as the board of directors shall approve, including, without limitation, a pledge of shares of stock of the corporation. Nothing in this section contained shall be deemed to deny, limit or restrict the powers of guaranty or warranty of the corporation at common law or under any statute. 3.14 REMOVAL OF DIRECTORS Unless otherwise restricted by statute, by the certificate of incorporation or by these Bylaws, any director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors; provided, however, that, so long as shareholders of the corporation are entitled to cumulative voting, if less than the entire board is to be removed, no director may be removed without cause if the votes cast against his removal would be sufficient to elect him if then cumulatively voted at an election of the entire board of directors. No reduction of the authorized number of directors shall have the effect of removing any 15 16 director prior to the expiration of such director's term of office. ARTICLE IV COMMITTEES 4.1 COMMITTEES OF DIRECTORS The board of directors may, by resolution passed by a majority of the whole board, designate one or more committees, with each committee to consist of one or more of the directors of the corporation. The board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. In the absence or disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the board of directors to act at the meeting in the place of any such absent or disqualified member. Any such committee, to the extent provided in the resolution of the board of directors or in the Bylaws of the corporation, shall have and may exercise all the powers and authority of the board of directors in the management of the business and affairs of the corporation, and may authorize the seal of the corporation to be affixed to all papers that may require it; but no such committee shall have the power or authority to (i) amend the certificate of incorporation (except that a committee may, to the extent authorized in the resolution or resolutions providing for the issuance of shares of stock adopted by the board of directors as provided in Section 151(a) of the General Corporation Law of Delaware, fix the designations and any of the preferences or rights of such shares relating to dividends, redemption, dissolution, any distribution of assets of the corporation or the conversion into, or the exchange of such shares for, shares of any other class or classes or any other series of the same or any other class or classes of stock of the corporation or fix the number of shares of any series of stock or authorize the increase or decrease of the shares of any series), (ii) adopt an agreement of merger or consolidation under Sections 251 or 252 of the General Corporation Law of Delaware, (iii) recommend to the stockholders the sale, lease or exchange of all or substantially all of the corporation's property and assets, (iv) recommend to the stockholders a dissolution of the corporation or a revocation of a dissolution, or (v) amend the Bylaws of the corporation; and, unless the board resolution establishing the committee, a supplemental resolution of the board of directors, the Bylaws or the certificate of incorporation expressly so provide, no such committee shall have the power or authority to declare a dividend, to authorize the issuance of stock, or to adopt a certificate of ownership and merger pursuant to Section 253 of the General Corporation Law of Delaware. 4.2 COMMITTEE MINUTES Each committee shall keep regular minutes of its meetings and report the same to the board of directors when required. 4.3 MEETINGS AND ACTION OF COMMITTEES Meetings and actions of committees shall be governed by, and held and taken in accordance with, the provisions of Article III of these Bylaws, Section 3.5 (place of meetings and 16 17 meetings by telephone), Section 3.6 (regular meetings), Section 3.7 (special meetings and notice), Section 3.8 (quorum), Section 3.9 (waiver of notice), and Section 3.11 (action without a meeting), with such changes in the context of those Bylaws as are necessary to substitute the committee and its members for the board of directors and its members; provided, however, that the time of regular meetings of committees may be determined either by resolution of the board of directors or by resolution of the committee, that special meetings of committees may also be called by resolution of the board of directors and that notice of special meetings of committees shall also be given to all alternate members, who shall have the right to attend all meetings of the committee. The board of directors may adopt rules for the government of any committee not inconsistent with the provisions of these Bylaws. ARTICLE V OFFICERS 5.1 GENERAL MATTERS The officers of the corporation shall be a president, a secretary, and a chief financial officer. The corporation may also have, at the discretion of the board of directors, a chairman of the board, a chief executive officer, one or more vice presidents, one or more assistant secretaries, one or more assistant treasurers, and any such other officers as may be appointed in accordance with the provisions of Section 5.3 of these Bylaws. Any number of offices may be held by the same person. 5.2 APPOINTMENT OF OFFICERS The officers of the corporation, except such officers as may be appointed in accordance with the provisions of Sections 5.3 or 5.5 of these Bylaws, shall be appointed by the board of directors, subject to the rights, if any, of an officer under any contract of employment. 5.3 SUBORDINATE OFFICERS The board of directors may appoint, or empower the chief executive officer or the president to appoint, such other officers and agents as the business of the corporation may require, each of whom shall hold office for such period, have such authority, and perform such duties as are provided in these Bylaws or as the board of directors may from time to time determine. Officers appointed by the board of directors shall constitute executive officers of the corporation. Officers appointed by the president or chief executive officer shall be subordinate officers, unless otherwise specified by the board of directors. 5.4 REMOVAL AND RESIGNATION OF OFFICERS Subject to the rights, if any, of an officer under any contract of employment, any officer may be removed, either with or without cause, by an affirmative vote of the majority of the board of directors at any regular or special meeting of the board or, except in the case of an officer chosen by the board of directors, by any officer upon whom such power of removal may be conferred by the board of directors. Any officer may resign at any time by giving written notice to the corporation. Any resignation shall take effect at the date of the receipt of that notice or at any later time specified 17 18 in that notice; and, unless otherwise specified in that notice, the acceptance of the resignation shall not be necessary to make it effective. Any resignation is without prejudice to the rights, if any, of the corporation under any contract to which the officer is a party. 5.5 VACANCIES IN OFFICES Any vacancy occurring in any office of the corporation shall be filled by the board of directors if such officer was appointed by the board of directors, or by such other person as appointed by the board of directors to fill such vacancy. 5.6 CHAIRMAN OF THE BOARD The chairman of the board, if such an officer be elected, shall, if present, preside at meetings of the board of directors and exercise and perform such other powers and duties as may from time to time be assigned to him by the board of directors or as may be prescribed by these Bylaws. If there is no chief executive officer or president, then the chairman of the board shall also be the chief executive officer of the corporation and shall have the powers and duties prescribed in Section 5.7 of these Bylaws. 5.7 CHIEF EXECUTIVE OFFICER Subject to such supervisory powers, if any, as may be given by the board of directors to the chairman of the board, if there be such an officer, the chief executive officer of the corporation shall, subject to the control of the board of directors, have general supervision, direction, and control of the business and the officers of the corporation. He shall preside at all meetings of the stockholders and, in the absence or nonexistence of a chairman of the board, at all meetings of the board of directors. He shall have the general powers and duties of management usually vested in the chief executive officer of a corporation and shall have such other powers and duties as may be prescribed by the board of directors or these Bylaws. 5.8 PRESIDENT Subject to such supervisory powers, if any, as may be given by the board of directors to the chairman of the board or the chief executive officer, if there be such officers, the president shall have general supervision, direction, and control of the business and other officers of the corporation. He shall have the general powers and duties of management usually vested in the office of president of a corporation and shall have such other powers and duties as may be prescribed by the board of directors or these Bylaws. 5.9 VICE PRESIDENTS In the absence or disability of the chief executive officer and president, the vice presidents, if any, in order of their rank as fixed by the board of directors or, if not ranked, a vice president designated by the board of directors, shall perform all the duties of the president and when so acting shall have all the powers of, and be subject to all the restrictions upon, the president and chief executive officer. The vice presidents shall have such other powers and perform such other duties as from time to time may be prescribed for them respectively by the board of directors, these Bylaws, the president, chief executive officer or the chairman of the board. 5.10 SECRETARY The secretary shall keep or cause to be kept, at the principal executive office of the corporation or such other place as the board of directors may direct, a book of minutes of all 18 19 meetings and actions of directors, committees of directors, and stockholders. The minutes shall show the time and place of each meeting, whether regular or special (and, if special, how authorized and the notice given), the names of those present at directors' meetings or committee meetings, the number of shares present or represented at stockholders' meetings, and the proceedings thereof. The secretary shall keep, or cause to be kept, at the principal executive office of the corporation or at the office of the corporation's transfer agent or registrar, as determined by resolution of the board of directors, a share register, or a duplicate share register, showing the names of all stockholders and their addresses, the number and classes of shares held by each, the number and date of certificates evidencing such shares, and the number and date of cancellation of every certificate surrendered for cancellation. The secretary shall give, or cause to be given, notice of all meetings of the stockholders and of the board of directors required to be given by law or by these Bylaws. He shall keep the seal of the corporation, if one be adopted, in safe custody and shall have such other powers and perform such other duties as may be prescribed by the board of directors or by these Bylaws. 5.11 CHIEF FINANCIAL OFFICER The chief financial officer shall keep and maintain, or cause to be kept and maintained, adequate and correct books and records of accounts of the properties and business transactions of the corporation, including accounts of its assets, liabilities, receipts, disbursements, gains, losses, capital retained earnings, and shares. The books of account shall at all reasonable times be open to inspection by any director. The chief financial officer shall deposit all moneys and other valuables in the name and to the credit of the corporation with such depositories as may be designated by the board of directors. He shall disburse the funds of the corporation as may be ordered by the board of directors, shall render to the chief executive officer, president and directors, whenever they request it, an account of all his transactions as chief financial officer and of the financial condition of the corporation, and shall have other powers and perform such other duties as may be prescribed by the board of directors or the Bylaws. 5.12 REPRESENTATION OF SHARES OF OTHER CORPORATIONS The chairman of the board, any executive officer of this corporation, or any other person designated by the board of directors, shall be authorized to vote, represent, and exercise on behalf of this corporation all rights incident to any and all shares of any other corporation or corporations standing in the name of this corporation. The authority granted herein may be exercised either by such person directly or by any other person authorized to do so by proxy or power of attorney duly executed by such person having the authority. 5.13 AUTHORITY AND DUTIES OF OFFICERS In addition to the foregoing authority and duties, all officers of the corporation shall respectively have such authority and perform such duties in the management of the business of the corporation as may be designated from time to time by the board of directors or the stockholders. 19 20 ARTICLE VI INDEMNITY 6.1 THIRD PARTY ACTIONS The corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending, or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that he is or was a director or officer of the corporation, or that such director or officer is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture trust or other enterprise (collectively "Agent"), against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement (if such settlement is approved in advance by the Company, which approval shall not be unreasonably withheld) actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interest of the corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful. 6.2 ACTIONS BY OR IN THE RIGHT OF THE CORPORATION The corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that he is or was an Agent (as defined in Section 6.1) against expenses (including attorneys' fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in manner he reasonably believed to be in or not opposed to the best interests of the corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Delaware Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Delaware Court of Chancery or such other court shall deem proper. 6.3 SUCCESSFUL DEFENSE To the extent that an Agent of the corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in Sections 6.1 and 6.2, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith. 6.4 DETERMINATION OF CONDUCT Any indemnification under Sections 6.1 and 6.2 (unless ordered by a court) shall be made 20 21 by the corporation only as authorized in the specific case upon a determination that the indemnification of the Agent is proper in the circumstances because he has met the applicable standard of conduct set forth in Sections 6.l and 6.2. Such determination shall be made (1) by the board of directors or the executive committee by a majority vote of a quorum consisting of directors who were not parties to such action, suit or proceeding or (2) or if such quorum is not obtainable or, even if obtainable, a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (3) by the stockholders. 6.5 PAYMENT OF EXPENSES IN ADVANCE Expenses incurred in defending a civil or criminal action, suit or proceeding shall be paid by the corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of the director, officer, employee or agent to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the corporation as authorized in this Article VI. 6.6 INDEMNITY NOT EXCLUSIVE The indemnification and advancement of expenses provided or granted pursuant to the other sections of this Article VI shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any Bylaw, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office. 6.7 INSURANCE INDEMNIFICATION The corporation shall have the power to purchase and maintain on behalf any person who is or was an Agent of the corporation, or is or was serving at the request of the corporation, as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the corporation would have the power to indemnify him against such liability under the provisions of this Article VI. 6.8 THE CORPORATION For purposes of this Article VI, references to "the corporation" shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors and officers, so that any person who is or was a director or Agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under and subject to the provisions of this Article VI (including, without limitation the provisions of Section 6.4) with respect to the resulting or surviving corporation as he would have with respect to such constituent corporation if its separate existence had continued. 6.9 EMPLOYEE BENEFIT PLANS For purposes of this Article VI, references to "other enterprises" shall include employee benefit plans; references to "fines" shall include any excise taxes assessed on a person with respect to an employee benefit plan; and references to "serving at the request of the corporation" shall 21 22 include any service as a director, officer, employee or agent of the corporation which imposes duties on, or involves services by, such director, officer, employee, or agent with respect to an employee benefit plan, its participants, or beneficiaries; and a person who acted in good faith and in a manner he reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interests of the corporation" as referred to in this Article VI. 6.10 INDEMNITY FUND Upon resolution passed by the board, the corporation may establish a trust or other designated account, grant a security interest or use other means (including, without limitation, a letter of credit), to ensure the payment of certain of its obligations arising under this Article VI and/or agreements which may be entered into between the company and its officers and directors from time to time. 6.11 INDEMNIFICATION OF OTHER PERSONS The provisions of this Article VI shall not be deemed to preclude the indemnification of any person who is not an agent (as defined in Section 6.1), but whom the corporation has the power or obligation to indemnify under the provisions of the General Corporation Law of the State of Delaware or other-wise. The corporation may, in its sole discretion, indemnify an employee, trustee or other agent as permitted by the General Corporation Law of the State of Delaware. The corporation shall indemnify an employee, trustee or other agent where required by law. 6.12 SAVINGS CLAUSE If this article or any portion thereof shall be invalidated on any ground by any court of competent jurisdiction, then the corporation shall nevertheless indemnify each agent against expenses (including attorney's fees), judgments, fines and amounts paid in settlement with respect to any action, suit, proceeding or investigation, whether civil, criminal or administrative, and whether internal or external, including a grand jury proceeding and an action or suit brought by or in the right of the corporation, to the full extent permitted by any applicable portion of this Article that shall not have been invalidated, or by any other applicable law. 6.13 CONTINUATION OF INDEMNIFICATION AND ADVANCEMENT OF EXPENSES The indemnification and advancement of expenses provided by, or granted pursuant to, this Article VI shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person. ARTICLE VII RECORDS AND REPORTS 7.1 MAINTENANCE AND INSPECTION OF RECORDS The corporation shall, either at its principal executive office or at such place or places as designated by the board of directors, keep a record of its stockholders listing their names and addresses and the number of class of shares held by each stockholder, a copy of these Bylaws as 22 23 amended to date, accounting books, and other records. Any stockholder of record, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose the corporation's stock ledger, a list of its stockholders, and its other books and records and to make copies or extracts therefrom. A proper purpose shall mean a purpose reasonably related to such person's interest as a stockholder. In every instance where an attorney or other agent is the person who seeks the right to inspection, the demand under oath shall be accompanied by a power of attorney or such other writing that authorizes the attorney or other agent to so act on behalf of the stockholder. The demand under oath shall be directed to the corporation at its registered office in Delaware or at its principal place of business. 7.2 INSPECTION BY DIRECTORS Any director shall have the right to examine the corporation's stock ledger, a list of its stockholders, and its other books and records for a purpose reasonably related to his position as a director. The Court of Chancery is hereby vested with the exclusive jurisdiction to determine whether a director is entitled to the inspection sought. The court may summarily order the corporation to permit the director to inspect any and all books and records, the stock ledger, and the stock list and to make copies or extracts therefrom. The Court may, in its discretion, prescribe any limitations or conditions with reference to the inspection, or award such other and further relief as the Court may deem just and proper. 7.3 ANNUAL STATEMENT TO STOCKHOLDERS The board of directors shall present at each annual meeting, and at any special meeting of the stockholders when called for by vote of the stockholders, a full and clear statement of the business and condition of the corporation. ARTICLE VIII GENERAL MATTERS 8.1 CHECKS From time to time, the board of directors shall determine by resolution which person or persons may sign or endorse all checks, drafts, other orders for payment of money, notes or other evidences of indebtedness that are issued in the name of or payable to the corporation, and only the persons so authorized shall sign or endorse those instruments. 8.2 EXECUTION OF CORPORATE CONTRACTS AND INSTRUMENTS The board of directors, except as otherwise provided in these Bylaws, may authorize any officer or officers, or agent or agents, to enter into any contract or execute any instrument in the name of and on behalf of the corporation; such authority may be general or confined to specific instances. Unless so authorized or ratified by the board of directors or within the agency power of an officer, no officer, agent or employee shall have any power or authority to bind the 23 24 corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or for any amount. 8.3 STOCK CERTIFICATES; PARTLY PAID SHARES The shares of a corporation shall be represented by certificates, provided that the board of directors of the corporation may provide by resolution or resolutions that some or all of any or all classes or series of its stock shall be uncertified shares. Any such resolution shall not apply to shares represented by a certificate until such certificate is surrendered to the corporation. Notwithstanding the adoption of such a resolution by the board of directors, every holder of stock represented by certificates and upon request every holder of uncertificated shares shall be entitled to have a certificate signed by, or in the name of the corporation by the chairman of or vice-chairman of the board of directors, or the secretary or an assistant secretary of such corporation representing the number of shares registered in certificate form. Any or all of the signatures on the certificate may be a facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate has ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if he were such officer, transfer agent or registrar at the date of issue. The corporation may issue the whole or any part of its shares as partly paid and subject to call for the remainder of the consideration to be paid therefor. Upon the face or back of each stock certificate issued to represent any such partly paid shares, upon the books and records of the corporation in the case or uncertificated partly paid shares, the total amount of the consideration to be paid therefor and the amount paid thereon shall be stated. Upon the declaration of any dividend on fully paid shares, the corporation shall declare a dividend upon partly paid shares of the same class, but only upon the basis of the percentage of the consideration actually paid thereon. 8.4 SPECIAL DESIGNATION ON CERTIFICATES If the corporation is authorized to issue more than one class of stock or more than one series of any class, then the powers, the designations, the preferences, and the relative, participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights shall be set forth in full or summarized on the face or back of the certificate that the corporation shall issue to represent such class or series of stock; provided, however, that, except as otherwise provided in Section 202 of the General Corporation Law or Delaware, in lieu of the foregoing requirements there may be set forth on the face or back of the certificate that the corporation shall issue to represent such class or series of stock a statement that the corporation will furnish without charge to each stockholder who so requests the powers, the designations, the preferences, and the relative, participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights. 8.5 LOST CERTIFICATES Except as provided in this Section 8.5, no new certificates for shares shall be issued to replace a previously issued certificate unless the latter is surrendered to the corporation and cancelled at the same time. The corporation may issue a new certificate of stock or uncertificated shares in the place of any certificate theretofore issued by it, alleged to have been lost, stolen or 24 25 destroyed, and the corporation may require the owner of the lost, stolen or destroyed certificate, or his legal representative, to give the corporation a bond sufficient to indemnify it against any claim that may be made against it on account of the alleged loss, theft or destruction of any such certificate or the issuance of such new certificate or uncertificated shares. 8.6 CONSTRUCTION; DEFINITIONS Unless the context requires otherwise, the general provisions, rules of construction, and definitions in the General Corporation Law of Delaware shall govern the construction of these Bylaws. Without limiting the generality of this provision, the singular number includes the plural, the plural number includes the singular, and the term "person" includes both a corporation and a natural person. 8.7 DIVIDENDS The directors of the corporation, subject to any restrictions contained in (i) the General Corporation Law of Delaware or (ii) the certificate of incorporation, may declare and pay dividends upon the shares of its capital stock. Dividends may be paid in cash, in property, or in shares of the corporation's capital stock. The directors of the corporation may set apart out of any of the funds of the corporation available for dividends a reserve or reserves for any proper purpose and may abolish any such reserve. Such purposes shall include but not be limited to equalizing dividends, repairing or maintaining any property of the corporation, and meeting contingencies. 8.8 FISCAL YEAR The fiscal year of the corporation shall be fixed by resolution of the board of directors and may be changed by the board of directors. 8.9 SEAL The corporation may adopt a corporate seal, which may be altered at pleasure, and may use the same by causing it or a facsimile thereof, to be impressed or affixed or in any other manner reproduced. 8.10 TRANSFER OF STOCK Upon surrender to the corporation or the transfer agent of the corporation of a certificate for shares duly endorsed or accompanied by proper evidence of succession, assignation or authority to transfer, it shall be the duty of the corporation to issue a new certificate to the person entitled thereto, cancel the old certificate, and record the transaction in its books. 8.11 STOCK TRANSFER AGREEMENTS The corporation shall have power to enter into and perform any agreement with any number of stockholders of any one or more classes of stock of the corporation to restrict the transfer of shares of stock of the corporation of any one or more classes owned by such stockholders in any manner not prohibited by the General Corporation Law of Delaware. 8.12 REGISTERED STOCKHOLDERS The corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends and to vote as such owner, shall be entitled to hold liable for calls and assessments the person registered on its hooks as the owner of shares, and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of another person, whether or not it shall have express or other notice thereof, 25 26 except as otherwise provided by the laws of Delaware. 