<PAGE> 1
Exhibit 13.0
WE LOOK GREAT ON PAPER AND EVEN BETTER ON THE WEB:
WWW.SUN.COM/ANNUALREPORT
<PAGE> 2
[SUN MICROSYSTEMS LOGO]
VISION + FOCUS + EXECUTION =
<PAGE> 3
Sun Microsystems began with the idea that individual computers should be built
with something more in mind than an individual computer--that the real value of
any system is in how well it connects with others. The phenomenal growth of the
Internet and network computing simply confirms that we've been on the right
track since day one. Another powerful affirmation of our vision is Sun's
remarkable record of financial growth--and fiscal 2000 was our most remarkable
year yet.
[GRAPHIC]
<TABLE>
<S> <C> <C> <C>
[BAR GRAPH] [BAR GRAPH] [BAR GRAPH] [BAR GRAPH]
NET REVENUES OPERATING INCOME OPERATING EBITDA NET INCOME PER SHARE -- DILUTED
(in millions of dollars) (in millions of dollars) (in millions of dollars) (in dollars)
</TABLE>
<PAGE> 4
[GRAPHIC]
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
2000 1999 CHANGE
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net revenues (in millions) $ 15,721 $ 11,806 33.2%
Operating income (in millions) $ 2,393 $ 1,520 57.4%
Net income (in millions) $ 1,854 $ 1,030 80.0%
Net income per common share--diluted $ 1.10 $ 0.63 74.6%
Operating EBITDA (in millions) $ 3,181 $ 2,272 40.0%
Return on average equity 31.0% 24.0% 29.2%
Return on average assets 16.0% 14.0% 14.3%
Approximate number of stockholders at year end 1,500,000 645,000 132.6%
Total employees at year end 36,738 30,074 22.2%
Shares used in the calculation of net
income per common share--diluted (in millions) 1,689 1,641 2.9%
Outstanding shares at year end (in millions) 1,597 1,566 2.0%
Book value per outstanding share at year end $ 4.58 $ 3.11 47.3%
</TABLE>
<PAGE> 5
The Internet is changing the way we live our lives: We use it to pay bills,
trade stocks, buy groceries, order tickets, share photos, and continue our
educations. The Net is changing the way companies do business too, streamlining
transactions among employees, partners, suppliers, and customers--everyone along
the value chain of the global economy.
VISION + FOCUS + EXECUTION =
ENABLING THE SERVICE-DRIVEN NETWORK
We call this new way of living and working the service-driven network. It's what
happens when you create systems based on open standards and make network
connectivity an integral part of the design. In short, it's an extension of
Sun's original vision--and for the past five years we've been expanding it to
include anyone, anywhere, anytime, using virtually any device.
Vision 2
<PAGE> 6
THE SERVICE-DRIVEN NETWORK
Providing the right information and services to anyone, no matter where they
are, what time of day it is, or what device they happen to be using.
ACCESS
Users access network-based services through an array of devices, including
mobile phones, PDAs, smart cards, and network computers. What's more, cars,
household appliances, and millions of other devices are joining the network age.
[GRAPHIC]
CONSUMER
Travel
Chat
Calendar
E-mail
Shopping
Entertainment
Personal Finance
INDUSTRY
Utilities
Finance
Manufacturing
Telecommunications
Education
Government
BUSINESS
Purchasing
ERP
Inventory
Supply Chain
Data Warehousing
Productivity Apps
Exchanges
SERVICES
From simple e-mail to online banking to giant Internet exchanges, the countless
options of the service-driven network come to us via an invisible middle layer
of software--directory, messaging, and e-commerce applications--that provides
the vital link between access devices and data-center resources.
INFRASTRUCTURE
Powerful data-center servers, high-capacity storage systems, and
industrial-strength software--all seamlessly integrated--are what it takes to
run the service-driven network, all day, every day.
3 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 7
Here's what we mean by focus: Each of our 37,000 employees and every R&D dollar
we spend are dedicated to the same thing--creating a seamless computing
infrastructure that's so reliable and easy to use you don't have to think about
it any more than you think about electricity today.
VISION + FOCUS + EXECUTION =
BUILDING THE INFRASTRUCTURE OF THE NET ECONOMY
To do that, we have invested in a diverse portfolio of intellectual properties
that combine to form a single, integrated computing platform. One microprocessor
architecture. One operating environment. One very powerful set of business
solutions from Sun and our software partners. All optimized to help our
customers address the challenges of doing business in the nonstop Net economy.