8.13 NOTICES Except as otherwise specifically provided herein or required by law, all notices required to be given to any stockholder, director, officer, employee or agent shall be in writing and may in every instance be effectively given by hand delivery, by mail, postage paid, or by facsimile transmission. Any such notice shall be addressed to such stockholder, director, officer, employee or agent at his last known address as it appears on the books of the corporation. The time when such notice shall be deemed received, if hand delivered, or dispatched, if sent by mail or facsimile, transmission, shall be the time of the giving of the notice. ARTICLE IX AMENDMENTS Any of these Bylaws may be altered, amended or repealed by the affirmative vote of a majority of the board of directors or, with respect to Bylaw amendments placed before the stockholders for approval and except as otherwise provided herein or required by law, by the affirmative vote of the holders of seventy-five percent of the shares of the corporation's stock entitled to vote in the election of directors, voting as one class. 26 EX-10.64 3 REGISTRANT'S 1988 DIRECTORS' STOCK OPTION PLAN 1 SUN MICROSYSTEMS, INC. 1988 DIRECTORS' STOCK OPTION PLAN (AMENDED AS OF AUGUST 11, 1999) 1. Purposes of the Plan. The purposes of this Directors' Stock Option Plan are to attract and retain the best available personnel for services as Directors of the Company, to provide additional incentive to the Outside Directors of the Company to serve as Directors, and to encourage their continued service on the Board. 2. Definitions. As used herein, the following definitions shall apply: (a) "Board" shall mean the Board of Directors of the Company. (b) "Common Stock" shall mean the Common Stock of the Company. (c) "Company" shall mean Sun Microsystems, Inc., a Delaware corporation. (d) "Continuous Status as a Director" shall mean the absence of any interruption or termination of service as a Director. (e) "Director" shall mean a member of the Board. (f) "Employee" shall mean any person, including officers and Directors, employed by the Company or any Parent or Subsidiary of the Company. The payment of a Director's fee by the Company shall not be sufficient in and of itself to constitute "employment" by the Company. (g) "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. (h) "Option" shall mean a stock option granted pursuant to the Plan. (i) "Optioned Stock" shall mean the Common Stock subject to an Option. (j) "Optionee" shall mean an Outside Director who receives an Option. (k) "Outside Director" shall mean a Director who is not an Employee. (l) "Parent" shall mean a "parent corporation", whether now or hereafter existing, as defined in Section 425(e) of the Internal Revenue Code of 1986. (m) "Plan" shall mean this 1988 Directors' Stock Option Plan. (n) "Share" shall mean a share of the Common Stock, as adjusted in accordance with Section 11 of the Plan. (o) "Subsidiary" shall mean a "subsidiary corporation", whether now or hereafter existing, as defined in Section 425(f) of the Internal Revenue Code of 1986. 3. Stock Subject to the Plan. Subject to the provisions of Section 11 of the Plan, the maximum aggregate number of Shares which may be optioned and sold under the Plan is 1 2 4,400,000 Shares (the "Pool") of Common Stock. The Shares may be authorized, but unissued, or required Common Stock. If an Option should expire or become unexercisable for any reason without having been exercised in full, the unpurchased Shares which were subject thereto shall, unless the Plan shall have been terminated, shall become available for future grant under the Plan. If Shares which were acquired upon exercise of an Option are subsequently repurchased by the Company, such Shares shall not in any event be returned to the Plan and shall not become available for future grant under the Plan. 4. Administration of and Grants of Options under the Plan. (a) Administrator. Except as otherwise required herein, the Plan shall be administered by the Board. (b) Procedure for Grants. All grants of Options hereunder shall be automatic and non-discretionary and shall be made strictly in accordance with the following provisions: (i) No person shall have any discretion to select which Outside Directors shall be granted Options or to determine the number of Shares to be covered by Options granted to Outside Directors. (ii) Each Outside Director who is a partner, officer or director of an entity having an equity investment in the Company (or who was so affiliated with such an entity at the time of his or her initial appointment or election to the Board) shall be automatically granted an Option to purchase 10,000 Shares (which number, notwithstanding the provisions of Section 11, shall not be adjusted to reflect any stock split, stock dividend, combination, reclassification or similar transaction that increases the number of issued shares of Common Stock without the receipt of consideration by the Company) (the "First Option") upon the effective date of the Plan, as determined in accordance with Section 6 hereof, or the date on which such person first becomes a Director, whether through election by the shareholders of the Company or appointment by the Board of Directors to fill a vacancy; provided, however, that no Option shall be issued under the Plan or become exercisable until shareholder approval of the Plan has been obtained. Each Outside Director who is not, on the date of his or her initial appointment or election to the Board, affiliated with an investment entity as described above, shall automatically be granted a First Option of 20,000 Shares (which number, notwithstanding the provisions of Section 11, shall not be adjusted to reflect any stock split, stock dividend, combination, reclassification or similar transaction that increases the number of issued shares of Common Stock without the receipt of consideration by the Company), subject to the above provision. 2 3 (iii) After the First Option has been granted to an Outside Director, such Outside Director shall thereafter be automatically granted an Option to purchase 10,000 Shares (which number, notwithstanding the provisions of Section 11, shall not be adjusted to reflect any stock split, stock dividend, combination, reclassification or similar transaction that increases the number of issued shares of Common Stock without the receipt of consideration by the Company) (a "Subsequent Option") on the date of and immediately following each Annual Meeting of Shareholders of the Company at which such non-employee director is re-elected, if on such date, he shall have served on the Board for at least six (6) months. (iv) Notwithstanding the provisions of subsections (ii) and (iii) hereof, in the event that a grant would cause the number of Shares subject to outstanding Options plus the number of Shares previously purchased upon exercise of Options to exceed the Pool, then each such automatic grant shall be for that number of Shares determined by dividing the total number of Shares remaining available for grant by the number of Directors on the automatic grant date. Any further grants shall then be deferred until such time, if any, as additional Shares become available for grant under the Plan of Shares which may be issued under the Plan or through cancellation or expiration of Options previously granted hereunder. (v) The terms of an Option granted hereunder shall be as follows: (A) The term of the Option shall be five (5) years. (B) The Option shall be exercisable only while the Outside Director remains a Director of the Company, except as set forth in Section 9 hereof. (C) The exercise price per Share shall be 100% of the fair market value per Share on the date of grant of the Option. (D) The Option shall become exercisable in installments cumulatively as to twenty-five percent (25%) of the Shares subject to the Option on each of the first, second, third and fourth anniversaries of the date of grant of the Option (each a "Vesting Date"); provided, however, if the Company's Annual Meeting of Shareholders for any year after the Annual Meeting at which the Option is granted is held prior to a Vesting Date, the Vesting Date for that year shall be the date of the Annual Meeting of Shareholders. Notwithstanding the foregoing, in no event shall any portion of the Option vest before the date six (6) months after the date of grant of the Option. (c) Powers of the Board. Subject to the provisions and restrictions of the Plan, the Board shall have the authority, in its discretion: (i) to determine, upon review of relevant information and in accordance with Section 8(b) of the Plan, the fair market value of the Common 3 4 Stock; (ii) to determine the exercise price per share of Options to be granted, which exercise price shall be determined in accordance with Section 8(a) of the Plan; (iii) to interpret the Plan; (iv) to prescribe, amend and rescind rules and regulations relating to the Plan; (v) to authorize any person to exercise on behalf of the Company any instrument required to effectuate the grant of an Option previously granted hereunder; and (vi) to make all other determinations deemed necessary or advisable for the administration of the Plan. (d) Effect of the Board's Decision. All decisions, determinations and interpretations of the Board shall be final and binding on all Optionees and any other holders of any Options granted under the Plan. (e) Suspension or Termination of Option. If the Chief Executive Officer or his designee reasonably believes that an Optionee has committed an act of misconduct, the Chief Executive Officer may suspend the Optionee's right to exercise any option pending a determination by the Board of Directors (excluding the Outside Director accused of such misconduct). If the Board of Directors (excluding the Outside Director accused of such misconduct) determines an Optionee has committed an act of embezzlement, fraud, dishonesty, nonpayment of an obligation owed to the Company, breach of fiduciary duty or deliberate disregard of the Company rules resulting in loss, damage or injury to the Company, or if an Optionee makes an unauthorized disclosure of any Company trade secret or confidential information, engages in any conduct constituting unfair competition, induces any Company customer to breach a contract with the Company or induces any principal for whom the Company acts as agent to terminate such agency relationship, neither the Optionee nor his estate shall be entitled to exercise any option whatsoever. In making such determination, the Board of Directors (excluding the Outside Director accused of such misconduct) shall act fairly and shall give the Optionee an opportunity to appear and present evidence on Optionee's behalf at a hearing before the Board or committee of the Board. 5. Eligibility. Options may be granted only to Outside Directors. All Options shall be automatically granted in accordance with the terms set forth in Section 4(b) hereof. An Outside Director who has been granted an Option may, if he is otherwise eligible, be granted an additional Option or Options in accordance with such provisions. The Plan shall not confer upon any Optionee any right with respect to continuation of service as a Director or nomination to serve as a Director, nor shall it interfere in any way with any rights which the Director or the Company may have to terminate his directorship at any time. 6. Term of Plan. The Plan shall become effective upon the earlier to occur of its adoption 4 5 by the Board of Directors or its approval by the shareholders of the Company. It shall continue in effect until December 31, 2008 unless sooner terminated under Section 13 of the Plan. 7. Term of Option. The term of each Option shall be five (5) years from the date of grant thereof. 8. Exercise Price and Consideration. (a) Exercise Price. The per Share exercise price for the Shares to be issued pursuant to exercise of an Option shall be 100% of the fair market value per Share on the date of grant of the Option. In the case of an Option granted to an Optionee who, immediately before the grant of such Option, owns stock representing more than ten percent (10%) of the voting power or value of all classes of stock of the Company or its parents or subsidiaries, the per Share exercise price for the Shares to be issued pursuant to exercise of such Option shall be at least 110% of the fair market value per Share on the date of grant of the Option. (b) Fair Market Value. The fair market value shall be the closing price of the Common Stock on the date of grant, as reported on the National Association of Securities Dealers Automated Quotation ("NASDAQ") System or, in the event the Common Stock is traded on a stock exchange, the fair market value per Share shall be the closing price on such exchange on the date of grant of the Option. (c) Form of Consideration. The consideration to be paid for the Shares to be issued upon exercise of an Option shall consist entirely of cash, check, other Shares of Common Stock having a fair market value on the date of surrender equal to the aggregate exercise price of the Shares as to which said Option shall be exercised, or any combination of such methods of payment. 9. Exercise of Option. (a) Procedure for Exercise; Rights as a Shareholder. Any Option granted hereunder shall be exercisable at such times as are set forth in Section 4(b) hereof; provided, however, that no Options shall be exercisable until shareholder approval of the Plan in accordance with Section 17 hereof has been obtained. An Option may not be exercised for a fraction of a Share. An Option shall be deemed to be exercised when written notice of such exercise has been given to the Company in accordance with the terms of the Option by the person entitled to exercise the Option and full payment for the Shares with respect to which the Option is exercised has been received by the Company. Full payment may consist of any consideration and method of payment allowable under Section 8(c) of the Plan. Until the issuance (as evidenced by 5 6 the appropriate entry on the books of the Company or of a duly authorized transfer agent of the Company) of the stock certificate evidencing such Shares, no right to vote or receive dividends or any other rights as a shareholder shall exist with respect to the Optioned Stock, notwithstanding the exercise of the Option. A share certificate for the number of Shares so acquired shall be issued to the Optionee as soon as practicable after exercise of the Option. No adjustment will be made for a dividend or other right for which the record date is prior to the date the stock certificate is issued, except as provided in Section 11 of the Plan. (b) Termination of Status as a Director. If an Outside Director ceases to serve as a Director, he may, but only within ninety (90) days after the date he ceases to be a Director of the Company, exercise his Option to the extent that he was entitled to exercise it at the date of such termination. Notwithstanding the foregoing, in no event may the Option be exercised after its five (5) year term has expired. To the extent that he was not entitled to exercise an Option at the date of such termination, or if he does not exercise such Option (which he was entitled to exercise) within the time specified herein, the Option shall terminate. (c) Disability of Optionee. Notwithstanding the provisions of Section 9(b) above, in the event a Director is unable to continue his service as a Director with the Company as a result of his total and permanent disability (as defined in Section 22(e)(3) of the Internal Revenue Code), he may, but only within six (6) months from the date of termination, exercise his Option to the extent he was entitled to exercise it at the date of such termination. Notwithstanding the foregoing, in no event may the Option be exercised after its five (5) year term has expired. To the extend that he was not entitled to exercise the Option at the date of termination, or if he does not exercise such Option (which he was entitled to exercise) within the time specified herein, the Option shall terminate. (d) Death of Optionee. In the event of the death of an Optionee: (i) During the term of the Option, Optionee who is, at the time of his death, a Director of the Company and who shall have been in Continuous Status as a Director since the date of grant of the Option, the Option may be exercised, at any time within six (6) months following the date of death, by the Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent of the right to exercise that would have accrued had the Optionee continued living and remained in Continuous Status as Director for six (6) months after the date of death. Notwithstanding the foregoing, in no event may the Option be exercised after its five (5) year term has expired. (ii) Within one (l) month after the termination of Continuous Status as a 6 7 Director, the Option may be exercised, at any time within six (6) months following the date of death, by the Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent of the right to exercise that had accrued at the date of termination. Notwithstanding the foregoing, in no event may the option be exercised after its five (5) year term has expired. 10. Non-Transferability of Options. Options may not be sold, pledged, assigned, hypothecated, transferred or disposed of in any manner other than by will or by the laws of descent and distribution or pursuant to a qualified domestic relations order as defined by the Code or Title l of the Employee Retirement Income Security Act, or the rules thereunder. The designation of a beneficiary by an Optionee does not constitute a transfer. An Option may be exercised, during the lifetime of the Optionee, only by the Optionee or a transferee permitted by this Section 10. 11. Adjustments Upon Changes in Capitalization or Merger. Subject to any required action by the shareholders of the Company, the number of shares of Common Stock covered by each outstanding Option, and the number of shares of Common Stock which have been authorized for issuance under the Plan but as to which no Options have yet been granted or which have been returned to the Plan upon cancellation or expiration of an Option, as well as the price per share of Common Stock covered by each such outstanding Option, shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been "effected without receipt of consideration". Such adjustment shall be made by the Board, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an Option. In the event of the proposed dissolution or liquidation of the Company, the Option will terminate immediately prior to the consummation of such proposed action. In the event of a proposed sale of all or substantially all of the assets of the Company or the merger of the Company with or into another corporation, the Option shall be assumed or an equivalent option shall be substituted by such successor corporation or a parent or subsidiary of such successor 7 8 corporation. In the event that such successor corporation refuses to assume the Option or to substitute an equivalent option, the Board shall, in lieu of such assumption or substitution, provide for the Optionee to have the right to exercise the Option as to all of the Optioned Stock, including Shares as to which the Option would not otherwise be exercisable, in which case, the Board shall notify the Optionee that the Option shall be fully exercisable for a period of thirty (30) days from the date of such notice, and the Option will terminate upon the expiration of such period. 12. Time of Granting Options. The date of grant of an Option shall, for all purposes, be the date determined in accordance with Section 4(b) hereof. Notice of the termination shall be given to each Outside Director to whom an Option is so granted within a reasonable time after the date of such grant. 13. Amendment and Termination of the Plan. (a) Amendment and Termination. The Board may amend or terminate the Plan from time to time in such respects as the Board may deem advisable; provided that, to the extent necessary and desirable to comply with Rule l6b-3 under the Exchange Act (or any other applicable law or regulation), the Company shall obtain approval of the shareholders of the Company of Plan amendments to the extent and in the manner required by such law or regulation. Notwithstanding the foregoing, the provisions set forth in Sections 2(k), 4(b), 5, 7 and 8(a) of this Plan (and any other Sections of this Plan that affect the formula award terms required to be specified in this Plan by Rule l6b-3) shall not be amended more than once every six months, other than to comport with changes in the Internal Revenue Code, the Employee Retirement Income Security Act, or the rules thereunder. (i) any increase in the number of Shares subject to the Plan, other than in connection with an adjustment under Section 11 of the Plan; or (ii) any change in the designation of the class of persons eligible to be granted Options; or (iii) any material increase in the benefits accruing to participants under the Plan; or (iv) any change in the number of shares subject to Options to be granted hereunder or in the terms thereof as set forth in Section 4(b) hereof. (b) Effect of Amendment or Termination. Any such amendment or termination of the Plan shall not affect Options already granted and such Options shall remain in full force and effect as if this Plan had not been amended or terminated, unless mutually agreed otherwise between the Optionee and the Board, which agreement must be in writing and signed by the 8 9 Optionee and the Company. 14. Conditions Upon Issuance of Shares. Shares shall not be issued pursuant to the exercise of an Option unless the exercise of such Option and the issuance and delivery of such Shares pursuant thereto shall comply with all relevant provisions of law, including, without limitation, the Securities Act of 1933, as amended the Exchange Act, the rules and regulations promulgated thereunder, state securities laws, and the requirements of any stock exchange upon which the Shares may then be listed, and shall be further subject to the approval of counsel for the Company with respect to such compliance. As a condition to the exercise of an Option, the Company may require the person exercising such Option to represent and warrant at the time of any such exercise that the Shares are being purchased only for investment and without any present intention to sell or distribute such Shares, if, in the opinion of counsel for the Company, such a representation is required by any of the aforementioned relevant provisions of law. Inability of the Company to obtain authority from any regulatory body having jurisdiction, which authority is deemed by the Company's counsel to be necessary to the lawful issuance and sale of any Shares hereunder, shall relieve the Company of any liability in respect of the failure to issue or sell such Shares as to which such requisite authority shall not have been obtained. 15. Reservation of Shares. The Company, during the term of this Plan, will at all times reserve and keep available such number of Shares as shall be sufficient to satisfy the requirements of the Plan. 16. Option Agreement. Options shall be evidenced by written option agreements in such form as the Board shall approve. 17. Information to Optionees. The Company shall provide to each Optionee, during the period for which such Optionee has one or more Options outstanding, copies of all annual reports to shareholders, proxy statements and other information provided to all shareholders of the Company. 9 EX-13.0 4 REGISTRANT'S 1999 ANNUAL REPORT TO STOCKHOLDERS 1 EXHIBIT 13.1 Annual Report 1999 o Sun Microsystems, Inc. S11 Management's Discussion and Analysis o Page S12 Consolidated Financial Statements o Page S16 Notes to Consolidated Financial Statements o Page S18 Report of Independent Auditors o Page S22 - -------------------------------------------------------------------------------- FINANCIAL REVIEW - -------------------------------------------------------------------------------- The Last Ten Years Sun's revenues have grown an average of 21% annually over the past decade as demand for our open, network computing products and services has increased. With over 49% of revenues generated from outside the United States in fiscal 1999, Sun's portfolio of revenues by geography is well balanced. Cash from operating activities has grown an average of 70% annually over the past ten years, demonstrating the strength and consistency of Sun's business model. While Sun's vision and strategy have remained consistent, the market opportunities for Sun's products and technologies have expanded as companies embrace Internet computing. Increasingly, Sun's business is being driven by customer efforts to implement e-commerce, middleware, network storage, and enterprise software. Customers are also increasingly demanding Sun's high-quality enterprise services to help them implement, manage, and monitor their Internet/network computing environments. In addition, Sun's component technologies, Java, Jini, and UltraSPARC, are increasingly being implemented in consumer and telecommunications environments, promising to increase the number of Internet-enabled devices and thus Internet traffic. The greater the demand for information and services over the Internet, the greater the opportunity for Sun to sell servers, storage, and software. In order to capitalize on these opportunities, Sun has invested carefully--in research and development, enterprise services, and other demand creation activities. Sun's excellence in financial and asset management continues to yield outstanding results in almost every conventional measure of profitability and productivity. Our balance sheet is superb, and we are strongly capitalized, effectively positioning Sun for the .com era. NET REVENUES (in millions of dollars)
90 91 92 93 94 95 95 96 97 98 99 - ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- 2,466 11,726
Net revenues grew to $11,726 million in fiscal 1999, an increase of 20% from $9,791 million in fiscal 1998. NET INCOME PER COMMON SHARE--DILUTED (in dollars)
90 91 92 93 94 95 95 96 97 98 99 - ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- 0.15 1.27
Earnings per share for fiscal 1999, including acquisition-related charges, totaled $1.27, an increase of 31% over fiscal 1998. Over the past ten years, Sun has grown earnings per share an average of 33%. OPERATING INCOME (in millions of dollars)
90 91 92 93 94 95 95 96 97 98 99 - ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- 177 1,522
Operating income as a percent of revenues for fiscal 1999 reached a record level of 13%. Over the past decade, Sun's operating income has increased 37% on an average annual basis. R&D INVESTMENT (in millions of dollars)
90 91 92 93 94 95 95 96 97 98 99 - ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- 302 1,263
During fiscal 1999, Sun invested nearly 11% of revenues in research and development, primarily in the areas of system design, SPARC microprocessors, Solaris software, network storage, and Java technologies. Sun's investments in research and development have led to increasingly innovative products and technologies that promise to change the ways in which customers use the Internet. CASH PORTFOLIO (in millions of dollars)
90 91 92 93 94 95 95 96 97 98 99 - ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- 393 2,665
Excellence in financial management resulted in another record cash balance for fiscal 1999. Sun's cash portfolio, which includes cash, cash equivalents, and short-term investments, totaled $2,665 million at the end of fiscal 1999. CASH FROM OPERATING ACTIVITIES (in millions of dollars)
90 91 92 93 94 95 95 96 97 98 99 - ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- 298 2,517
In fiscal 1999, Sun achieved record cash from operating activities increasing by nearly $1 billion over fiscal 1998 to reach $2,517 million during fiscal 1999. LONG-TERM DEBT-TO-EQUITY RATIO (percentage)
90 91 92 93 94 95 95 96 97 98 99 - ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- 39.0 0.0
At the end of fiscal 1998 and 1999, Sun had no long-term debt, resulting in a 0.0% debt-to-equity ratio. RETURN ON AVERAGE EQUITY (percentage)
90 91 92 93 94 95 95 96 97 98 99 - ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- 14.0 25.0
In fiscal 1999, Sun's return on equity was 25%, demonstrating the strong customer acceptance of Sun's server, storage, workstation, and software products and technologies. REVENUES BY GEOGRAPHY (in millions of dollars) [ ] Rest of World [ ] Europe [ ] U.S.
90 91 92 93 94 95 95 96 97 98 99 - ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- 2,466 11,726
Sun is a global company with more than 49% of its revenues generated outside the United States. Despite the ongoing macroeconomic difficulties in Japan and Southeast Asia, Sun continued to experience strong revenue growth in the United States, Europe, and Latin America, demonstrating the value of a balanced geographical portfolio. - -------------------------------------------------------------------------------- 2 - -------------------------------------------------------------------------------- SUMMARY CONSOLIDATED STATEMENTS OF INCOME - -------------------------------------------------------------------------------- (In millions, except per share amounts)
Years Ended June 30, 1999 1998 1997 1996 1995 --------------- --------------- --------------- -------------- -------------- Dollars % Dollars % Dollars % Dollars % Dollars % - ------------------------------------------------------------------------------------------------------------------------ Net revenues $11,726 100.0 $9,791 100.0 $8,598 100.0 $7,095 100.0 $5,902 100.0 Costs and expenses: Cost of sales 5,648 48.2 4,693 47.9 4,320 50.2 3,921 55.3 3,336 56.5 Research and development 1,262 10.8 1,014 10.4 826 9.6 653 9.2 563 9.5 Selling, general and administrative 3,173 27.1 2,777 28.4 2,402 27.9 1,788 25.2 1,503 25.5 Purchased in-process research and development 121 0.9 177 1.8 23 0.3 58 0.8 -- -- Total costs and expenses 10,204 87.0 8,661 88.5 7,571 88.0 6,420 90.5 5,402 91.5 - ------------------------------------------------------------------------------------------------------------------------ Operating income 1,522 13.0 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 84 0.7 46 0.5 32 0.4 34 0.5 23 0.4 Litigation settlement -- -- -- -- -- -- -- -- -- -- Income before income taxes 1,606 13.7 1,176 12.0 1,121 13.1 709 10.0 523 8.9 Provision for income taxes 575 4.9 413 4.2 359 4.2 232 3.3 167 2.8 - ------------------------------------------------------------------------------------------------------------------------ Net income $ 1,031 8.8 $ 763 7.8 $ 762 8.9 $ 477 6.7 $ 356 6.1 Net income per common share--diluted $ 1.27 $ 0.97 $ 0.98 $ 0.61 $ 0.46 - ------------------------------------------------------------------------------------------------------------------------ Shares used in the calculation of net income per common share--diluted 814 788 778 786 788 - ------------------------------------------------------------------------------------------------------------------------ Years Ended June 30, 1994 1993 1992 1991 1990 -------------- -------------- -------------- ------------ ------------- Dollars % Dollars % Dollars % Dollars % Dollars % - ---------------------------------------------------------------------------------------------------------------------- Net revenues $4,690 100.0 $4,309 100.0 $3,589 100.0 $3,221 100.0 $2,466 100.0 Costs and expenses: Cost of sales 2,753 58.7 2,518 58.4 1,963 54.7 1,758 54.6 1,399 56.7 Research and development 500 10.7 445 10.3 382 10.6 356 11.1 302 12.2 Selling, general and administrative 1,160 24.7 1,105 25.7 983 27.4 812 25.2 588 23.9 Purchased in-process research and development -- -- -- -- -- -- -- -- -- -- Total costs and expenses 4,413 94.1 4,068 94.4 3,328 92.7 2,926 90.9 2,289 92.8 - ---------------------------------------------------------------------------------------------------------------------- Operating income 277 5.9 241 5.6 261 7.3 295 9.1 177 7.2 Gain on sale of equity investment -- -- -- -- -- -- -- -- -- -- Interest income (expense), net 6 0.1 (2) -- (6) (0.2) (11) (0.3) (23) (0.9) Litigation settlement -- -- (15) (0.4) -- -- -- -- -- -- Income before income taxes 283 6.0 224 5.2 255 7.1 284 8.8 154 6.3 Provision for income taxes 87 1.8 67 1.6 82 2.3 94 2.9 43 1.8 - ---------------------------------------------------------------------------------------------------------------------- Net income $ 196 4.2 $ 157 3.6 $ 173 4.8 $ 190 5.9 $ 111 4.5 Net income per common share--diluted $ 0.25 $ 0.19 $ 0.21 $ 0.23 $ 0.15 - ---------------------------------------------------------------------------------------------------------------------- Shares used in the calculation of net income per common share--diluted 776 860 862 878 790 - ----------------------------------------------------------------------------------------------------------------------
3 - -------------------------------------------------------------------------------- OPERATING AND CAPITALIZATION DATA - --------------------------------------------------------------------------------
Years Ended June 30, 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 - ---------------------------------------------------------------------------------------------------------------------------------- Total assets (millions) $ 8,420 $ 5,711 $ 4,697 $ 3,801 $ 3,545 $ 2,898 $ 2,768 $ 2,672 $ 2,326 $ 1,779 - ---------------------------------------------------------------------------------------------------------------------------------- Long-term debt, deferred income taxes, and other obligations (millions) $ 382 $ 75 $ 106 $ 60 $ 91 $ 122 $ 178 $ 348 $ 401 $ 359 - ---------------------------------------------------------------------------------------------------------------------------------- Current ratio 1.9 2.0 2.0 2.0 2.2 2.0 2.4 2.6 2.5 2.6 - ---------------------------------------------------------------------------------------------------------------------------------- Long-term debt-to-equity ratio -- -- 0.02 0.02 0.04 0.08 0.11 0.23 0.33 0.39 - ---------------------------------------------------------------------------------------------------------------------------------- Return on average equity 25% 24% 31% 22% 19% 12% 10% 13% 18% 14% - ---------------------------------------------------------------------------------------------------------------------------------- Return on average capital 23% 24% 30% 23% 18% 12% 9% 10% 13% 11% - ---------------------------------------------------------------------------------------------------------------------------------- Return on average assets 15% 15% 18% 13% 11% 7% 6% 7% 9% 7% - ---------------------------------------------------------------------------------------------------------------------------------- Effective income tax rate 36% 35% 32% 33% 32% 33% 30% 32% 33% 28% - ---------------------------------------------------------------------------------------------------------------------------------- Average shares and equivalents (thousands) 814,241 788,548 777,934 786,760 787,400 774,112 841,000 813,120 824,536 754,952 - ---------------------------------------------------------------------------------------------------------------------------------- Book value per outstanding share $ 6.19 $ 4.67 $ 3.70 $ 3.03 $ 2.70 $ 2.17 $ 2.02 $ 1.86 $ 1.58 $ 1.26 - ----------------------------------------------------------------------------------------------------------------------------------
4 S12 Annual Report 1999 o SUN MICROSYSTEMS, INC. ================================================================================ MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION - -------------------------------------------------------------------------------- The following table sets forth items from our Consolidated Statements of Income as a percentage of total net revenues:
- -------------------------------------------------------------------------------- 1999 1998 1997 - -------------------------------------------------------------------------------- Net revenues Products 86.1 87.9 90.1 Services 13.9 12.1 9.9 - -------------------------------------------------------------------------------- Total net revenues 100.0% 100.0% 100.0% Cost of sales: Products 39.9 40.5 44.0 Services 8.3 7.4 6.2 - -------------------------------------------------------------------------------- Total cost of sales 48.2 47.9 50.2 - -------------------------------------------------------------------------------- Gross margin 51.8 52.1 49.8 Research and development 10.8 10.4 9.6 Selling, general and administrative 27.1 28.4 27.9 Purchased in-process research and development 0.9 1.8 0.3 Operating income 13.0 11.5 12.0 Gain on sale of investment -- -- 0.7 Interest income (expense), net 0.7 0.5 0.4 - -------------------------------------------------------------------------------- Income before income taxes 13.7 12.0 13.1 Provision for income taxes 4.9 4.2 4.2 - -------------------------------------------------------------------------------- Net income 8.8% 7.8% 8.9% - --------------------------------------------------------------------------------
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 economic trends in geographic markets, trends relating to customer buying patterns, and the Company's expectations relating to future research and development and selling, general and administrative expenses. These forward-looking statements involve risks and uncertainties, and the cautionary statements set forth below and 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 our 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. 5 RESULTS OF OPERATIONS NET REVENUES Our products net revenues increased $1,488 million, or 17.3%, to $10,091 million in fiscal 1999, compared with an increase of $856 million, or 11%, in fiscal 1998. More than 50% of the increase in products revenues in fiscal 1999 was primarily due to strong demand for our enterprise and workgroup servers, and to a lesser extent from increased revenues generated by our storage products. The growth in products revenue was partially offset by a decline in high-end desktop system volumes as the result of a shift in customer purchasing patterns towards low-end desktop systems and workgroup servers. More than 50% of the increase in net revenues in fiscal 1998 over fiscal 1997 resulted from increased demand for workgroup, enterprise, and departmental servers and high-end desktop systems and to a lesser extent from high-end storage, memory, and related products. Our services net revenues increased $448 million, or 37.7%, to $1,635 million in fiscal 1999, compared with an increase of $336 million, or 40%, in fiscal 1998. The dollar increase in services revenues in fiscal 1999 was primarily the result of a shift in product mix toward premium-priced service and support contracts and a larger installed product base due to increased product unit sales, as well as increased revenues associated with our professional and education services. The increase in services revenues from fiscal 1997 to fiscal 1998 was primarily the result of a larger installed product base due to increased product unit sales, as well as increased revenues associated with our professional services. In fiscal 1999 and fiscal 1998, domestic net revenues grew by 19% and 16%, respectively, while international net revenues (including United States exports) grew 21% and 12%, respectively. Revenues from international operations represented 49%, 48%, and 49% of total revenues in fiscal 1999, 1998, and 1997, respectively. European net revenues increased 23% and 20% in fiscal 1999 and 1998, respectively. The increase in fiscal 1999 was due to increased demand for our network computing products and services. We experienced continued growth in all European regions during fiscal 1999, with the strongest growth in Germany and Southern Europe. The increase in fiscal 1998 was primarily due to continued market acceptance of our network computing products and services in most major European markets. Although we have experienced U.S. dollar revenue growth in the European marketplace on a year over year basis, there can be no assurance that such trends will continue. In particular, if capital spending declines in certain countries or industries, our results of operations and cash flow could suffer. Japan net revenues increased 14% for fiscal 1999, compared to a decrease of 5% in fiscal 1998. The increase in fiscal 1999 was primarily due to increased demand within the region for our products, with the most notable increase in demand for our servers. We attribute the decrease in revenues in fiscal 1998 to macroeconomic trends affecting the Japanese market, including currency movements against the U.S. dollar. We remain cautious with regard to the Japanese market and do not expect the current Japanese macroeconomic trends to change significantly in the near term. In addition, if the economic trends in Japan significantly worsen in a quarter or decline over an extended period of time, our results of operations and cash flows could suffer. Net revenues in Rest of World increased by 22% in fiscal 1999 compared with 9% in fiscal 1998. The increases in fiscal 1999 and fiscal 1998 were primarily due to increased demand for our network computing products and services from expanding markets in China, Australia, and Latin America. A portion of our operations consists of manufacturing and sales activities in foreign jurisdictions. As a result, our results of operations 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 we distribute our products. We are primarily exposed to changes in exchange rates on the Japanese yen, British pound, 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 we are a net receiver of currencies other than the U.S. dollar and, as such, benefit from a weaker dollar, and are adversely affected by a stronger dollar relative to major currencies worldwide. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, may adversely affect our consolidated sales and operating margins as expressed in U.S. dollars. To mitigate the short-term effect of changes in currency exchange rates on our non-U.S. dollar-based sales, product procurement, and operating expenses, we regularly hedge our 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 our foreign exchange forward and option contracts, our exposure to risk associated with currency market movement on the instruments is not material. See "Other Financial Instruments" in Note 1--"Summary of Significant Accounting Policies." 6 GROSS MARGIN Products gross margin was 53.7% for fiscal 1999, compared with 53.8% and 51.1% for fiscal 1998 and 1997, respectively. Fiscal year 1999 products gross margin was relatively flat in relation to fiscal 1998. Products gross margin was adversely impacted by increased volumes of low-end desktop systems and certain workgroup servers, as well as increased manufacturing costs, the effects of which were offset by an increased volume of higher margin, richly configured enterprise servers and storage products. The increase in gross margin in fiscal 1998 over fiscal 1997 resulted primarily from sales of more richly configured, higher margin servers and desktop systems, and to a lesser extent from decreased component costs. There could be a further downward impact on our products gross margins as the result of continued shifts in customer purchasing patterns toward low-end desktop systems and workgroup servers. Services gross margin was 40.4% for fiscal 1999, compared with 39.3% and 37.7% for fiscal 1998 and 1997, respectively. The increase in fiscal 1999 reflects increased market penetration in enterprise data center accounts, an overall shift toward premium priced service and support contracts resulting from a larger installed base of high-end server products, continued growth in professional services, and increased economies of scale in certain geographic markets. The increase in services gross margin in fiscal 1998 over fiscal 1997 was primarily the result of a larger installed base offset by our increased investment in services business. There can be no assurance that services gross margins will continue to grow at rates consistent with the rates previously realized. We continuously evaluate the competitiveness of our product and service offerings. These evaluations could result in repricing actions in the near term. Our future operating results would be adversely affected if such repricing actions were to occur and we were unable to mitigate the resulting margin pressure by maintaining a favorable mix of systems, software, service, and other products, and by achieving component cost reductions, operating efficiencies, and increasing volumes. RESEARCH AND DEVELOPMENT Research and development (R&D) expenses increased $249 million, or 24.5%, in fiscal 1999 to $1,263 million, compared with an increase of $188 million, or 22.7%, in fiscal 1998. As a percentage of net revenues, R&D expenses were 10.8%, 10.4%, and 9.6% in fiscal 1999, 1998, and 1997, respectively. The increase in spending in fiscal 1999 was focused on the development of a broad line of scalable hardware products, including servers, workstations, and storage technologies, software products which utilize the Java platform, Solaris operating environment software, and SPARC(TM) microprocessors. The remaining increase in R&D expenses was due to further development of products acquired through acquisitions and increased compensation and compensation-related costs due primarily to higher levels of R&D staffing. The increase as a percentage of net revenues reflects our belief that to maintain our competitive position in a market characterized by rapid rates of technological advancement, we must continue to invest significant resources in new systems, software, and microprocessor development, as well as in enhancements to existing products. The Company expects research and development expenses to increase in dollar amount in fiscal 2000 while remaining in the range of 11% of revenue in fiscal 2000. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative (SG&A) expenses increased $396 million, or 14.2%, in fiscal 1999 to $3,173 million compared with an increase of $375 million, or 15.6%, in fiscal 1998. As a percentage of net revenues, these expenses were 27.1%, 28.4%, and 27.9% in fiscal 1999, 1998, and 1997, respectively. The increase in dollar amount in fiscal 1999 was primarily attributable to increased compensation and compensation-related expenses resulting from higher levels of headcount, principally in the sales organization, annual salary adjustments, and to a lesser extent, marketing costs related to promotional programs and increased goodwill amortization expense resulting from several acquisitions. We also made additional investments aimed at improving our own business processes. In fiscal 2000, we expect SG&A expenses to increase in dollar amount, as we continue to invest in efforts to achieve additional operating efficiencies through the continual review and improvement of business processes. In addition, we expect to continue to hire personnel to drive demand-creation programs and service and support organizations. 7 PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT The following paragraphs contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, particularly statements regarding our expectations, including percentage of completion, expected product release dates, dates for which we expect to begin generating benefits from projects, expected product capabilities and product life cycles, costs and efforts to complete projects, growth rates, royalty rates, projected revenue and expense information used by us to 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, our 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 achieve either technological or commercial success or that we will receive any economic benefit from such products as a result of delays in the development of the technology, 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 $121 million, $176 million, and $23 million in fiscal 1999, 1998, and 1997, respectively, represents the write-off of in-process technologies associated with our acquisitions of NetDynamics, Inc. (NetDynamics), Maxstrat Corporation (Maxstrat), i-Planet, Inc. (i-Planet), and Beduin Communications Incorporated (Beduin) in fiscal 1999, 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, and Long View Technologies, LLC (Long View) in fiscal 1997 (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 process had no alternative future uses. Accordingly, these amounts were expensed on the respective acquisition dates of each of the Acquired Companies. Also see Note 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, we have expanded our disclosures related to acquisitions involving IPRD charges for each of the Acquired Companies. VALUATION OF IPRD The following table summarizes the significant assumptions underlying the valuations in fiscal years 1999, 1998, and 1997 related to the IPRD from each of the Acquired Companies (in millions, except percentages). - -------------------------------------------------------------------------------- Acquisition Assumptions - --------------------------------------------------------------------------------
ESTIMATED COST TO COMPLETE RISK ADJUSTED TECHNOLOGY AT DISCOUNT RATE ON ENTITY/PROJECT TIME OF ACQUISITION LICENSE RATE(1) IN-PROCESS R&D - ------------------------------------------------------------------------------------------- FISCAL 1999 ACQUISITIONS NetDynamics $ 5.7 n/a 20% - ------------------------------------------------------------------------------------------- Maxstrat $ 8.0 n/a 25% - ------------------------------------------------------------------------------------------- i-Planet $ 6.0 n/a 25% - ------------------------------------------------------------------------------------------- Beduin $ 0.4 n/a 40% - ------------------------------------------------------------------------------------------- FISCAL 1998 ACQUISITIONS Red Cape $ 7.4 n/a 25% - ------------------------------------------------------------------------------------------- Encore $ 30.0 12% in 1999 30% 10% in 2000 6% for 2001-2005 - ------------------------------------------------------------------------------------------- Chorus-JaZZr.1.1 $ 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% - ------------------------------------------------------------------------------------------- FISCAL 1997 ACQUISITION Long View $ 8.1 6.5% 33% - -------------------------------------------------------------------------------------------
(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 the valuation method used. 8 The following table provides information regarding the status of IPRD projects upon acquisition and as of June 30, 1999 (except as otherwise described in the footnotes):
- -------------------------------------------------------------------------------- PERCENTAGE COMPLETE AT ACTUAL OR EXPECTED ENTITY/PROJECT TIME OF ACQUISITION PRODUCT RELEASE DATE - -------------------------------------------------------------------------------- NetDynamics 60% Q3 Fiscal 1999 - -------------------------------------------------------------------------------- Maxstrat 70% Q1 Fiscal 2000 - -------------------------------------------------------------------------------- i-Planet 30% Q4 Fiscal 1999 - -------------------------------------------------------------------------------- Beduin 65% Q2 Fiscal 2000 - -------------------------------------------------------------------------------- Red Cape 15% Q4 Fiscal 1999 - -------------------------------------------------------------------------------- Encore 60% Fiscal 1999(1) - -------------------------------------------------------------------------------- Chorus-JaZZr.1.1 50% Q4 Fiscal 1998(2) - -------------------------------------------------------------------------------- Chorus-Other IPRD 20% Q4 Fiscal 1999(3) - -------------------------------------------------------------------------------- Integrity Arts 5% Q3 Fiscal 1998(4) - -------------------------------------------------------------------------------- Diba 10% Q4 Fiscal 1999(5) - -------------------------------------------------------------------------------- Long View 25% Q4 Fiscal 1998(6) - --------------------------------------------------------------------------------