Focus 4
<PAGE> 8
[GRAPHIC]
"Some companies change directions more often than I change the oil in my car.
Sun's focus is right where it's always been: the Net."
------------
SCOTT MCNEALY
------------
Chairman of the Board and CEO
"Our focus is simple: Be the number one provider of technologies, products, and
services that drive the Net Economy."
--------
ED ZANDER
--------
President and COO
"From UNIX(R) to NFS to Java(TM) technology--it's all about the network.
First, last, and always, that's our focus."
-------
BILL JOY
-------
Cofounder and Chief Scientist
"All of our R&D, all of our intellectual property investments, are dedicated to
bringing the power of the Net to anyone, anywhere, anytime, on anything."
----------------
GREG PAPADOPOULOS
----------------
Senior Vice President and CTO
5 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 9
[GRAPHIC]
Having the right vision and the right focus can only take a company so far. Then
you have to deliver the goods. You have to produce the real-world products and
services that transform vision into reality.
VISION + FOCUS + EXECUTION =
DELIVERING OUTSTANDING PRODUCTS AND PROFITS
It's a matter of implementing efficient processes--taking time and cost out of
the system--and getting the right products to market at the right time. It also
means putting together the best possible solutions for our customers, through
innovative programs and strategic partnerships. And it means delivering
consistent results, year after year, as we've done since 1982, when Sun was
founded.
Execution
6
<PAGE> 10
SYSTEMS
Demand for Sun(TM) systems--servers, storage, workstations, information
appliances--has grown in virtually every market, particularly
telecommunications, financial services, manufacturing, retail, and media.
PROGRAMS
Our iForce(SM) initiative delivers products, programs, and services built on the
expertise of Sun and an extensive community of leading companies. Our
SunTone(TM) certification program, for example, includes more than 400 service
providers and software vendors who have applied for certification.
[GRAPHIC]
SOFTWARE
Sun's software offerings extend from developer tools to the industrial-strength
Solaris(TM) Operating Environment and from innovative Java(TM) technologies to
the full range of iPlanet(TM) e-commerce solutions, plus the StarOffice(TM)
productivity suite.
SERVICES
Our 10,000-person service organization supports more than 1.2 million systems
worldwide and is a leading provider of training for the Java platform and
UNIX(R) system software.
[LOGO]
SOLARIS
The operating environment that scales to meet data-center and dot-com
requirements.
[LOGO]
iPLANET
A leading software platform enabling the rapid development, assembly, and
deployment of scalable Internet services.
[LOGO]
JAVA
The cross-platform technology for building network-aware applications.
[LOGO]
JINI
The connection technology that enables devices and services to form spontaneous
networks.
[LOGO]
JIRO
The open standards-based software for managing Net-based data storage.
[LOGO]
ULTRASPARC
Powerful microprocessors that drive the Internet and enterprise networks.
7 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 11
Growth is just a single metric of our success. At Sun, we have a long history of
making the right decisions at just the right time, positioning ourselves to set
the agenda for our industry, grow market share quickly, and become the thought
leaders that others look to in a fast-changing world. The decisions we've made
have clearly paid off for us, for our partners, for our customers, and for our
stockholders.
VISION + FOCUS + EXECUTION =
SUCCESS
[PIE CHART]
28.0%
MARKET-SHARE LEADER IN UNIX SERVER REVENUES IN CY99*
[PIE CHART]
15.0%
MARKET-SHARE LEADER IN APPLICATION SERVER SOFTWARE PLATFORM REVENUES IN CY99*
[PIE CHART]
19.2%
MARKET-SHARE LEADER IN UNIX DISK STORAGE SYSTEMS*
[PIE CHART]
51.0%
MARKET-SHARE LEADER FOR E-BUSINESS PROGRAMMING LANGUAGE (JAVA)**
[PIE CHART]
29.0%
MARKET-SHARE LEADER IN UNIX SERVER SHIPMENTS IN CY99*
[PIE CHART]
60.0%
MARKET-SHARE LEADER OF STAND-ALONE ENTERPRISE E-MAIL SOFTWARE (iPLANET) NEW
USER LICENSES WORLDWIDE IN CY99*
[PIE CHART]
25.4%
SHIPMENTS OF SUN'S SOLARIS LEAD THE PACK FOR UNIX SERVER SOFTWARE FROM A MAJOR
HARDWARE SUPPLIER*
[PIE CHART]
57.0%
MARKET-SHARE LEADER IN WORKSTATION SHIPMENTS IN CY99*
*Market reference per IDC, 2000.