(1) Revised expected release date is Q1 Fiscal 2000. (2) Released in Q4 Fiscal 1999. (3) Revised expected release date is Q2 Fiscal 2000. (4) Released in Q4 Fiscal 1999. (5) Project was abandoned in Fiscal 1999. See additional discussion at "Overall status of IPRD acquired prior to fiscal 1999." (6) Released in Q4 Fiscal 1999. We calculated amounts allocated to IPRD using established valuation techniques in the high technology industry and expensed such amounts in the quarter that each acquisition was consummated because technological feasibility had not been achieved and no alternative future uses had been established. This approach gave consideration to relevant market sizes and growth factors, expected industry trends, the anticipated nature and timing of new product introductions by us and our competitors, individual product sales cycles, and the estimated life of each products' underlying technology. The values assigned to developed technologies related to each acquisition were based upon future discounted cash flows related to the existing products' 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. We do 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 ACQUIRED PRIOR TO FISCAL 1999 With respect to acquisitions completed prior to fiscal 1999, with the exception of Encore, which is discussed separately below, we believe that the projections we used in performing our valuations with respect to each acquisition are still valid; however, there can be no assurance that the projected results will be achieved. We expect to continue the development of each project and believe that there is a reasonable chance of successfully completing such development efforts, except for IPRD technology acquired from Lighthouse and Diba, 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. As of June 30, 1999 and for each of the three fiscal years then ended, the impact upon our consolidated results of operations or financial position with respect to the success, or lack thereof, related to any acquisition, individually or in aggregate, is not considered material, except as discussed below. In fiscal 1997, we terminated our 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 our commitment to OpenStep was scaled back thereby impacting development decisions related to the Lighthouse Software Products. Additionally, in fiscal 1999 we terminated our development efforts with respect to the IPRD technology acquired from Diba, which related to the completion of a set-top box product. The decisions to abandon the in-process technologies acquired from Lighthouse and Diba were based upon changes in the long-term strategy for certain of our products, the impact of which was not material to our consolidated results of operations or financial position. Included below are further details regarding the nature of technology acquired, the valuation assumptions, and the status of the IPRD related to our acquisitions completed during fiscal 1999, as well as Encore, our largest additional acquisition, completed during the three years ended June 30, 1999. 9 NETDYNAMICS IPRD OVERVIEW--NETDYNAMICS At the acquisition date (August 28, 1998), NetDynamics was conducting development, engineering, and testing activities associated with the completion of a new enterprise application platform product. This new product offering (NetDynamics New Product Offering) employs a new server-side component model, based on the Enterprise JavaBeans(TM) (EJB) architecture, which allows business logic to reside in the middle tier of the enterprise computing model independent of the client presentation layer and independent of legacy and database systems. This architecture is significantly different than the business logic architecture in NetDynamics' existing product offering, which is tightly integrated with the presentation interface. The EJB architecture allows for the development of more robust and scalable applications with improved reusability, better connectivity to a wide variety of data sources, and a more-industry standard interface through the use of Java enterprise application programming interfaces. Other new features include significant security enhancements and performance improvements, and the addition of new platform adaptor components for legacy systems integration. VALUATION ANALYSIS--NETDYNAMICS We calculated the value of the IPRD technology using a discounted cash flow analysis on the anticipated income stream of the related product sales. The discounted cash flow analysis was based upon our forecast of future revenues, cost of revenues, and operating expenses related to the product and technology acquired from NetDynamics, which are intended to be used in our future enterprise application platform products. We projected total revenue for NetDynamics to increase at a compound growth rate of approximately 30% from fiscal 1999 through 2008. Revenues are expected to peak in fiscal 2000 and decline thereafter, as we expect to introduce new product technologies. These projections are based on our estimates of market size and growth, expected trends in technology, and the expected timing of new product introductions. Our assumptions with respect to operating expenses used in the valuation analysis included: (i) cost of goods sold, (ii) SG&A expenses, and (iii) R&D expenses. Selected operating expense assumptions we used were based on an evaluation of NetDynamics' overall business model, including both historical and expected direct expense levels (as appropriate), and an assessment of general industry metrics. We projected that the cost of revenues (expressed as a percentage of revenue) for the IPRD would decrease over time from approximately 26% in fiscal 1999 to 15% in fiscal 2005. We estimated SG&A (expressed as a percentage of revenue) for the IPRD to average 34% over the projection period. Maintenance R&D related to the IPRD was estimated to be approximately 1% of revenue over the projection period. The discount rate we selected for the IPRD was 20%. In the selection of the appropriate discount rate, we gave consideration to our 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 were known at the valuation date, and the stage of completion of the technology. The discount rate we used for the IPRD was determined to be greater than our 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 relative value and contribution of the acquired research and development. We gave consideration to the R&D's stage of completion, the complexity of the work completed at the valuation date, the difficulty of completing the remaining development, costs already incurred, and the projected cost to complete the project in determining the value assigned to IPRD. COMPARISON TO ACTUAL RESULTS--NETDYNAMICS The NetDynamics New Product Offering was completed in March 1999 for a total cost of approximately $4.7 million, compared to the planned total cost of $5.7 million. We began to realize the benefits of the NetDynamics acquired technology during the fourth quarter of fiscal 1999. Through June 30, 1999, no significant adjustments have been made in the economic assumptions or expectations which underlie our acquisition decision and related purchase accounting. Given the uncertainties of the commercialization process, no assurance can be given that deviations from our estimates will not occur. We believe there is a reasonable chance of realizing the economic return expected from the acquired in-process technology. However, as there is risk associated with the realization of benefits related to commercialization of an in-process project due to rapidly changing customer needs, complexity of technology, and growing competitive pressures, there can be no assurance that any project will meet with commercial success. Failure to successfully commercialize an in-process project would result in the loss of the expected economic return inherent in the fair value allocation. Additionally, the value of our intangible assets acquired may become impaired. 10 MAXSTRAT IPRD OVERVIEW--MAXSTRAT At the acquisition date (January 22, 1999), Maxstrat was conducting development, engineering, and testing activities associated with the completion of a new modular mass data storage system product family (Noble Product Offering) scheduled to be released during the first quarter of fiscal 2000. The Noble Product Offering utilizes Fibre Channel, a fiber-optic technology designed for mass storage devices requiring very high bandwidth. Using optical fiber to connect devices, each Fibre Channel Arbitrated Loop (FC-AL) supports full-duplex data transfer rates of 100 mbps. Multiple FC-ALs increase the redundancy and availability of the system. If an FC-AL fails, another automatically takes over to keep the traffic flow consistent and predictable. At the acquisition date, Maxstrat had made substantial progress in the areas of specifications, design, and implementation. Remaining efforts necessary to complete the Noble Product Offering relate primarily to coding, testing, and addressing additional implementation issues. We anticipate that the Noble Product Offering will be complete by the end of our first quarter of fiscal 2000, after which we expect to begin generating economic benefits from the IPRD associated with the Noble Product Offering. Expenditures to complete the Noble Product Offering are expected to total approximately $8 million during fiscal 1999 and fiscal 2000. VALUATION ANALYSIS--MAXSTRAT We calculated the IPRD technology using a discounted cash flow analysis on the anticipated income stream of the related product sales. The discounted cash flow analysis was based upon our forecast of future revenues, cost of revenues, and operating expenses related to the product and technology acquired from Maxstrat, which are intended to be used in our future enterprise application platform products. We projected total revenue for Maxstrat to increase at a compound growth rate of approximately 30% from fiscal 1999 through 2008. We also expect revenues to peak in fiscal 2003 and decline thereafter, as we expect to introduce new product technologies. These projections are based on our estimates of market size and growth, expected trends in technology, and the expected timing of new product introductions. Operating expenses used in the valuation analysis included: (i) cost of goods sold, (ii) SG&A expenses, and (iii) R&D expenses. Selected operating expense assumptions we used were based on an evaluation of Maxstrat's overall business model, including both historical and expected direct expense levels (as appropriate), and an assessment of general industry metrics. Cost of revenues (expressed as a percentage of revenue) for the IPRD averages 50% over the projection period. SG&A (expressed as a percentage of revenue) for the IPRD averages 20% over the projection period. Maintenance R&D related to the IPRD was estimated to be approximately 2% of revenue over the projection period. The discount rate we selected for the IPRD was 25%. In the selection of the appropriate discount rate, we gave consideration to our 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 valuation date, and the stage of completion of the technology. The discount rate we used for the IPRD was determined to be greater than our 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 relative value and contribution of the acquired research and development. We gave consideration to the R&D's stage of completion, the complexity of the work completed to date, the difficulty completing the remaining development, costs already incurred, and the projected cost to complete the project in determining the value assigned to IPRD. COMPARISON TO ACTUAL RESULTS--MAXSTRAT At June 30, 1999, significant progress had been made on the development related to the Noble Product Offering that was underway as of the acquisition date. We are continuing to invest in the development of new technologies that were underway at the consummation of the Maxstrat acquisition. At June 30, 1999, we had incurred approximately $5 million of the planned total cost to complete of $8 million, and no significant adjustments have been made in the economic assumptions or expectations which underlie our acquisition decision and related purchase accounting. We are continuing our development efforts related to the IPRD technology acquired. These development efforts are advancing at a rate consistent with our expectations. Given the uncertainties of the development and commercialization process, no assurance can be given that deviations from these estimates will not occur. We expect to continue the development of the Noble Product Offering and believe that there is a reasonable chance of successfully completing such development. However, as there is risk associated with the completion of the in-process project 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 this in-process project would result in the loss of the expected economic return inherent in the fair value allocation. Additionally, the value of our intangible assets acquired may become impaired. 11 IPRD OVERVIEW--i-PLANET At the acquisition date (September 28, 1998), i-Planet was conducting development, engineering, and testing activities associated with the completion of a new Java technology-based remote Internet access product scheduled to be released in early calendar year 1999. It was anticipated that this new product offering (i-Planet(TM) New Product Offering) would allow cost-effective, secure, and ubiquitous Internet access for applications such as remote access to corporate intranets, supply chain management, and commerce applications. At the acquisition date, i-Planet was performing development efforts in the areas of specifications, design, and implementation. Remaining efforts necessary to complete the i-Planet New Product Offering related primarily to coding, testing, and addressing additional implementation issues. Approximately $3 million of the total costs to complete the i-Planet New Product Offering of $6 million had been incurred at June 1999. We completed and released the product related to the i-Planet technology, i-Planet Webtop, in May 1999. As of June 30, 1999, no significant adjustments have been made in the economic assumptions or expectations which underlie our acquisition decision and related purchase accounting. IPRD OVERVIEW--BEDUIN At the acquisition date (October 16, 1998), Beduin was conducting development, engineering, and testing activities associated with the completion of a suite of products (Beduin New Product Offerings) which included the Lifestyle Manager Personal Information Manager (PIM) (a next-generation PIM targeted at smart devices incorporating Java technology), and "e-mail client" (a next generation e-mail client specialized to take advantage of the benefits of these smart devices). We anticipate that these Beduin New Product Offerings will provide the core functionality for smart devices incorporating Java technology and enable more efficient communication, regardless of time, location, or type of device. These Beduin New Product Offerings are designed to integrate and synchronize communications and data processing systems, enabling communications across time and space. At the acquisition date, Beduin was performing development efforts and substantial progress had been made in the areas of specifications, design, and implementation. Remaining efforts necessary to complete the Beduin New Product Offerings relate primarily to coding, testing, and addressing additional implementation issues. We anticipate that the Beduin New Product Offerings will be completed during the second quarter of our fiscal year ending June 30, 2000, after which we expect to begin generating economic benefits from the value of the completed development associated with the IPRD. We expect that the total costs to complete the Beduin New Product Offerings will approximate $2 million. VALUATIONS OF IPRD--i-PLANET AND BEDUIN Forecasts of future results that we believe are likely to occur were our basis for assigning value to IPRD. For the i-Planet and Beduin acquisitions, we assigned values to IPRD by estimating the costs to develop the purchased in-process technology into commercially viable products, estimating the resulting net cash flows from each project, excluding the cash flows related to the portion of each project that was incomplete at the acquisition date, and discounting the resulting net cash flows to their present value. Each of our forecasts was based upon future discounted cash flows, taking into account the state of development of each in-process project, the cost to complete that project, the expected income stream, the life cycle of the product ultimately developed, and the risks associated with successful development and commercialization of each project. Projected future net cash flows attributable to the in-process technology, assuming successful development of such technologies, were discounted to their present value using a discount rate that was derived based on our estimated WACC plus a risk premium to account for the inherent uncertainty surrounding the successful completion of each project and the associated estimated cash flows. The discount rates used in valuing the net cash flows from each purchased in-process technology were 25% for the i-Planet acquisition and 40% for the Beduin acquisition. These discount rates are higher than our WACC due to the inherent uncertainties in the estimates described above, including the uncertainty surrounding the successful development of the purchased in-process technologies, the useful life of such technologies, the profitability levels of such technologies, and the uncertainty of technological advances that are unknown at this time. The estimates we used in the valuation of the IPRD charges are subject to change. Given the uncertainties of the development and commercialization process, no assurance can be given that deviations from these estimates will not occur. We expect to continue the development of each project and believe 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 our intangible assets acquired may become impaired. 12 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). We anticipated that completion of the Encore Products would help us 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 could 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 we 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 that 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, we 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. We projected that revenues would peak in fiscal 2002 and decline thereafter as we expect to introduce new product technologies. These projections were based on our estimates of market size and growth, expected trends in technology, and the expected timing of new product introductions. The product life cycle used by us resulted in the use of estimated royalty rates of 12% in 1999, 10% in 2000, and 6% for 2001 through 2005. 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. We selected a discount rate of 30%. In the selection of the appropriate discount rate, we considered our 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 chosen was greater than our WACC, as the technology had not yet reached technological feasibility as of the valuation date. The value assigned to the IPRD reflects our determination of the relative value and contribution of the acquired research and development. We 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 difficulty in completing the remaining development, costs already incurred, and the projected costs to complete the project. COMPARISON TO ACTUAL RESULTS--ENCORE As of June 30, 1999, we had made progress on the development efforts related to the Encore Products that were underway as of the acquisition date, and approximately $19 million of the estimated total cost to complete of $30 million had been incurred. Although the research and development effort is behind schedule, 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. As of June 30, 1999, we have delayed our expected release of the Encore Products from the fourth quarter of fiscal 1999 until the first quarter of fiscal 2000. We have experienced this delay in the realization of benefits related to the acquired technology as the result of increased complexities associated with the completion of the project. The impact of the delay in completion of the Encore Products has resulted in a net shortfall from our original projections of approximately $40 million on our consolidated results of operations for the year ended June 30, 1999. This amount reflects a shortfall in our original plan assumptions with regard to the technologies acquired from Encore only, and does not reflect any offsetting benefits we may have achieved from our overall business plan, including those resulting from a reallocation of resources among alternative development projects. Although the realization of benefits related to the Encore Products has been delayed, we are actively developing the acquired technology and expect over the long term to realize benefits associated with the Encore Products that are consistent with the initial acquisition strategy. Given the uncertainties of the development and commercialization process, no assurance can be given that deviations from these estimates will not occur. We expect to continue the development of each project and believe 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 our intangible assets acquired may become impaired. 13 INTEREST INCOME (EXPENSE), NET Our interest income and expense are 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 our cash equivalents and short-term investments, as well as interest paid on our short-term borrowings. To mitigate the impact of fluctuations in U.S. interest rates, we entered into an interest rate swap transaction. This swap was intended to better match our floating-rate interest income on cash equivalents and short-term investments with the interest expense on our note payable. Net interest income increased to $84 million in fiscal 1999, compared with $46 million and $32 million in fiscal 1998 and fiscal 1997, respectively. The increase in net interest income for fiscal 1999 was primarily the result of higher interest earnings due to a larger average portfolio of cash and investments as compared with the corresponding periods in fiscal 1998 and 1997. The principal/notional amount of our cash equivalents and short-term investments at June 30, 1999 was $2,035 million. These investments, which generally mature in fiscal 2000, bear interest at an average rate of 4.6% and have a fair market value of $2,034 million. INCOME TAXES Our effective income tax rate for fiscal 1999 was 33% before non-recurring tax charges of $45 million resulting from our write-off of IPRD associated with the acquisitions of Maxstrat, i-Planet and NetDynamics. The effective tax rate including such charges was 35.8%. Our effective income tax rate for fiscal 1998 was 33% before non-recurring tax charges of $25 million resulting from the write-off of IPRD associated with the acquisitions of Red Cape, Diba, and Integrity Arts. The effective tax rate including such charges was 35.1%. Our effective tax rate for fiscal 1997 was 32%. We currently expect an effective tax rate of 33% for fiscal 2000. The expected rate excludes the impact of potential mergers and acquisitions. The tax effects of merger and acquisition transactions would be accounted for in the interim quarter in which the transactions occur. The expected rate is based on current tax law and current estimates of earnings, and is subject to change. LIQUIDITY AND CAPITAL RESOURCES Our financial condition strengthened as of the end of fiscal 1999 when compared with fiscal 1998. During fiscal 1999, operating activities generated $2,517 million in cash, compared with $1,527 million in fiscal 1998. Accounts receivable increased $433 million, or 23%, to $2,287 million, due primarily to a 20% increase in net revenues in fiscal 1999 as compared with the fiscal 1998. Deferred tax assets, other current and noncurrent assets increased $533 million, or 58%, to $1,552 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 our acquisitions. Other current and noncurrent liabilities increased $1,186 million, or 72% due to liabilities resulting from the strategic development and marketing agreement with America Online, Inc. (AOL), increased compensation and compensation-related costs, and increases in sales and marketing costs. Accounts payable increased $256 million, or 52%, due to additional operating expenses associated with the expansion of our business. Our investing activities used $2,096 million of cash in fiscal 1999, an increase of $927 million from the $1,169 million used in fiscal 1998. The increase resulted primarily from additions to short-term investments. Additions to short-term investments totaled $2,433 million, up $1,474 million, or 154%, from fiscal 1998 additions, primarily due to having additional resources available for investment. Also included in investing activities is capital spending for real estate development, as well as capital additions to support increased headcount, primarily in our engineering, services, and marketing organizations. Approximately $154 million of cash was used by financing activities in fiscal 1999, compared with $195 million used in fiscal 1998. The decrease was primarily due to an increase in stock issuances, as well as a decrease in short-term borrowings. Our exposure to interest rate risk on the international short-term borrowings of $1.6 million was not material, given the short-term maturity of these instruments and our evaluation of the potential for rate changes associated with such instruments. At June 30, 1999, our primary sources of liquidity consisted of cash, cash equivalents, and short-term investments of $2,665 million and a revolving credit facility with banks aggregating $500 million, which was available subject to compliance with certain covenants, and $740 million of borrowings under available lines of credit to our international subsidiaries. On October 16, 1997, we filed a shelf 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, this shelf registration statement became effective. On June 18, 1999, we filed an additional shelf registration statement with the Securities and Exchange Commission relating to the registration for public offering of senior and subordinated debt securities and common and preferred stock with an aggregate initial public offering price of up to $3 billion. On July 14, 1999, this shelf registration statement became effective. As a result, we may choose to offer up to $4 billion, from time to time, of debt securities and common and preferred 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 these registration statements and in one or more supplements to the prospectus. On August 4, 1999, the Company issued $1.5 billion in unsecured debt securities in four tranches. Each tranche is comprised of the following notes (the Senior Notes): $200 million (due on August 15, 2002 and bearing interest at 7%), $250 million (due on August 15, 2004 and bearing interest at 7.35%), $500 million (due on August 15, 2006 and bearing interest at 7.5%), $550 million (due on August 15, 2009 and bearing interest at 7.65%). Sun also entered into various interest rate swap agreements to modify the interest characteristics of the Senior Notes such that the interest associated with these Senior Notes becomes variable. We believe that the liquidity provided by existing cash and short-term investments, and the borrowing arrangements described above will provide sufficient capital to meet our requirements through fiscal 2000. We believe the level of financial resources is a significant competitive factor in our industry and may choose at any time to raise additional capital through debt or equity financings to strengthen our financial position, facilitate growth, and provide us with additional flexibility to take advantage of business opportunities that may arise. 14 FUTURE OPERATING RESULTS IF WE ARE UNABLE TO COMPETE EFFECTIVELY WITH EXISTING OR NEW COMPETITORS, OUR RESULTING LOSS OF COMPETITIVE POSITION COULD RESULT IN PRICE REDUCTIONS, FEWER CUSTOMER ORDERS, REDUCED REVENUES, REDUCED MARGINS, REDUCED LEVELS OF PROFITABILITY, AND LOSS OF MARKET SHARE. We compete in the hardware and software products and services markets. These markets are intensely competitive. If we fail to compete successfully in these markets, the demand for our products would decrease. Any reduction in demand could lead to a decrease in the prices of our products, fewer customer orders, reduced revenues, reduced margins, reduced levels of profitability, and loss of market share. These competitive pressures could seriously harm our business and operating results. Our competitors are some of the largest, most successful companies in the world. They include Hewlett-Packard Company (HP), International Business Machines Corporation (IBM), Compaq Computer Corporation (Compaq), and EMC Corporation (EMC). Our future competitive performance depends on a number of factors, including our ability to: continually develop and introduce new products and services with better prices and performance than offered by our competitors; offer a wide range of products and solutions from small single-processor systems to large complex enterprise-level systems; offer solutions to customers that operate effectively within a computing environment that includes hardware and software from multiple vendors; offer products that are reliable and that ensure the security of data and information; create products for which third-party software vendors will develop a wide range of applications; and offer high-quality products and services. We also compete with systems manufacturers and resellers of systems based on microprocessors from Intel Corporation (Intel) and Windows NT operating system software from Microsoft Corporation (Microsoft). These competitors include Dell Computer Corporation (Dell), HP, and Compaq, in addition to Intel and Microsoft. This competition creates increased pressure, including pricing pressure, on our workstation and lower-end server product lines. We expect this competitive pressure to intensify considerably during our fiscal year 2000 with the anticipated releases of new software products from Microsoft and new microprocessors from Intel. The computer systems that we sell are made up of many products and components, including workstations, servers, storage products, microprocessors, the Solaris operating environment and other software products. In addition, we sell some of these components separately and as add-ons to installed systems. If we are unable to offer products and services that compete successfully with the products and services offered by our competitors or that meet the complex needs of our customers, our business and operating results could be seriously harmed. In addition, if in responding to competitive pressures, we are forced to lower the prices of our products and services and we are unable to reduce our component costs or improve operating efficiencies, our business and operating results would be seriously harmed. Over the last two years, we have invested significantly in our storage products business with a view to increasing the sales of these products both on a stand-alone basis to customers using the systems of our competitors, and as part of the systems that we sell. The intelligent storage products business is intensely competitive. EMC is currently the leader in this market. To the extent we are unable to penetrate this market and compete effectively, our business and operating results could be seriously harmed. In addition, we will be making significant investments over the next few years to develop, market, and sell software products under our recent alliance with AOL and have agreed to significant minimum revenue commitments. These alliance products are targeted at the e-commerce market and are strategic to our ability to successfully compete in this market. If we are unable to successfully compete in this market, our business and operating results could be seriously harmed. THE PRODUCTS WE MAKE ARE VERY COMPLEX AND IF WE ARE UNABLE TO RAPIDLY AND SUCCESSFULLY DEVELOP AND INTRODUCE NEW PRODUCTS, WE WILL NOT BE ABLE TO SATISFY CUSTOMER DEMAND. We operate in a highly competitive, quickly changing environment, and our future success depends on our ability to develop and introduce new products that our customers choose to buy. If we are unable to develop new products, our business and operating results would be seriously harmed. We must quickly develop, introduce, and deliver in quantity new, complex systems, software, and hardware products and components including our UltraSPARC microprocessors, the Solaris operating environment, our intelligent storage products, and other software products, such as those products under development or to be developed under our recent alliance with AOL. The development process for these complicated products is very uncertain. It requires high levels of innovation from both our product designers and our suppliers of the components used in our products. The development process is also lengthy and costly. If we fail to accurately anticipate our customers' needs and technological trends, or are otherwise unable to complete the development of a product on a timely basis, we will be unable to introduce new products into the market on a timely basis, if at all, and our business and operating results would be adversely affected. In addition, the successful development of software products under our alliance with AOL depends on many factors, including our ability to work effectively within the alliance on complex product development and any encumbrances that may arise from time to time that may prevent us from developing, marketing, or selling these alliance software products. If we are unable to successfully develop, market, or sell the alliance software products or other software products, our business and operating results could be seriously harmed. 15 Software and hardware products such as ours may contain known as well as undetected errors, and these defects may be found following introduction and shipment of new products or enhancements to existing products. Although we attempt to fix errors that we believe would be considered critical by our customers prior to shipment, we may not be able to detect or fix all such errors, and this could result in lost revenues and delays in customer acceptance, and could be detrimental to our business and reputation. The manufacture and introduction of our new hardware and software products is also a complicated process. Once we have developed a new product we face the following challenges in the manufacturing process. We must be able to manufacture new products in high enough volumes so that we can have an adequate supply of new products to meet customer demand. We must be able to manufacture the new products at acceptable costs. This requires us to be able to accurately forecast customer demand so that we can procure the appropriate components at optimal costs. Forecasting demand requires us to predict order volumes, the correct mixes of our software and hardware products, and the correct configurations of these products. We must manage new product introductions so that we can minimize the impact of customers delaying purchases of existing products in anticipation of the new product release. We must also try to reduce the levels of older product and component inventories to minimize inventory write-offs. We may also decide to adjust prices of our existing products during this process in order to try to increase customer demand for these products. If we are introducing new products at the same time or shortly after the price adjustment, this will complicate our ability to anticipate customer demand for our new products. If we were unable to timely develop, manufacture, and introduce new products in sufficient quantity to meet customer demand at acceptable costs, or if we were unable to correctly anticipate customer demand for our new products, our business and operating results could be significantly harmed. OUR RELIANCE ON SINGLE SOURCE SUPPLIERS COULD DELAY PRODUCT SHIPMENTS AND INCREASE OUR COSTS. We depend on many suppliers for the necessary parts and components to manufacture our products. There are a number of vendors producing the parts and components that we need. However, there are some components that can only be purchased from a single vendor due to price, quality, or technology reasons. For example, we depend on Sony for various monitors, and on Texas Instruments for our SPARC microprocessors. If we were unable to purchase the necessary parts and components from a particular vendor and we had to find a new supplier for such parts and components, our new and existing product shipments could be delayed, severely affecting our business and operating results. OUR FUTURE OPERATING RESULTS DEPEND ON OUR ABILITY TO PURCHASE A SUFFICIENT AMOUNT OF COMPONENTS TO MEET THE DEMANDS OF OUR CUSTOMERS. We depend heavily on our suppliers to timely design, manufacture, and deliver the necessary components for our products. While many of the components we purchase are standard, we do purchase some components, specifically color monitors and custom memory integrated circuits such as SRAMs and VRAMs, that require long lead times to manufacture and deliver. Long lead times make it difficult for us to plan component inventory levels in order to meet the customer demand for our products. In addition, in the past, we have experienced shortages in certain of our components (specifically DRAMs and SRAMs). If a component delivery from a supplier is delayed, if we experience a shortage in one or more components, or if we are unable to provide for adequate levels of component inventory, our new and existing product shipments could be delayed and our business and operating results could suffer. SINCE WE ORDER OUR COMPONENTS (AND IN SOME CASES COMMIT TO PURCHASE) FROM SUPPLIERS IN ADVANCE OF RECEIPT OF CUSTOMER ORDERS FOR OUR PRODUCTS THAT INCLUDE THESE COMPONENTS, WE FACE A SUBSTANTIAL INVENTORY RISK. As part of our component inventory planning, we frequently pay certain suppliers well in advance of receipt of customer orders. For example, we often enter into noncancelable purchase commitments with vendors early in the manufacturing process of our microprocessors to make sure we have enough of these components for our new products to meet customer demand. Because the design and manufacturing process for these components is very complicated it is possible that we could experience a design or manufacturing flaw that could delay or even prevent the production of the components for which we have previously committed to pay. We also face the risk of ordering too many components, or conversely, not enough components, since the orders are based on the forecasts of customer orders rather than actual orders. If we cannot change or be released from the noncancelable purchase commitments, we could incur significant costs from the purchase of unusable components, due to a delay in the production of the components or as a result of inaccurately predicting component orders in advance of customer orders. Our business and operating results could be seriously harmed as a result of these increased costs. 16 DELAYS IN PRODUCT DEVELOPMENT OR CUSTOMER ACCEPTANCE AND IMPLEMENTATION OF NEW PRODUCTS AND TECHNOLOGIES COULD SERIOUSLY HARM OUR BUSINESS. Delays in product development and customer acceptance and implementation of new products could seriously harm our business. Delays in the development and introduction of our products may occur for various reasons. For example, delays in software development could delay shipments of related new hardware products. Generally, the computer systems we sell to customers incorporate hardware and software products that we sell, such as the UltraSPARC microprocessor, the Solaris operating environment, and intelligent storage products. Any delay in the development of the software and hardware included in our systems could delay our shipment of these systems. In addition, if customers decided to delay the adoption and implementation of new releases of our Solaris operating environment this could also delay customer acceptance of new hardware products tied to that release. Adopting a new release of an operating environment requires a great deal of time and money for a customer to convert its systems to the new release. The customer must also work with software vendors who port their software applications to the new operating system and make sure these applications will run on the new operating system. As a result, customers may decide to delay their adoption of a new release of an operating system because of the cost of a new system and the effort involved to implement it. Also, customers may wait to implement new systems until after January 1, 2000 so that there is less likelihood of Year 2000 computer problems. IF WE ARE UNABLE TO CONTINUE GENERATING SUBSTANTIAL REVENUES FROM INTERNATIONAL SALES, OUR BUSINESS COULD BE SUBSTANTIALLY HARMED. Currently, approximately half of our revenues come from international sales. Our ability to sell our products internationally is subject to the following risks: general economic and political conditions in each country could adversely affect demand for our products and services in these markets, as recently occurred in certain Asian and Latin American markets; currency exchange rate fluctuations could result in lower demand for our products, as well as currency translation losses; changes to and compliance with a variety of foreign laws and regulations may increase our cost of doing business in these jurisdictions; trade protection measures and import and export licensing requirements subject us to additional regulation and may prevent us from shipping products to a particular market, and increase our operating costs. WE EXPECT OUR QUARTERLY REVENUES AND OPERATING RESULTS TO FLUCTUATE FOR A NUMBER OF REASONS. Future operating results will continue to be subject to quarterly fluctuations based on a wide variety of factors, including: Seasonality. Our operating results usually fluctuate downward in the first and third quarters of each fiscal year due to customer buying patterns for hardware and software products and services. Increases in Operating Expenses. Our operating expenses will continue to increase as we continue to expand our operations. Our operating results could suffer if our revenues do not increase at least as fast as our expenses. Acquisitions/Alliances. If, in the future, we acquire technologies, products, or businesses, or we form alliances with companies requiring technology investments or revenue commitments (such as our recent alliance with AOL), we will face a number of risks to our business. The risks we may encounter include those associated with integrating or comanaging operations, personnel, and technologies acquired or licensed, and the potential for unknown liabilities of the acquired or combined business. Also, we will include amortization expense of acquired intangible assets in our financial statements for several years following these acquisitions. Our business and operating results on a quarterly basis could be harmed if our acquisition or alliance activities are not successful. Significant Customers. Only one of our customers accounted for more than 10% of our revenues in fiscal 1999 and fiscal 1998. Sales to this customer accounted for approximately 14% of our fiscal 1999 and 1998 revenues. Our business could suffer if this customer or another significant customer terminated its business relationship with us or significantly reduced the amount of business it did with us. OUR FAILURE OR THE FAILURE OF OUR BUSINESS PARTNERS AND CUSTOMERS TO BE YEAR 2000 COMPLIANT COULD HARM OUR BUSINESS. 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 be able to distinguish years beginning with "19" from those beginning with "20." As a result, in less than six months, computer systems and/or software products used by many companies may need to be upgraded to comply with such Year 2000 requirements. We are currently expending resources to review our products and services, as well as our internal-use software in order to identify and modify those products, services, and systems that are not Year 2000 compliant. We believe that the vast majority of these costs are not incremental to us but represent a reallocation of existing resources and include regularly scheduled systems upgrades and maintenance. In addition, we have made custom coding enhancements to our mission-critical internal business systems, and we believe that such internal systems are now Year 2000 compliant. We are working to make our remaining internal systems Year 2000 compliant by September 30, 1999. 17 Although we believe that the costs associated with the aforementioned Year 2000 efforts are not material, we currently estimate that such costs will be between $40 to $45 million, of which approximately $25 million had been spent through June 30, 1999. The aforementioned costs are estimates due in large part to the fact that we do not separately track the internal labor costs associated with Year 2000 compliance, unless such costs are incurred by individuals devoted primarily to Year 2000 compliance efforts. These cost estimates do not include any potential costs related to any customer or other claim. In addition, these cost estimates are based on the current assessment of the ongoing activities described above, and are subject to change as we continuously monitor these activities. We believe any modifications deemed necessary will be made on a timely basis and we do not believe that the cost of such modifications will seriously harm our business. We currently expect the aforementioned evaluation of our products, services, and systems and any remediation necessary will be completed by September 30, 1999. As of June 30, 1999, we had not identified any items or areas that would require material remediation efforts. Our expectations as to the extent and timeliness of any modifications required in order to achieve Year 2000 compliance and the costs related thereto are forward-looking statements 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 section. We cannot be sure, however, that we will be able to successfully modify on a timely basis such products, services, and systems to comply with Year 2000 requirements. Our business could suffer if we fail to make our products, services, and systems Year 2000 compliant in time. We have established a program to assess whether certain of our products are Year 2000 compliant. Under this program, we are in the process of performing tests on Sun products listed on our price lists. To monitor this program and to help customers evaluate their Year 2000 issues we have created a Web site at http://sun.com/y2000/cpl.html that identifies the following categories: products that were released Year 2000 compliant; products that require modifications to be Year 2000 compliant; products under review; products that are not Year 2000 compliant and need to be replaced with a Year 2000 compliant product; source code products that could be modified and implemented without our review; and products that do not process or manipulate date data or have no date-related technology. We update this list periodically as our analysis of additional products is completed. Based on our assessment to date, most of our newly introduced products and services are Year 2000 compliant; however, we cannot be sure that our current products do not contain undetected errors or defects associated with Year 2000 functions that may result in material costs to us. In addition, some of our customers are running products that are not Year 2000 compliant and will require an upgrade or other remediation to become Year 2000 compliant. We provide limited warranties as to Year 2000 compliance on certain of our products and services. Except as specifically provided for in the limited warranties, we do not believe that we are legally responsible for costs incurred by customers to achieve Year 2000 compliance. We have been taking steps to identify affected customers, raise customer awareness related to noncompliance of our older products, and encourage such customers to migrate to current products or product versions. It is possible that we may experience increased expenses if we need to upgrade or perform other remediation on products that our customers are using that are not Year 2000 compliant. Our business may also materially suffer if customers become concerned about or are dissatisfied with our products and services as a result of Year 2000 issues. We also face risks to the extent that suppliers of products, services, and systems purchased by us or the suppliers of others with whom we transact business cannot timely provide us with products, components, services, or systems that meet Year 2000 requirements. To the extent that we are not able to test technology provided by third-party hardware or software vendors, we are in the process of carrying out audits and obtaining Year 2000 compliance certifications from each of our major vendors that their products and internal systems, as applicable, are Year 2000 compliant. In the event any such third parties cannot timely provide us with products, services, or systems that meet the Year 2000 requirements, our business could be harmed. Furthermore, a reasonably likely worst-case scenario would be if one of our major vendors experienced a material disruption in business, which caused us to experience a material disruption in business. If either our internal systems or the internal systems, products, or services of one or more of our major vendors (including banks, energy suppliers, and transportation providers) fail to achieve Year 2000 compliance, our business could be seriously harmed. We are currently developing contingency plans to deal with potential Year 2000 problems related to our internal systems that are deemed to be high risk and with respect to products and services provided by outside vendors. We expect these plans to be complete by September 30, 1999. If these plans are not timely completed or if they are not successful or if new Year 2000 problems not covered by our contingency plans emerge, our business and operating results may be seriously harmed. Although we believe that the cost of Year 2000 modifications for both internal use software and systems, as well as Sun's products are not material, we cannot be sure that various factors relating to the Year 2000 compliance issues will not seriously harm our business or operating results. For example, a significant amount of litigation may arise out of Year 2000 compliance issues and we cannot be sure about the extent to which we may be affected by any of this litigation. Even though we do not believe that we are legally responsible for our customers' Year 2000 compliance obligations, it is unclear whether different governments or governmental agencies may decide to allocate liability relating to Year 2000 compliance to us without regard to specific warranties or warranty disclaimers. Our business could suffer in any given quarter if any liability is allocated to us. Furthermore, we do not know how customer spending patterns may be affected by Year 2000 issues. We believe, however, that customers will focus on preparing their businesses for the Year 2000 and that their capital budgets will be spent in large part on remediation efforts, potentially delaying the purchase and implementation of new systems, thereby creating less demand for our products and services. Our business could be harmed if customers delay purchasing our products during the first half of our fiscal Year 2000 because of Year 2000 concerns, or if our customers are unable to conduct their business or are prevented from placing orders or paying us because of their own Year 2000 problems. A significant disruption of our financial management and control systems or a lengthy interruption in our operations caused by a Year 2000 related issue could also result in a material adverse impact on our operating results and financial condition. 18 OUR ACQUISITION AND ALLIANCE ACTIVITIES COULD DISRUPT OUR ONGOING BUSINESS. We intend to continue to make investments in companies, products, and technologies, either through acquisitions or investment alliances. For example, we have purchased several companies in the past and formed alliances, including our recent alliance with AOL. Acquisitions and alliance activities often involve risks, including: we may experience difficulty in assimilating the acquired operations and employees; we may experience difficulty in managing product codevelopment activities with our alliance partners; we may be unable to retain the key employees of the acquired operation; the acquisition or investment may disrupt our ongoing business; we may not be able to incorporate successfully the acquired technology and operations into our business and maintain uniform standards, controls, policies, and procedures; and we may lack the experience to enter into new markets, products, or technologies. Some of these factors are beyond our control. Failure to manage these alliance activities effectively and to integrate acquisitions could affect our operating results or financial condition. WE DEPEND ON KEY EMPLOYEE AND FACE COMPETITION IN HIRING AND RETAINING QUALIFIED EMPLOYEES. Our employees are vital to our success, and our key management, engineering, and other employees are difficult to replace. We generally do not have employment contracts with our key employees. Further, we do not maintain key person life insurance on any of our employees. The expansion of high technology companies in Silicon Valley and Colorado, as well as many other cities, has increased demand and competition for qualified personnel. We may not be able to attract, assimilate, or retain additional highly qualified employees in the future. These factors could harm our business. 19 - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF INCOME - --------------------------------------------------------------------------------
(In thousands, except share and per share amounts) YEARS ENDED JUNE 30, 1999 1998 1997 Net revenues: Products $10,091,046 $8,603,259 $7,747,115 Services 1,635,251 1,187,581 851,231 - ---------------------------------------------------------------------------------------------------- Total net revenues 11,726,297 9,790,840 8,598,346 Cost and expenses: Cost of sales--products 4,674,390 3,972,283 3,790,284 Cost of sales--services 973,970 721,053 530,176 Research and development 1,262,517 1,013,782 825,968 Selling, general and administrative 3,172,955 2,777,264 2,402,442 Purchased in-process research and development 120,700 176,384 22,958 - ---------------------------------------------------------------------------------------------------- Total costs and expenses 10,204,532 8,660,766 7,571,828 Operating income 1,521,765 1,130,074 1,026,518 Gain on sale of equity investment -- -- 62,245 Interest income 84,599 47,663 39,899 Interest expense (675) ( 1,571) ( 7,455) - ---------------------------------------------------------------------------------------------------- Income before income taxes 1,605,689 1,176,166 1,121,207 Provision for income taxes 574,355 413,304 358,787 - ---------------------------------------------------------------------------------------------------- Net income $ 1,031,334 $ 762,862 $ 762,420 - ---------------------------------------------------------------------------------------------------- Net income per common share--basic $1.35 $1.02 $1.03 - ---------------------------------------------------------------------------------------------------- Net income per common share--diluted $1.27 $0.97 $0.98 - ---------------------------------------------------------------------------------------------------- Shares used in the calculation of net income per common share--basic 765,853 747,456 736,852 - ---------------------------------------------------------------------------------------------------- Shares used in the calculation of net income per common share--diluted 814,241 788,548 777,934 See accompanying notes.