**Market reference per Cutter Consortium.
Letter From The Chairman 8
<PAGE> 12
LETTER FROM THE CHAIRMAN
TRANSLATIONS OF THIS LETTER--IN JAPANESE, GERMAN, SPANISH, CHINESE, KOREAN, AND
FRENCH--ARE AVAILABLE ON THE INTERNET AT WWW.SUN.COM/CEOLETTER
To our stockholders:
Let me start with a heartfelt thank you to everyone who has invested in Sun
Microsystems. Your confidence in us has spurred everyone here to work harder
than ever to give you the best possible return on your investment--not just this
year, but long term.
With that in mind, I also want to thank the whole Sun team for really bringing
home some stellar numbers--record revenues, record earnings per share, and all
the rest of it. It's amazing what you can do with 37,000 people all focused on
the twin goals of customer satisfaction and stockholder value.
GROWING ACCEPTANCE IN THE MARKET
As incredible as fiscal 2000 was--Sun's market value grew $91 billion and our
share price rose 162 percent--we are even more excited about the opportunities
ahead.
We believe that one day every man, woman, and child on the planet will be
connected to a high-speed network at all times--and even that is only a small
part of the story currently unfolding.
We can foresee a time when everyone and everything will be connected--a time
when your alarm clock communicates with your coffeemaker, when the sprinklers in
your yard tune into the latest weather forecast, when your car's navigation
system checks your calendar to see where you want to go next and lets you know
where you can find a good price on gas along the way.
All the fantastic innovations happening today, and all the cool services yet to
come, add up to one thing: The biggest equipment industry in history.
We're convinced, in fact, that the greatest challenge ahead may be simply
keeping up with the demand for our powerhouse servers, high-capacity data
storage systems, industrial-strength software, and comprehensive service
offerings--the very products that power the new Net economy.
Indeed, the market we sell into has grown dramatically in recent years, and so
has our share of that market. For the past five years, we've grown revenues at a
compound annual rate of more than 20 percent. In that same time frame, many of
our competitors experienced single-digit growth or no growth at all.
The key to our success? Focus. As hockey legend Wayne Gretzky used to say,
"Don't skate to the puck; skate to where it's going."
That's why we plowed more than $1.6 billion into research and development during
fiscal 2000. Investing in the future is what we do--what we've always done. It's
how we developed powerful network standards such as NFS, XML, and Java, plus
promising new technologies such as Jini and Jiro. It's why
9 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 13
each generation of our UltraSPARC microprocessors, Solaris Operating
Environment, Forte development tools, and iPlanet e-commerce software is ready
to take on bigger challenges.
Investing in the future also means growing the business responsibly, hiring
people with character and integrity, and devoting millions of dollars and
countless hours each year to training and career development--much of it
delivered just-in-time via the Internet--to help our employees stay ahead of
the curve.
As we grow, we intend to stay focused on a winning formula that has always
emphasized three things--and take each to an entirely new level.
THE CHOICE OF CUSTOMERS WORLDWIDE
The first is scalability--being able to add capacity without degrading
performance, to grow quickly without adding undue complexity. We see this as
imperative. The continued growth of the Internet and e-commerce depends on the
ability to accommodate computing on a massive scale.
Next is what we call continuous real-time access. We want to make "Webtone" more
reliable than dialtone--more available, and more useful. And we're getting
there. We're getting there with remote-monitoring and load-balancing
capabilities, with built-in redundancy and fault tolerance, with everything we
can think of so that you never get a busy signal on the Net.
Finally, we are focusing more than ever on integration. The name of our company
is Sun Microsystems, with the emphasis on "systems"--combining all the hardware
components and all the necessary software programs into a cohesive unit. Call it
the Webtone switch. As tightly integrated as a telephone switch, it will be the
key to building a never-say-die network.
Here at Sun, we have always been passionate about the possibilities of open
network computing, and it's gratifying to see our ideas play out in the
marketplace--boosting productivity, strengthening the economy, and improving
people's lives.