20 - -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS - --------------------------------------------------------------------------------
(In thousands, except share and per share amounts) AT JUNE 30, 1999 1998 ----------- ----------- ASSETS Current assets: Cash and cash equivalents $ 1,088,972 $ 822,267 Short-term investments 1,576,079 476,185 Accounts receivable, net of allowances of $338,771 in 1999 and $235,563 in 1998 2,286,911 1,845,765 Inventories 307,873 346,446 Deferred tax assets 487,150 371,841 Other current assets 369,365 285,021 - ----------------------------------------------------------------------------------------------- Total current assets 6,116,350 4,147,525 Property, plant and equipment: Machinery and equipment 1,552,184 1,251,660 Furniture and fixtures 172,912 113,636 Leasehold improvements 287,740 256,233 Land, buildings and building improvements 858,512 635,699 - ----------------------------------------------------------------------------------------------- 2,871,348 2,257,228 Accumulated depreciation and amortization (1,262,427) (956,616) - ----------------------------------------------------------------------------------------------- 1,608,921 1,300,612 Other assets, net 695,081 262,925 - ----------------------------------------------------------------------------------------------- $ 8,420,352 $ 5,711,062 - ----------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term borrowings $ 1,646 $ 7,169 Accounts payable 753,838 495,603 Accrued payroll-related liabilities 520,068 315,929 Accrued liabilities and other 1,126,497 810,562 Deferred service revenues 422,115 264,967 Income taxes payable 402,813 188,641 Note payable -- 40,000 - ----------------------------------------------------------------------------------------------- Total current liabilities 3,226,977 2,122,871 Deferred income taxes and other obligations 381,595 74,563 Commitments and contingencies Stockholders' equity: Preferred stock, $0.001 par value, 10,000,000 shares authorized (3,000,000 of which have been designated as Series A Preferred participating stock); no shares issued and outstanding -- -- Common stock, $0.00067 par value, 1,800,000,000 shares authorized; issued: 867,254,728 shares in 1999 and 860,622,882 shares in 1998 581 288 Additional paid-in capital 1,742,652 1,345,508 Retained earnings 4,124,607 3,150,935 Treasury stock, at cost: 89,919,137 shares in 1999 and 108,015,732 shares in 1998 (1,045,961) (1,003,191) - ----------------------------------------------------------------------------------------------- Accumulated other comprehensive income (loss) (10,099) 20,088 - ----------------------------------------------------------------------------------------------- Total stockholders' equity 4,811,780 3,513,628 - ----------------------------------------------------------------------------------------------- $ 8,420,352 $ 5,711,062 - -----------------------------------------------------------------------------------------------
See accompanying notes. 21 - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS - --------------------------------------------------------------------------------
(In thousands) YEARS ENDED JUNE 30, 1999 1998 1997 Cash flow from operating activities: Net income $ 1,031,334 $ 762,862 $ 762,420 Adjustments to reconcile net income to operating cash flows: Depreciation and amortization 626,946 439,921 356,003 Gain on sale of equity investment -- -- (62,245) Tax benefit of options exercised 222,364 111,375 59,799 Purchased in-process research and development 120,700 176,384 22,958 Net increase in accounts receivable (433,136) (176,075) (334,911) Net decrease in inventories 39,206 97,394 22,936 Net increase (decrease) in accounts payable 256,117 (12,298) 143,845 Net increase in other current and non-current assets (532,979) (206,210) (152,510) Net increase in other current and non-current liabilities 1,186,305 333,159 286,793 - ------------------------------------------------------------------------------------------------------------------------- Net cash provided from operating activities 2,516,857 1,526,512 1,105,088 - ------------------------------------------------------------------------------------------------------------------------- Cash flow from investing activities: Additions to property, plant and equipment (738,707) (830,143) (554,018) Acquisition of other assets (108,240) (91,521) (37,645) Acquisition of short-term investments (2,432,725) (958,354) (973,884) Maturities of short-term investments 688,154 523,032 634,765 Sales of short-term investments 625,690 432,047 347,771 Proceeds from sale of equity investment -- -- 62,245 Payments for acquisitions, net of cash acquired (130,300) (244,020) (22,958) - ------------------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (2,096,128) (1,168,959) (543,724) - ------------------------------------------------------------------------------------------------------------------------- Cash flow from financing activities: Issuance of stock, net of repurchases 142,596 71,975 52,969 Acquisition of treasury stock (358,434) (284,396) (456,090) Proceeds from employee stock purchase plans 115,699 93,581 81,313 Proceeds (reduction) of short-term borrowings, net (15,523) (92,967) 51,769 Repayment of receivable purchase agreement -- -- (125,000) Proceeds (reduction) of note payable and other (38,362) 16,351 (35,009) - ------------------------------------------------------------------------------------------------------------------------- Net cash used by financing activities (154,024) (195,456) (430,048) - ------------------------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 266,705 162,097 131,316 Cash and cash equivalents, beginning of year 822,267 660,170 528,854 - ------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $1,088,972 $ 822,267 $ 660,170 - ------------------------------------------------------------------------------------------------------------------------- Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 836 $ 905 $ 15,126 Income taxes $ 138,596 $ 334,550 $380,814 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 $ 305,242 $ 301,415 $-- Cash paid for assets (134,895) (249,806) -- Stock issued (144,483) -- -- - ------------------------------------------------------------------------------------------------------------------------- Liabilities assumed $ 25,864 $ 51,609 $-- - -------------------------------------------------------------------------------------------------------------------------
See accompanying notes. 22 - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - --------------------------------------------------------------------------------
COMMON STOCK ADDITIONAL TREASURY STOCK THREE YEARS ENDED JUNE 30, 1999 -------------------- PAID-IN RETAINED --------------------- (In thousands, except share amounts) SHARES AMOUNT CAPITAL EARNINGS SHARES AMOUNT Balances at June 30, 1996 852,640,236 $ 72 $ 1,164,349 $ 1,662,355 (108,711,752) $ (596,910) Net income -- -- -- 762,420 -- -- Currency translation adjustments and other -- -- -- -- -- -- Total comprehensive income -- -- -- -- -- -- Issuance of stock, net of repurchases (20,000) -- -- (14,710) 20,756,230 137,574 Treasury stock purchased -- -- -- -- (32,145,238) (456,090) Exercise of warrants 8,451,536 1 1,611 -- -- -- Tax benefit of employee stock transactions and other -- -- 63,837 -- -- -- Issuance of common stock dividend -- 215 -- (215) -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Balances at June 30, 1997 861,071,772 288 1,229,797 2,409,850 (120,100,760) (915,426) Net income -- -- -- 762,862 -- -- Currency translation adjustments and other -- -- -- -- -- -- Total comprehensive income -- -- -- -- -- -- Issuance of stock, net of repurchases (448,890) -- (2) (21,777) 25,276,768 196,631 Treasury stock purchased -- -- -- -- (13,191,740) (284,396) Tax benefit of employee stock transactions and other -- -- 115,713 -- -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Balances at June 30, 1998 860,622,882 288 1,345,508 3,150,935 (108,015,732) (1,003,191) Net income -- -- -- 1,031,334 -- -- Currency translation adjustments and other -- -- -- -- -- -- Total comprehensive income -- -- -- -- -- -- Issuance of stock, net of repurchases 6,631,846 2 144,483 (57,371) 27,506,499 315,664 Treasury stock purchased -- -- -- -- (9,409,904) (358,434) Tax benefit of employee stock transactions and other -- -- 252,661 -- -- -- Issuance of common stock dividend -- 291 -- (291) -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Balances at June 30, 1999 867,254,728 $581 $ 1,742,652 $ 4,124,607 (89,919,137) $(1,045,961) - ------------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED OTHER TOTAL THREE YEARS ENDED JUNE 30, 1999 COMPREHENSIVE STOCKHOLDERS' (In thousands, except share amounts) INCOME (LOSS) EQUITY Balances at June 30, 1996 $ 21,620 $ 2,251,486 Net income -- 762,420 Currency translation adjustments and other (4,192) (4,192) ------------- Total comprehensive income -- 758,228 Issuance of stock, net of repurchases -- 122,864 Treasury stock purchased -- (456,090) Exercise of warrants -- 1,612 Tax benefit of employee stock transactions and other -- 63,837 Issuance of common stock dividend -- -- - ---------------------------------------------------------------------------------------- Balances at June 30, 1997 17,428 2,741,937 Net income -- 762,862 Currency translation adjustments and other 2,660 2,660 ------------- Total comprehensive income -- 765,522 Issuance of stock, net of repurchases -- 174,852 Treasury stock purchased -- (284,396) Tax benefit of employee stock transactions and other -- 115,713 - ---------------------------------------------------------------------------------------- Balances at June 30, 1998 20,088 3,513,628 Net income -- 1,031,334 Currency translation adjustments and other (30,187) (30,187) ------------- Total comprehensive income -- 1,001,147 Issuance of stock, net of repurchases -- 402,778 Treasury stock purchased -- (358,434) Tax benefit of employee stock transactions and other -- 252,661 Issuance of common stock dividend -- -- - ---------------------------------------------------------------------------------------- Balances at June 30, 1999 $(10,099) $ 4,811,780 - ----------------------------------------------------------------------------------------
See accompanying notes. 23 Notes to Consolidated Financial Statements 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS - -------------------------------------------------------------------------------- Sun Microsystems, Inc. (the Company or Sun) is a provider of products, services, and support solutions for building and maintaining network computing environments. Sun sells scalable computer systems, high-speed microprocessors, and a line of high-performance software for operating networks, computing equipment, and storage products. Sun also provides a full range of services including support, education, and professional services. The Company markets its products primarily to business, government, and education customers and operates in various product segments across geographically diverse markets. 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 and tax-exempt securities 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 were classified as either trading or available-for-sale and are carried at fair value. All of the Company's cash equivalents and short-term investments were classified as available-for-sale at June 30, 1999 and 1998. Realized and unrealized gains and losses are computed on the specific identification method based upon actual sales prices 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 the consolidated balance sheet caption "Accumulated other comprehensive income (loss)." The change in net unrealized gains and losses on investments, net of income taxes, included in stockholders' equity at June 30, 1999 and 1998, was not material. The Company maintains certain trading assets to generate returns that offset changes in certain liabilities related to deferred compensation arrangements. The trading assets consist of marketable equity securities and are stated at fair value. Both realized and unrealized gains and losses generally offset the change in the deferred compensation liability and have not been 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 records inventory write downs for potentially excess and obsolete inventory based on backlog and forecasted demand. However, such backlog and forecasted demand is subject to revisions, cancellations, and rescheduling. Actual demand will inevitably differ from such backlog and forecasted demand, and such differences may be material to the financial statements. Inventories consist of:
(in thousands) 1999 1998 Raw materials $113,070 $ 92,197 Work in progress 51,183 58,765 Finished goods 143,620 195,484 -------- -------- Total $307,873 $346,446 ======== ========
24 PROPERTY, PLANT AND EQUIPMENT - -------------------------------------------------------------------------------- Property, plant and equipment are stated at cost. Depreciation and amortization are provided principally on the straight-line method over the estimated useful lives of the assets. Depreciation of fixed assets is generally calculated for machinery and equipment, furniture and fixtures, and buildings and related building improvements based upon useful lives of one to five years, five years, and seven to twenty-five years, respectively. Leasehold improvement useful lives are the shorter of five years or the applicable lease term. OTHER ASSETS - -------------------------------------------------------------------------------- Other assets consist primarily of 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 1999, 1998, and 1997 was $78 million, $42 million, and $27 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 sheet caption "Accumulated other comprehensive income (loss)." Currency transaction gains or losses are recognized in current operations and have not been significant to the Company's operating results in any period. The effect of foreign currency rate changes on cash and cash equivalents is not material. OTHER FINANCIAL INSTRUMENTS - -------------------------------------------------------------------------------- The Company enters into interest-rate swap agreements to modify the interest characteristics of its outstanding long-term debt. An interest-rate swap agreement is designated as a hedge and its effectiveness is determined by matching principal balance and terms with that of a specific debt obligation. Such an agreement involves the exchange of amounts based on a fixed interest rate for amounts based on variable interest rates over the life of the agreement without an exchange of the notional amount upon which payments are based. The differential to be paid or received as interest rates change is accrued and recognized as an adjustment of interest expense related to the debt (the accrual method of accounting). The related amount payable to or receivable from counterparties is included in accrued liabilities or other assets, respectively. The Company purchases foreign currency option contracts that effectively enable it to sell currencies expected to be received as a result of certain of its foreign currency denominated sales during the ensuing quarter at specified dollar amounts. The option contracts, which have only nominal intrinsic value at the time of purchase, are denominated in the same foreign currency in which sales are expected to be denominated. These contracts are designated and effective as hedges of a portion of probable foreign currency exposure on anticipated net sales transactions during the next quarter, which otherwise would expose the Company to foreign currency risk. Premiums related to option contracts are recognized into income over the life of the contract. Gains on foreign currency option contracts that are designated as hedges on anticipated transactions are deferred until the designated net sales are recorded. Option contracts that would result in losses if exercised are allowed to expire. The Company uses forward foreign exchange contracts that are designated to reduce a portion of its exposure to foreign currency risk from operational and balance sheet exposures resulting from changes in foreign currency exchange rates. Such exposures result from the portion of the Company's operations, assets, and liabilities that are denominated in currencies other than the functional currency of the legal entity, 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 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. 25 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 expense was $246 million, $235 million, and $272 million for fiscal years 1999, 1998, and 1997, 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 EXPENSE - -------------------------------------------------------------------------------- The Company provides currently for the estimated costs that may be incurred under warranties for product shipped. Accrued warranty liability of $166 million and $116 million at June 30, 1999 and 1998, respectively, is included in the consolidated balance sheet caption "Accrued liabilities and other." NET INCOME PER COMMON SHARE - -------------------------------------------------------------------------------- Basic earnings per common share is calculated by dividing net income by the weighted average number of common shares outstanding during the period and excludes any dilutive effects of options, warrants, and convertible securities. Dilutive earnings per common share is calculated by dividing net income by the weighted average number of common shares used in the basic earnings per common share calculation plus the dilutive effect of options, warrants, and convertible securities.