So, again, I want to thank you for investing in Sun. You have given us the
capital to turn the dream of global connectivity into a profitable reality.
/s/ SCOTT G. MCNEALY
-----------------------------
Scott G. McNealy
Chairman of the Board and Chief Executive Officer
[email protected]
This Annual Report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995, particularly statements
regarding market expectations and opportunities, market share growth, new
product and service expectations and capabilities and our expectations regarding
the growth of the Internet. These forward-looking statements are just
predictions and involve risks and uncertainties such that actual results may
differ materially. For a detailed listing of potential factors affecting our
business and these forward-looking statements, please refer to "Future Operating
Results" on page 29.
Letter From The Chairman
10
<PAGE> 14
COMMUNICATIONS NETWORKING
[LUCENT TECHNOLOGIES LOGO]
Lucent Technologies will use up to $500 million worth of Sun's carrier-grade
Netra(TM) servers over the next seven years as the platform for its
third-generation (3G) Flexent(TM) wireless architecture.
MANUFACTURING
[DOW CORNING LOGO]
Dow Corning Corporation uses Sun servers, storage systems, software, and
remote-monitoring services to handle worldwide enterprise resource planning.
FINANCIAL SERVICES
[VISA LOGO]
Sun is helping Visa create what may become the largest and most reliable
electronic payment system in the world, the newly announced Visa Direct
Exchange--expected to process 100 billion transactions annually.
EDUCATION
[CORNELL UNIVERSITY LOGO]
The Cornell University Library is working with Sun to construct the technology
platform for a new generation of digital libraries, with multimedia publishing
and data preservation services.
E-COMMERCE
[eBAY LOGO]
One of the Web's busiest online trading communities, eBay has chosen Sun as its
preferred provider of system hardware and utilizes Sun for its technology and
mission-critical support.
SERVICE PROVIDER
[DIGEX LOGO]
Digex, Inc., became one of the first companies to have its services certified
under the SunTone initiative to promote excellence in the market for Net-based
application services.
FINANCIAL SERVICES
[A.B. WATLEY LOGO]
To support real-time online stock trading, A.B. Watley Group, Inc., is
standardizing its technology infrastructure on Sun servers, storage, and desktop
systems.
RETAIL
[SEARS LOGO]
Sun servers and storage systems power a national merchandising system for Sears,
Roebuck, and Co., a $41 billion seller of home, apparel, and automotive products
and services.
ENERGY
[AMERICAN PETROLEUM EXCHANGE LOGO]
When the American Petroleum Exchange (www.apexchange.com) built its automated
e-marketplace for refined petroleum products, it turned to Sun for servers,
storage, rapid support, and expertise in high availability.
LIFE SCIENCE RESEARCH
[DOUBLETWIST LOGO]
DoubleTwist, Inc., chose Sun servers and storage systems, as well as our Java
technology, to build a unique Internet portal for life science research.
SERVICE PROVIDER
[LOUDCLOUD LOGO]
A leading full-service infrastructure provider, Loudcloud, Inc., selected Sun
for its proven, scalable Internet platforms and has joined the SunTone
certification and branding program.
11 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 15
THE LAST TEN YEARS
A RECORD OF STRENGTH AND CONSISTENCY
Sun's revenues have grown an average of 20% annually over the past decade as the
demand for open, network computing products and services increased. In this past
year, Sun's revenue grew to more than $15.7 billion, representing a 33%
increase over the previous fiscal year and demonstrating that demand for Sun's
products and services continued to accelerate in fiscal 2000. Sun's revenues
remain well diversified, with over 47% of revenues generated from outside the
United States.
Cash flow from operating activities has grown an average of 35% annually over
the past ten years, showing 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
continue to embrace Internet computing. Increasingly, Sun's business is being
driven by customer efforts to implement e-commerce, middleware, network storage,
and enterprise services to help them build, 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,
making Sun a blue-chip technology company.
[BAR GRAPH]
NET REVENUE
(in millions of dollars)
Net Revenues grew to $15,721 million in fiscal 2000, an increase of 33% from
$11,806 million in fiscal 1999.
The Last Ten Years 12
<PAGE> 16
[BAR GRAPH]
REVENUES BY GEOGRAPHY
(in millions of dollars)
Sun generated more than 47% of its revenues from outside the United States,
making it a truly global company. In fiscal 2000, Sun experienced strong revenue
growth across all geographies.
[BAR GRAPH]
R&D INVESTMENT
(in millions of dollars)
During fiscal 2000, Sun invested over 10% of revenues in research and
development, primarily in the areas of network storage, system design, SPARC
microprocessors, Solaris software, and Java technologies. Sun's investments in
research and development have led to increasingly innovative products and
technologies aimed at changing the ways in which customers use the Internet.
[BAR GRAPH]
OPERATING EBITDA
(in millions of dollars)
In fiscal 2000, operating EBITDA grew to $3,181 million, an increase of 40% over
fiscal 1999. The rate of growth in operating EBITDA has continued to exceed our
revenue growth.
[BAR GRAPH]
OPERATING INCOME
(in millions of dollars)
Operating income as a percentage of revenues for fiscal 2000 reached a record
level of 15%, an increase of 18% over fiscal 1999.
[BAR GRAPH]
NET INCOME PER COMMON SHARE--DILUTED
Earnings per share for fiscal 2000, including acquisition-related charges,
totaled $1.10, an increase of 75% over fiscal 1999. Over the past ten years, Sun
has grown earnings per share an average of 36% annually, including
acquisition-related charges.
[BAR GRAPH]
CASH AND INVESTMENT PORTFOLIO
(in millions of dollars)
Superb financial management resulted in a record cash balance for fiscal 2000.
Sun's cash portfolio, which includes cash, cash equivalents, and short-term and
long-term investments, totaled $6,971 million at the end of fiscal 2000.
[BAR GRAPH]
CASH FROM OPERATING ACTIVITIES
(in millions of dollars)
In fiscal 2000, Sun achieved record cash from operating activities, increasing
by over $1.2 billion over fiscal 1999 to reach $3,754 million.
[BAR GRAPH]
NET INCOME PER EMPLOYEE
(in thousands of dollars)
Net Income per employee reached a record $50,500 in fiscal 2000, up 48% from
fiscal 1999 and an increase of 232% in the past decade.
[BAR GRAPH]
RETURN ON AVERAGE EQUITY
(percentage)
In fiscal 2000, Sun's return on equity was 31%, demonstrating the strong demand
for Sun's products and services and the superb operational management within the
company.
13 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 17
<TABLE>
------------------------------------------------------------------------------------------------
TABLE OF CONTENTS
------------------------------------------------------------------------------------------------
<S> <C>
Historical Financial Review of Sun Microsystems, Inc. 16
------------------------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of Operations 18
------------------------------------------------------------------------------------------------
Consolidated Statements of Income 34
------------------------------------------------------------------------------------------------
Consolidated Balance Sheets 35
------------------------------------------------------------------------------------------------
Consolidated Statements of Cash Flows 36
------------------------------------------------------------------------------------------------
Consolidated Statements of Stockholders' Equity 37
------------------------------------------------------------------------------------------------
Notes to Consolidated Financial Statements 38
------------------------------------------------------------------------------------------------
Report of Ernst & Young LLP, Independent Auditors 57
------------------------------------------------------------------------------------------------
</TABLE>
Financial Review 14
<PAGE> 18
[GRAPHIC]
<PAGE> 19
HISTORICAL FINANCIAL REVIEW OF SUN MICROSYSTEMS, INC.