- -------------------------------------------------------------------------------- (In thousands, except per share amounts) Years Ended June 30, - -------------------------------------------------------------------------------- NET INCOME PER COMMON SHARE 1999 1998 1997 Net income $1,031,334 $762,862 $762,420 - -------------------------------------------------------------------------------- Shares used to compute net income per common share--basic 765,853 747,456 736,852 Effect of dilutive securities 48,388 41,092 41,082 - -------------------------------------------------------------------------------- Shares used to compute net income per common share--diluted 814,241 788,548 777,934 - -------------------------------------------------------------------------------- Net income per common share--basic $ 1.35 $ 1.02 $ 1.03 - -------------------------------------------------------------------------------- Net income per common share--diluted $ 1.27 $ 0.97 $ 0.98 - --------------------------------------------------------------------------------
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, 1999 and 1998. 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 1999, the Company provided approximately $18 million for doubtful accounts ($23 million and $20 million in 1998 and 1997, respectively). 26 STOCK DIVIDEND - -------------------------------------------------------------------------------- The Company announced a two-for-one stock split (in the form of a stock dividend) on January 21, 1999, which was distributed at the close of business on April 8, 1999. The Company also effected a two-for-one stock split (in the form of a stock dividend) to stockholders of record as of the close of business on November 18, 1996. All earnings per common share amounts, as well as references to common stock and stockholders' equity amounts have been restated as if these stock dividends had occurred as of the earliest period presented. 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 Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees," and has provided in Note 9 pro forma disclosures of the effect on net income and earnings 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 - -------------------------------------------------------------------------------- In fiscal 1999, the Company adopted 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." Comprehensive income is defined as the change in equity of a company during a period from transactions and other events and circumstances excluding transactions resulting from investment by owners and distributions to owners. The primary difference between net income and comprehensive income for the Company is due to currency translation adjustments. Comprehensive income is reflected in the consolidated statements of stockholders' equity. FAS 131 supersedes Financial Accounting Standards No. 14, "Financial Reporting for Segments of a Business Enterprise," replacing the "industry segment" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. FAS 131 also requires disclosures about products and services, geographic areas, and major customers. See Note 10 for these disclosures. In June 1998, Financial Accounting Standards No. 133 (FAS 133), "Accounting for Derivative Instruments and Hedging Activities" was issued and was effective for all fiscal years beginning after June 15, 1999. FAS 133 was subsequently amended by Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133" and will now be effective for fiscal years beginning after June 15, 2000, with early adoption permitted. FAS 133, as amended, requires the Company to recognize all derivatives as either assets or liabilities and measure those instruments at fair value. It further provides criteria for derivative instruments to be designated as fair value, cash flow, and foreign currency hedges and establishes respective accounting standards for reporting changes in the fair value of the derivative instruments. Upon adoption, the Company will be required to adjust hedging instruments to fair value in the balance sheet and recognize the offsetting gains or losses as adjustments to be reported in net income or other comprehensive income, as appropriate. The Company has not completed its assessment of the impact of FAS 133, as amended, on its consolidated financial position or results of operations and is in the process of determining when it will adopt FAS 133. The Company also adopted Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" effective July 1, 1998. The adoption of SOP 98-1 did not have a material effect on the Company's consolidated financial position or operating results. 27 2. ACQUISITIONS During the three years ended June 30, 1999, the Company completed ten 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. On August 28, 1998, the Company completed its acquisition of NetDynamics, Inc. (NetDynamics), a company conducting development, engineering, and testing activities associated with the completion of a new enterprise application platform product. Sun 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 based upon an agreed-upon exchange ratio which was calculated using an agreed-upon average market price for Sun common stock. The Company issued 5,493,570 shares of Sun common stock (with a fair market value of $24.13 per share) as consideration for the acquisition. Additionally, Sun issued approximately 1,136,000 stock options in exchange for NetDynamics stock options previously outstanding, including approximately 344,000 Sun options in exchange for vested NetDynamics stock options, with terms similar to Sun stock options. The fair value of the Sun stock options exchanged for rights to vested NetDynamics stock options at the time of the acquisition was included as part of the purchase price. The excess purchase price over the estimated fair value of net tangible assets has been allocated to various intangible assets, primarily consisting of developed technology ($20 million), goodwill ($36.2 million), customer base ($10 million), and assembled work force ($2 million). In addition to the intangible assets acquired, an $80 million charge representing the write-off of purchased in-process research development (IPRD) was recorded. On January 22, 1999, the Company acquired all of the outstanding capital stock of Maxstrat Corporation (Maxstrat), by means of a merger transaction pursuant to which all of the shares of Maxstrat capital stock were converted into the right to receive cash for total consideration of $101.5 million, net of cash received of $18.7 million and including $2.5 million associated with vested stock options. The excess purchase price over the estimated fair value of net tangible assets has been allocated to various intangible assets, primarily consisting of developed technology of $8.6 million and goodwill and goodwill-like assets totaling $61.5 million. In addition to the intangible assets acquired, the Company recorded a $28.7 million charge, representing the write-off of IPRD. On September 28, 1998, the Company completed its acquisition of i-Planet, Inc. (i-Planet), a company conducting development, engineering, and testing activities associated with the completion of a new Java technology based remote Internet access product. Sun acquired all of the outstanding capital stock of i-Planet by means of a merger transaction pursuant to which all the shares of i-Planet capital stock were converted into the right to receive cash for total consideration of $30 million, including $1.2 million associated with vested stock options. The excess purchase price over the estimated fair value of net tangible assets has been allocated to various intangible assets, primarily consisting of developed technology of $3.3 million and various goodwill and goodwill-like assets totaling $18.3 million. In addition to the intangible assets acquired, an $8.4 million charge representing the write-off of IPRD was recorded. On October 16, 1998, the Company completed its acquisition of Beduin Communications Incorporated (Beduin), a company conducting development, engineering, and testing activities associated with the completion of a suite of smart device products. Sun acquired all of the outstanding capital stock of Beduin by means of a share purchase transaction pursuant to which all the shares of Beduin capital stock were converted into the right to receive cash for total consideration of $8.4 million. The excess purchase price over the estimated fair value of net tangible assets has been allocated to various intangible assets, primarily consisting of developed technology of $3.1 million and various goodwill and goodwill-like assets totaling $1.7 million. In addition to the intangible assets acquired, a $3.6 million charge was recorded, representing the write-off of IPRD. 28 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-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 that 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 Java Card(TM) 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 that will offer improved performance 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 Java virtual machine for the Microsoft 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. A summary of the Company's purchase transactions that included IPRD charges is included in the following table (in millions):
Entity Name Consideration Date IPRD Charge Form of Consideration & Other Notes FISCAL 1999 - ----------- NetDynamics $148.2 August 28, 1998 $80.0 $140.8 in common stock and $7.4 in assumed liabilities; developed technology of $20.0; goodwill and other intangibles of $48.2 Maxstrat $101.5 January 22, 1999 $28.7 $99.0 in cash and $2.5 in common stock; developed technology of $8.6; goodwill and other intangibles of $61.5 i-Planet $ 30.0 September 28, 1998 $ 8.4 $28.6 in cash, $1.2 in common stock, and $0.2 in assumed liabilities Beduin $ 8.4 October 16, 1998 $ 3.6 Cash FISCAL 1998 - ----------- Red Cape $ 16.7 May 29, 1998 $14.1 Cash Encore $186.2 November 24, 1997 $97.0 Cash; developed technology of $56; goodwill and other intangibles of $6.7 Chorus $ 26.5 October 21, 1997 $13.1 Cash Integrity Arts $ 30.2 September 22, 1997 $29.9 Cash Diba $ 29.7 August 22, 1997 $22.3 $25.6 in cash and $4.1 in assumed liabilities FISCAL 1997 - ----------- Long View $ 23.0 February 14, 1997 $23.0 Cash
29 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 Company computed its valuations of purchased IPRD for certain of the above acquisitions, specifically NetDynamics, Maxstrat, i-Planet, Beduin, Red Cape, Integrity Arts, and Diba, as well as certain technology acquired from Chorus, using a discounted cash flow analysis on the anticipated income stream to be generated by the purchased technologies. The Company computed its valuations of IPRD related to certain of the acquisitions, specifically, Encore and Long View, as well as certain technology acquired from Chorus, using an income approach that is based on the assumption that in lieu of ownership, a company would be willing to pay for the right to exploit the related benefits of the acquired technology. This method utilizes revenue related to the acquired technology, an appropriate rate for the use of such technology, expected technology life cycles, amortization cost of the asset acquired, and an appropriate discount rate. 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 work force. The values assigned to developed technologies related to each acquisition were based upon future discounted cash flows related to the existing products' 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 work forces. Amounts allocated to goodwill and other intangibles are amortized on a straight-line basis over periods ranging from two to five years. 3. STRATEGIC DEVELOPMENT AND MARKETING AGREEMENT WITH AMERICA ONLINE, INC. On November 23, 1998, Sun and America Online, Inc. (AOL) entered into a Strategic Alliance consisting of several agreements between the parties, including a Strategic Development and Marketing Agreement (SDMA). The SDMA has a term of three years which commenced on March 17, 1999 in accordance with its terms upon the consummation of AOL's acquisition of Netscape Communications, Inc. (Netscape). Under the terms of the SDMA, AOL and Sun are committed to collaboratively develop, market, and sell client and server software, and collaboratively develop an AOL-specific Java environment that will enable AOL services to be accessed through a variety of hardware devices. The SDMA provides that over its term, AOL will develop and market, together with Sun, client software and network application and server software based in part on Netscape code, on Sun code and technology, and on certain AOL services features to business enterprises. In addition, AOL and Sun have agreed to coordinate their sales efforts with respect to designated AOL, Netscape, Sun, and collaboratively developed client software and network application and server software and associated services. Under the terms of the SDMA, Sun has committed that the total revenue earned by AOL from certain existing Netscape contracts, the sale or license by Sun or AOL of certain AOL, Netscape, and collaboratively developed software products and services will not be less than $312 million, $330 million, and $333 million in the first, second, and third years of the SDMA. In addition, the terms of the SDMA require Sun to pay AOL approximately $275 million over the term of the SDMA for software and trademark rights granted to Sun by AOL. The long-term portion of this contractual obligation of $165 million is reflected in the consolidated balance sheet caption "Deferred income taxes and other obligations." 4. FAIR VALUE OF FINANCIAL INSTRUMENTS Fair values of cash equivalents and short-term investments approximate cost due to the short period of time to maturity. The fair value of long-term debt was estimated based on current interest rates available to 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. 30 The fair value of the Company's cash equivalents and short-term investments is as follows:
- -------------------------------------------------------------------------------------------- (In thousands) At June 30, 1999 - -------------------------------------------------------------------------------------------- GROSS GROSS FAIR VALUE OF CASH EQUIVALENTS UNREALIZED UNREALIZED ESTIMATED AND SHORT-TERM INVESTMENTS COST GAINS LOSSES FAIR VALUE State and local government debt $ 236,644 $-- $195 $ 236,449 Corporate and other non-governmental debt 1,024,320 -- 72 1,024,248 U.S. government debt 332,993 -- 234 332,759 Floating rate notes 229,540 -- 15 229,525 Money market fund 184,600 -- -- 184,600 Other investments 26,771 -- -- 26,771 - -------------------------------------------------------------------------------------------- Total $2,034,868 $-- $516 $2,034,352 - --------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------- (In thousands) At June 30, 1999 - -------------------------------------------------------------------------------------------- GROSS GROSS FAIR VALUE OF CASH EQUIVALENTS UNREALIZED UNREALIZED ESTIMATED AND SHORT-TERM INVESTMENTS COST GAINS LOSSES FAIR VALUE State and local government debt $ 94,843 $22 $11 $ 94,854 Corporate and other non-governmental debt 421,573 -- -- 421,573 U.S. government debt 53,474 74 -- 53,548 Floating rate notes 99,460 -- -- 99,460 Money market fund 97,900 -- -- 97,900 Other investments 16,599 -- -- 16,599 - -------------------------------------------------------------------------------------------- Total $ 783,849 $96 $11 $783,934 - --------------------------------------------------------------------------------------------
The cost and estimated fair value of cash equivalents and short-term investments by contractual maturity are as follows:
- -------------------------------------------------------------------------------------------- (In thousands) At June 30, 1999 - -------------------------------------------------------------------------------------------- ESTIMATED CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS COST FAIR VALUE Maturing in one year or less $1,805,328 $1,804,827 Maturing after one year 229,540 229,525 - ------------------------------------------------------------------------------------------- Total $2,034,868 $2,034,352 - -------------------------------------------------------------------------------------------
The fair value of the Company's borrowing arrangements and other financial instruments is as follows:
- ------------------------------------------------------------------------------------------------ (In thousands) At June 30, 1999 At June 30, 1999 - ------------------------------------------------------------------------------------------------ FAIR VALUE OF BORROWING ARRANGEMENTS ASSET (LIABILITY) ASSET (LIABILITY) CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE 10.18% mortgage loan $ -- $ -- $(40,000) $(41,495) Forward foreign exchange contracts 4,640 4,640 4,265 4,265 Foreign currency option contracts -- 8,574 -- 7,531 Short-term borrowings (1,646) (1,646) (7,169) (7,169) Interest-rate swap agreement -- -- -- 292 - ------------------------------------------------------------------------------------------------
31 5. DERIVATIVE FINANCIAL INSTRUMENTS Outstanding notional amounts for derivative financial instruments at fiscal year-ends are as follows:
- --------------------------------------------------------------------------- (In thousands) - --------------------------------------------------------------------------- NOTIONAL AMOUNTS FOR DERIVATIVES 1999 1998 Swaps hedging debt $ -- $ 40,000 Forward foreign exchange contracts 844,551 930,155 Foreign currency option contracts 476,260 241,861
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 Note 1. At June 30, 1999 and 1998, the Company had forward foreign exchange contracts of less than three months duration, to exchange principally Japanese yen, British pounds, French francs, and German marks for U.S. dollars in the total gross notional amount of $845 million and $930 million, respectively. Of these notional amounts, forward contracts to purchase foreign currency represented $126 million and $139 million, and forward contracts to sell foreign currency represented $719 million and $791 million, at June 30, 1999 and 1998, respectively. The Company also has purchased foreign currency options of less than two months duration, to exchange principally Japanese yen, British pounds, German marks, and French francs for U.S. dollars. 6. BORROWING ARRANGEMENTS As of June 30, 1998, the Company had a $40 million mortgage loan which was secured by real property and a building. The loan agreement provided for interest at a fixed interest rate of 10.18%. However, the Company maintained an interest-rate swap agreement with a third party (receive fixed, pay variable) that resulted in the Company paying a rate based on three-month LIBOR over the life of the loan. The Company settled this mortgage in full in May 1999. The related interest-rate swap agreement matured 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 Euro 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, 1999. There were no borrowings outstanding under this facility at June 30, 1999. At June 30, 1999, Sun's international subsidiaries had uncommitted lines of credit aggregating approximately $740 million, of which approximately $1.6 million, denominated in British pound and Euro, had been drawn. The average interest rate at June 30, 1999 was 4.06%. On October 16, 1997, the Company filed a shelf registration statement with the Securities and Exchange Commission (SEC) relating to the registration 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, this shelf registration statement became effective, so that the Company may 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. On June 18, 1999, the Company filed an additional shelf registration statement with the SEC relating to the registration of additional senior and subordinated debt securities and common and preferred stock with an aggregate initial public offering price of up to $3 billion. See Note 12--"Subsequent Events (unaudited)." 32 7. INCOME TAXES Income before income taxes and the provision for income taxes consists of the following:
- ------------------------------------------------------------------------------------ (In thousands) Years Ended June 30, - ------------------------------------------------------------------------------------ 1999 1998 1997 Income before income taxes: United States $ 975,394 $ 589,387 $ 566,554 Foreign 630,295 586,779 554,653 Total income before income taxes $1,605,689 $1,176,166 $1,121,207 Provision for income taxes: Current: United States federal $ 384,563 $ 349,095 $ 303,537 State 41,517 47,270 46,894 Foreign 129,794 106,192 67,234 Total current income taxes 555,874 502,557 417,665 Deferred: United States federal (2,563) (81,319) (66,027) State 7,432 (6,492) (5,231) Foreign 13,612 (1,442) 12,380 Total deferred income taxes 18,481 (89,253) (58,878) Provision for income taxes $ 574,355 $ 413,304 $ 358,787
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:
- --------------------------------------------------------------------------- (In thousands) At June 30, - --------------------------------------------------------------------------- 1999 1998 Deferred tax assets: Inventory valuation $ 79,565 $ 67,006 Reserves and other accrued expenses 215,489 165,724 Fixed asset basis differences 74,672 81,926 Compensation not currently deductible 39,958 41,407 State income taxes 18,089 15,468 Other 55,864 68,687 Gross deferred tax assets 483,637 440,218 Deferred tax liabilities: Net undistributed profits of subsidiaries (171,839) (124,777) Other (14,410) 428 Gross deferred tax liabilities (186,249) (124,349) Net deferred tax assets $297,388 $ 315,869
33 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:
- -------------------------------------------------------------------------------------------- (In thousands) Years Ended June 30, - -------------------------------------------------------------------------------------------- 1999 1998 1997 Expected tax rate at 35% $561,991 $411,658 $392,423 State income taxes, net of federal tax benefit 31,817 26,506 27,081 Foreign earnings permanently reinvested in foreign operations (82,150) (49,600) (63,550) Acquired in-process research and development 44,498 25,194 -- Other 18,199 (454) 2,833 Provision for income taxes $574,355 $413,304 $358,787
As of June 30, 1999, the Company has unrecognized deferred tax liabilities of approximately $265 million related to cumulative net undistributed earnings of foreign subsidiaries of approximately $824 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 were $222 million, $111 million, and $60 million in fiscal 1999, 1998, and 1997, respectively, and were credited to stockholders' equity. The Company's United States income tax returns for fiscal years ended June 30, 1993 through 1996 are under examination, and the Internal Revenue Service has proposed certain adjustments. Management believes that adequate amounts have been provided for any adjustments that may ultimately result from these examinations. 8. COMMITMENTS AND CONTINGENCIES The Company leases certain facilities and equipment under noncancelable operating leases. The future minimum annual lease payments are approximately $145 million, $116 million, $92 million, $73 million, and $61 million for fiscal years 2000, 2001, 2002, 2003, and 2004, respectively, and approximately $195 million for years following fiscal 2004. Rent expense under the noncancelable operating leases was $166 million in 1999, $139 million in 1998, and $113 million in 1997. From time to time and in the ordinary course of business, the Company may be subject to various claims, charges, and litigation. In the opinion of management, final judgments from such pending claims, charges, and litigation, if any, against the Company would not have a material adverse effect on its consolidated financial position, results of operations, or cash flows. 9. 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 $150, 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. 34 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. Additionally, in connection with the acquisition of Lighthouse Design, Ltd., in fiscal year 1996, former shareholders who are employees of the Company were entitled to receive up to approximately 1,300,000 shares of stock upon achievement of specific performance criteria over a three year period. As of June 30, 1999 all outstanding performance shares related to Lighthouse Design, Ltd., had vested. Information with respect to stock option and stock purchase rights activity is as follows:
- ----------------------------------------------------------------------------------------------- (In thousands, except per share amounts) Outstanding Options/Rights - ----------------------------------------------------------------------------------------------- SHARES WEIGHTED AVAILABLE NUMBER AVERAGE FOR GRANT OF SHARES PRICE PER SHARE EXERCISE PRICE Balance at June 30, 1996 90,556 95,512 $0.0025-$15.0625 $ 5.42 Additional shares reserved 600 -- -- -- Grants (26,578) 26,578 $0.000335-$16.96875 $13.45 Exercises -- (14,734) $0.005-$ 15.0625 $ 3.50 Cancellations 3,680 (4,638) $0.005-$ 16.6875 $ 6.66 - ----------------------------------------------------------------------------------------------- Balance at June 30, 1997 68,258 102,718 0.000335-$16.96875 $ 7.72 Additional shares reserved 10,344 -- -- -- Grants (29,762) 29,762 $0.0003-$ 23.6875 $18.91 Exercises -- (18,526) $0.0003-$16.96875 $ 4.27 Cancellations 3,982 (3,982) $0.675-$ 23.6875 $10.63 - ----------------------------------------------------------------------------------------------- Balance at June 30, 1998 52,822 109,972 $0.000335-$ 23.6875 $11.14 Additional shares reserved 37,053 -- -- -- Grants (22,995) 22,995 $0.00067-$ 62.1891 $40.07 Exercises -- (22,156) $0.00067-$ 31.4688 $ 6.51 Cancellations 6,469 (6,469) $0.01-$ 54.375 $15.07 Balance at June 30, 1999 73,349 104,342 $0.005-$ 62.1891 $17.96 - -----------------------------------------------------------------------------------------------
35 The following table summarizes significant ranges of outstanding and exercisable options at June 30, 1999:
- ----------------------------------------------------------------------------------------- (In thousands, except per share amounts) Outstanding Options Options Exercisable - ----------------------------------------------------------------------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE RANGE OF REMAINING EXERCISE EXERCISE EXERCISE PRICES SHARES LIFE IN YEARS PRICE SHARES PRICE $ 0.005-$ 6.2189 26,649 3.9 $ 3.84 18,835 $ 3.60 $ 6.219-$12.4378 12,154 5.0 $11.28 4,827 $11.31 $12.4379-$18.6567 24,135 6.0 $14.27 7,206 $14.18 $18.6568-$24.8756 23,203 7.1 $20.64 3,674 $20.42 $24.8757-$31.0946 330 8.0 $26.43 -- $ -- $31.0947-$37.3135 5,284 7.2 $31.47 5 $31.47 $37.3136-$43.5324 525 7.9 $39.94 -- $39.94 $43.5325-$49.7513 450 7.6 $48.75 -- $ -- $49.7514-$55.9702 10,338 8.2 $50.13 7 $50.13 $55.9703-$62.1891 1,274 8.3 $58.91 -- $ -- - ----------------------------------------------------------------------------------------- 104,342 5.9 $17.96 34,554 $ 8.69 - -----------------------------------------------------------------------------------------
At June 30, 1999, options to purchase 34,554,000 shares were exercisable at prices from $0.01 to $50.13 with a weighted average and aggregate exercise price of $8.69 and $300,146,000, respectively, (29,920,000 shares at an aggregate price of $190,505,000 at June 30, 1998). At June 30, 1999, the Company retained repurchase rights to 181,000 shares issued pursuant to stock purchase agreements and other stock plans. The weighted average fair value at date of grant for options granted during 1999, 1998, and 1997 was $24.93, $13.09, and $8.94 per option, respectively. EMPLOYEE STOCK PURCHASE PLAN - -------------------------------------------------------------------------------- To provide employees with an opportunity to purchase common stock of Sun through payroll deductions, Sun established the 1990 Employee Stock Purchase Plan. Under this plan, Sun's employees, subject to certain restrictions, may purchase shares of common stock at 85% of the fair market value at either the date of enrollment or the date of purchase, whichever is less. Pursuant to this plan, the Company issued approximately 5,579,000, 7,010,000, and 5,857,000 shares of common stock in fiscal 1999, 1998, and 1997, respectively. At June 30, 1999, approximately 33,956,000 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 1999, the Company repurchased 4,738,000 shares at a cost of approximately $199 million under this program (5,883,000 shares at a cost of approximately $127 million in 1998). In August 1996, the Board of Directors approved a systematic common stock repurchase program related to the 1990 Incentive Plan. In June 1999, the Board renewed this repurchase plan for an additional three years. In fiscal 1999, the Company repurchased 4,672,000 shares at a cost of approximately $159 million under this program (7,309,000 shares at a cost of approximately $157 million in 1998). In June 1995, the Board of Directors approved a plan to repurchase approximately 96 million shares of the Company's common stock. In July and August 1996, the Company repurchased 17,809,000 shares at a cost of approximately $236 million under this program. 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. 36 STOCK-BASED COMPENSATION - -------------------------------------------------------------------------------- FAS 123 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 applies the existing accounting rules under APB 25 and provides pro forma net income and pro forma earnings per common share disclosures for stock-based awards made during the year as if the fair-value-based method defined in FAS 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 6.63 year Treasury Yield as of the date of grant ranging from 4.26% to 5.95% for fiscal year 1999. 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, - ---------------------------------------------------------------- 1999 1998 1997 Expected life 6.6 7.8 8.1 Interest rate 5.06% 5.73% 6.06% Volatility 49.51% 49.60% 46.60% Dividend yield -- -- --
For the Employee Stock Purchase Plan, the fair value of the stock was calculated using actuals for the plans expiring during the year. For plans expiring after year end, the fair value was calculated using estimated shares to be purchased and estimated purchase price. Stock-based compensation costs would have reduced pretax income by $194,777,000, $132,985,000, and $76,033,000 in 1999, 1998, and 1997, respectively ($130,135,000, $89,374,000, and $51,703,000 after tax and $0.15, $0.09, and $0.04 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 1999, 1998, and 1997 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:
- ------------------------------------------------------------------------------------------------ (In thousands, except per share amounts) - ------------------------------------------------------------------------------------------------ 1999 1998 1997 Pro forma net income $901,199 $673,488 $710,717 - ------------------------------------------------------------------------------------------------ Basic: Pro forma shares used in the calculation of pro forma net income per common share--basic 765,853 747,456 736,852 - ------------------------------------------------------------------------------------------------ Pro forma net income per common share--basic $ 1.18 $ 0.90 $ 0.96 - ------------------------------------------------------------------------------------------------ Diluted: Pro forma shares used in the calculation of pro forma net income per common share--diluted 805,253 766,754 754,576 - ------------------------------------------------------------------------------------------------ Pro forma net income per common share--diluted $ 1.12 $ 0.88 $ 0.94 - ------------------------------------------------------------------------------------------------
37 10. INDUSTRY SEGMENT, GEOGRAPHIC, AND CUSTOMER INFORMATION In fiscal 1999 the Company adopted FAS 131, which establishes standards for reporting information about operating segments and related disclosures about products, geographic information, and major customers. Operating segment information for 1998 and 1997 is also presented in accordance with FAS 131. Sun designs, manufactures, markets, and services network computing systems and software solutions that feature networked desktops and servers. The Company is organized by various product divisions including Computer Systems and Storage, Enterprise Services, and various other divisions. Each division has a divisional president who reports to the President of the Company. The President of the Company allocates resources to each of these divisions using information regarding their respective revenues and operating income. The President of the Company has been identified as the Chief Operating Decision Maker as defined by FAS 131. In addition to the aforementioned divisions, finance and administration, as well as certain other corporate groups, report to the Chief Executive Officer of the Company. Expenses of these groups are not allocated to the operating segments and are included in the operating results of the Other segment reported below. Although the Company has various divisions, only Computer Systems and Storage and Enterprise Services are considered reportable segments under the criteria of FAS 131. Products in the Computer Systems and Storage segment include a broad range of desktop systems, servers, storage, and network switches, incorporating the UltraSPARC processors and Solaris operating environment. In the Enterprise Services segment, the Company provides a full range of services and support to existing and new customers, including education, professional services, and systems integration. The Other segment consists of various software and other miscellaneous divisions, such as corporate, which did not meet the requirements individually for a reportable segment as defined in FAS 131. The Company does not identify or allocate depreciation by operating segments, nor does the President of the Company evaluate divisions on depreciation expense. Additionally, the Company does not allocate interest and other income, interest expense, charges related to IPRD, or taxes to operating segments. The accounting policies for segment reporting are the same as for the Company taken as a whole. See "Summary of Significant Accounting Policies" in Note 1. 38 Information on reportable segments for the three years ended June 30, 1999 is as follows:
- -------------------------------------------------------------------------------------------- (In thousands) - -------------------------------------------------------------------------------------------- COMPUTER ENTERPRISE 1999 SYSTEMS AND STORAGE SERVICES OTHER TOTAL Revenues $9,553,098 $1,635,251 $ 537,948 $11,726,297 Interdivision revenues -- 321,388 (321,388) -- Operating income 1,644,234 219,716 (342,185) 1,521,765 Capital additions 204,003 33,686 501,018 738,707 Accounts receivable 1,746,028 447,377 93,506 2,286,911 Inventory 287,425 4,787 15,661 307,873 Total assets $4,316,120 $ 723,807 $3,380,425 $ 8,420,352
COMPUTER ENTERPRISE 1998 SYSTEMS AND STORAGE SERVICES OTHER TOTAL Revenues $8,251,490 $1,187,581 $ 351,769 $ 9,790,840 Interdivision revenues 106,543 265,826 (372,369) -- Operating income 1,377,331 87,247 (334,504) 1,130,074 Capital additions 255,310 38,995 535,838 830,143 Accounts receivable 1,412,414 357,429 75,922 1,845,765 Inventory 312,743 7,115 26,588 346,446 Total assets $3,127,849 $ 531,197 $ 2,052,016 $ 5,711,062
COMPUTER ENTERPRISE 1997 SYSTEMS AND STORAGE SERVICES OTHER TOTAL Revenues $7,406,193 $ 851,231 $ 340,922 $ 8,598,346 Interdivision revenues 270,881 192,653 (463,534) -- Operating income 1,167,617 96,490 (237,589) 1,026,518 Capital additions 222,349 22,758 308,911 554,018 Accounts receivable 1,385,282 213,647 67,594 1,666,523 Inventory 370,243 805 66,930 437,978 Total assets $2,884,569 $ 340,390 $1,472,315 $ 4,697,274
One customer accounted for 14% of revenues in both fiscal 1999 and 1998. No customer accounted for 10% or more of revenues in fiscal 1997. The Company's significant operations outside the United States include manufacturing facilities, design centers, and sales offices in Europe, Japan, and Rest of World. Transfers between operating segments and geographic areas are primarily accounted for at prices that approximate arm's length transactions. In fiscal 1999, sales from Computer Systems and Storage to Enterprise Services are at cost. In addition, United States export sales approximated 2.5%, 2.3%, and 3.0% of net revenues during fiscal 1999, 1998, and 1997, respectively. Information regarding geographic areas at June 30, 1999, 1998, and 1997, and for each of the years then ended, is as follows:
- --------------------------------------------------------------------------------------------------------------------------- (In thousands) UNITED STATES EUROPE JAPAN REST OF WORLD ELIMINATIONS TOTAL - --------------------------------------------------------------------------------------------------------------------------- June 30, 1999, and for the year then ended: Sales to unaffiliated customers $6,210,865 $3,418,412 $1,047,253 $1,049,767 $ -- $11,726,297 - --------------------------------------------------------------------------------------------------------------------------- Long-lived assets $2,041,514 $ 403,949 $ 54,135 $ 88,515 $(284,111) $ 2,304,002 - --------------------------------------------------------------------------------------------------------------------------- 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 - --------------------------------------------------------------------------------------------------------------------------- Long-lived assets $1,426,183 $ 331,422 $ 45,187 $ 69,303 $(308,558) $ 1,563,537 - --------------------------------------------------------------------------------------------------------------------------- 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 - --------------------------------------------------------------------------------------------------------------------------- Long-lived assets $ 885,224 $ 225,548 $ 46,223 $ 55,719 $(243,890) $ 968,824 - ---------------------------------------------------------------------------------------------------------------------------
39 11. QUARTERLY FINANCIAL DATA (UNAUDITED)
- ------------------------------------------------------------------------------------------------- (In thousands, except per share amounts) Fiscal 1999 Quarter Ended - ------------------------------------------------------------------------------------------------- June 30 March 28 December 27 September 27 Net revenues $3,514,645 $2,936,028 $2,784,440 $2,491,184 Gross margin 1,826,356 1,539,504 1,437,230 1,274,847 Operating income 563,833 383,808 374,145 199,979 Net income 395,170 261,203 261,087 113,874 Net income per common share--diluted $ 0.48 $ 0.32 $ 0.32 $ 0.15
- ------------------------------------------------------------------------------------------------- (In thousands, except per share amounts) Fiscal 1998 Quarter Ended - ------------------------------------------------------------------------------------------------- June 30 March 29 December 28 September 28 Net revenues $2,881,065 $2,360,928 $2,450,243 $2,098,604 Gross margin 1,488,429 1,259,292 1,278,613 1,071,170 Operating income 402,448 333,916 212,835 180,875 Net income 272,988 232,009 149,432 108,433 Net income per common share--diluted $ 0.35 $ 0.29 $ 0.19 $ 0.14
12. SUBSEQUENT EVENTS (UNAUDITED) On August 5, 1999, the Company acquired all of the outstanding capital stock of Star Division Corporation (Star Division), by means of a merger transaction pursuant to which all of the shares of Star Division were converted into the right to receive cash for total consideration of approximately $54 million. Simultaneous with the acquisition of Star Division, Sun acquired certain assets and liabilities of Star Division Software-Entwicklung und Vertriebs GmbH, a related party of Star Division, for total cash consideration of approximately $14 million. These transactions will be accounted for as purchases, and the purchase prices will be allocated to tangible and intangible assets and in-process research and development. On July 14, 1999, the shelf registration statement that Sun filed with the SEC on June 18, 1999, relating to the registration of senior and subordinated debt securities and common and preferred stock with an aggregate initial offering price of up to $3 billion, became effective. The securities registered by Sun were in addition to the $1 billion of securities previously registered and declared effective under a different shelf registration statement filed with the SEC. On August 4, 1999, the Company issued $1.5 billion of unsecured senior debt securities in four tranches. Each tranche is comprised of the following notes (the Senior Notes): $200 million (due on August 15, 2002 and bearing interest at 7%), $250 million (due on August 15, 2004 and bearing interest at 7.35%), $500 million (due on August 15, 2006 and bearing interest at 7.5%), and $550 million (due on August 15, 2009 and bearing interest at 7.65%). Interest on the Senior Notes will be payable semi-annually. Sun may redeem all or any part of any tranche of the Senior Notes at any time at a price equal to 100% of the principal plus accrued and unpaid interest and an amount as determined by a quotation agent, which represents the present value of the remaining scheduled payments. Sun anticipates that the net proceeds from this offering will be used to fund expansion of the Company's business, including additional working capital, capital expenditures, acquisition of products, technologies, and businesses and general corporate matters. Sun also entered into various interest rate swap agreements to modify the interest characteristics of the Senior Notes such that the interest associated with these Senior Notes becomes variable. In August 1999, the Company signed a definitive agreement (the Agreement) to acquire Forte Software, Inc. (Forte), a publicly held enterprise tools software company, by means of a stock-for-stock merger. Under terms of the Agreement, each share of Forte common stock will be converted into 0.3 shares of Sun common stock. Additionally, Sun will assume the remaining outstanding Forte stock options, which will be converted to options to purchase Sun common stock based on the exchange ratio used for the common shares exchanged. The merger is subject to certain regulatory approvals, the approval of Forte's shareholders, and other customary closing conditions. The transaction is expected to be accounted for as a pooling of interests, and it is anticipated that it will close in the second quarter of fiscal 2000. The historic results of operations of Forte are not expected to be material to the financial position or results of operations of the Company. 40 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, 1999 and 1998, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended June 30, 1999. 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, 1999 and 1998, and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 1999, in conformity with generally accepted accounting principles. [ERNST & YOUNG LLP] Palo Alto, California July 21, 1999 EX-21.0 5 SUBSIDIARIES OF REGISTRANT 1 EXHIBIT 21.0 SUN MICROSYSTEMS, INC. SUBSIDIARIES Beduin Nova Scotia Company Belle Gate Investment B.V. Dakota Scientific Software, Inc. Diba, Inc. Diba Europe Limited Integrity Arts, Inc. i-Planet, Inc. Lighthouse Design, Ltd. Lighthouse Design R&D Corporation MAXSTRAT Corporation MAXSTRAT FS Corporation NetDynamics International, Inc. NetDynamics Europe Limited Sun Microsystems K.K Red Cape Software, Inc. Sarrus Software, Inc. Solaris Corporation Star Division Corporation Star Office GmbH Sun Microsystems (Barbados), Ltd. Sun Microsystems (Schweiz) A.G Sun Microsystems AB Sun Microsystems AO Sun Microsystems AS Sun Microsystems Australia Pty. Ltd. Sun Microsystems Belgium N.V./S.A. Sun Microsystems Benelux B.V. Sun Microsystems Bilgisayar Sistemleri Limited Sirketi Sun Microsystems Czech s.r.o Sun Microsystems Distributions International, Inc. Sun Microsystems Danmark A/S Sun Microsystems (Egypt) LLC Sun Microsystems Europe Properties, Inc. Sun Microsystems Europe Properties B.V Sun Microsystems Federal, Inc. Sun Microsystems France S.A. Sun Microsystems GmbH Sun Microsystems (Hellas) S.A. Sun Microsystems Holdings Limited Sun Microsystems Hungary Computing Limited Liability Company Sun Microsystems Iberica, S.A. Sun Microsystems India Private Limited Sun Microsystems Intercontinental Operations Sun Microsystems International, Inc. Sun Microsystems International B.V. Sun Microsystems Ireland Limited Sun Microsystems Italia S.p.A. Sun Microsystems Korea, Ltd. Sun Microsystems Limited Sun Microsystems Malaysia Sdn. Bhd. Sun Microsystems Management Services Corporation Sun Microsystems Nederland B.V. Sun Microsystems (NZ) Limited Sun Microsystems Oy Sun Microsystems Poland Sp.z.o.o. Sun Microsystems (Portugal) Tecnias de Informatica, Sociedade Unipessdal, Limitada Sun Microsystems Properties, Inc. Sun Microsystems Pte. Ltd. Sun Microsystems Saudi Arabia B.V. Sun Microsystems Scotland B.V. Sun Microsystems Scotland Limited Sun Microsystems Slovakia, s.r.o. Sun Microsystems (South Africa) (Pty) Limited Sun Microsystems Superannuation Nominees Pty. Ltd. Sun Microsystems (Thailand) Limited Sun Microsystems (U.A.E.) Ltd. Sun Microsystems de Chile S.A. Sun Microsystems de Colombia, S.A. Sun Microsystems de Mexico, S.A. de C.V. Sun Microsystems de Venezuela, S. A. Sun Microsystems do Brasil Industria e Comercio Ltda. Sun Microsystems of California, Inc. Sun Microsystems of California, Limited Sun Microsystems of Canada Inc. Sun Microsystems China Ltd. Sun TSI Subsidiary, Inc. SunSoft, Inc. SunSoft International, Inc. Solaris Indemnity, Ltd. Solaris Assurance, Inc. Sun Microsystems Risk Management, Inc. Sun Microsystems Taiwan Limited Sun Microsystems Israel Limited Sun Microsystems Technology Pty. Ltd. Sun Microsystems (China) Co., Ltd. Sun Microsystems de Argentina S.A. EX-23.1 6 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS 1 EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of Sun Microsystems, Inc. of our report dated July 21, 1999, included in the 1999 Annual Report to Stockholders of Sun Microsystems, Inc. Our audits also included the financial statement schedule of Sun Microsystems, Inc. listed in Item 14(a). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 33-9293, 33-11154, 33-15271, 33-18602, 33-25860, 33-28505, 33-33344, 33-38220, 33-51129, 33-56577, 333-01459, 333-09867, 333-15179, 333-34543, 333-34651, 333-38163, 333-40677, 33-40675, 333-59503, 333- 62987, 333-65531, 333-67183, 333-72413, and 333-86267) 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 Director's 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, the i-Planet, Inc. 1996 Stock Option/Stock Issuance Plan, the Maxstrat Corporation 1994 Stock Option Plan, and the Star Division Corporation 1998 Stock Plan and we also consent to the incorporation by reference in Amendment No. 1 to the Registration Statement (Form S-3 No. 333-81101) and related Prospectus of our report dated July 21, 1999, with respect to the consolidated financial statements incorporated herein by reference and our report included in the preceding paragraph with respect to the financial statement schedule included in this Annual Report (Form 10-K) of Sun Microsystems, Inc. for the year ended June 30, 1999. ERNST & YOUNG LLP Palo Alto, California September 23, 1999 EX-27 7 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS JUN-30-1999 JUL-01-1998 JUN-30-1999 1,088,972 1,576,079 2,286,911 338,771 307,873 6,116,350 2,871,348 1,262,427 8,420,352 3,226,977 0 0 0 581 4,811,780 8,420,352 10,091,046 11,726,297 4,674,390 10,204,532 0 0 675 1,605,689 574,355 1,031,334 0 0 0 1,031,334 1.35 1.27
-----END PRIVACY-ENHANCED MESSAGE-----