SUMMARY CONSOLIDATED STATEMENTS OF INCOME(1)
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
(In millions, except per share amounts) 2000 1999 1998 1997
-----------------------------------------------------------------------------------------------------------------
Dollars % Dollars % Dollars % Dollars %
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues $15,721 100.0 $11,806 100.0 $ 9,862 100.0 $ 8,661 100.0
-----------------------------------------------------------------------------------------------------------------
Costs and expenses:
Cost of sales 7,549 48.0 5,670 48.0 4,713 47.8 4,332 50.0
Research and development 1,630 10.4 1,280 10.8 1,029 10.4 837 9.7
Selling, general and administrative 4,137 26.3 3,215 27.2 2,830 28.7 2,436 28.1
In-process research and development 12 0.1 121 1.1 176 1.8 23 0.3
Total costs and expenses 13,328 84.8 10,286 87.1 8,748 88.7 7,628 88.1
-----------------------------------------------------------------------------------------------------------------
Operating income 2,393 15.2 1,520 12.9 1,114 11.3 1,033 11.9
Interest income, net 170 1.1 85 0.7 48 0.5 34 0.4
Gain on sale of investments, net 208 1.3 -- -- -- -- 62 0.7
Litigation settlement -- -- -- -- -- -- -- --
Income before taxes 2,771 17.6 1,605 13.6 1,162 11.8 1,129 13.0
Provision for income taxes 917 5.8 575 4.9 407 4.1 352 4.0
-----------------------------------------------------------------------------------------------------------------
Net income $ 1,854 11.8 $ 1,030 8.7 $ 755 7.7 $ 777 9.0
=================================================================================================================
Net income per common share--
diluted(2) $ 1.10 $ 0.63 $ 0.47 $ 0.50
-----------------------------------------------------------------------------------------------------------------
Shares used in the calculation of
net income per common share--
diluted(2) 1,689 1,641 1,590 1,569
-----------------------------------------------------------------------------------------------------------------
</TABLE>
OPERATING AND CAPITALIZATION DATA(1)
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------
2000 1999 1998 1997
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating EBITDA(3) (in millions) $ 3,181 $2,272 $1,734 $1,414
-----------------------------------------------------------------------------
Return on average equity 31% 24% 24% 31%
-----------------------------------------------------------------------------
Return on average assets 16% 14% 14% 18%
-----------------------------------------------------------------------------
Effective income tax rate 33% 36% 35% 31%
-----------------------------------------------------------------------------
Total assets (in millions) $14,152 $8,499 $5,794 $4,783
-----------------------------------------------------------------------------
Long-term debt and other obligations
(in millions) $ 2,084 $ 384 $ 77 $ 109
-----------------------------------------------------------------------------
Current ratio 1.4 1.9 2.0 2.0
-----------------------------------------------------------------------------
Long-term debt-to-equity ratio 29% 8% 2% 4%
-----------------------------------------------------------------------------
Outstanding shares at June 30
(in millions)(2) 1,597 1,566 1,517 1,493
-----------------------------------------------------------------------------
Book value per outstanding share(2) $ 4.58 $ 3.11 $ 2.35 $ 1.88
-----------------------------------------------------------------------------
</TABLE>
(1) All historical financial information has been restated to reflect the
merger with Forte Software, Inc. on October 19, 1999.
(2) Share and per share amounts for all periods presented have been adjusted
to reflect stock splits through June 30, 2000.
(3) Operating EBITDA represents earnings before interest, income taxes,
depreciation, amortization (including amortization of stock-based
compensation), gain on sale of investments, and in-process research and
development.
Financial Review 16
<PAGE> 20
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991
------------------------------------------------------------------------------------------------------------------
Dollars % Dollars % Dollars % Dollars % Dollars % Dollars %
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 7,125 100.0 $ 5,912 100.0 $ 4,690 100.0 $ 4,308 100.0 $ 3,589 100.0 $ 3,221 100.0
------------------------------------------------------------------------------------------------------------------
3,927 55.1 3,338 56.5 2,753 58.7 2,518 58.4 1,963 54.7 1,758 54.6
661 9.3 568 9.6 504 10.8 448 10.4 382 10.7 356 11.1
1,806 25.4 1,513 25.6 1,164 24.8 1,106 25.7 984 27.4 812 25.1
58 0.8 -- -- -- -- -- -- -- -- -- --
6,452 90.6 5,419 91.7 4,421 94.3 4,072 94.5 3,329 92.8 2,926 90.8
------------------------------------------------------------------------------------------------------------------
673 9.4 493 8.3 269 5.7 236 5.5 260 7.2 295 9.2
34 0.5 23 0.4 6 0.2 (1) (0.1) (6) (0.1) (11) (0.4)
-- -- -- -- -- -- -- -- -- -- -- --
-- -- -- -- -- -- (15) (0.3) -- -- -- --
707 9.9 516 8.7 275 5.9 220 5.1 254 7.1 284 8.8
233 3.2 168 2.8 87 1.9 67 1.6 82 2.3 94 2.9
------------------------------------------------------------------------------------------------------------------
$ 474 6.7 $ 348 5.9 $ 188 4.0 $ 153 3.5 $ 172 4.8 $ 190 5.9
==================================================================================================================
$ 0.30 $ 0.22 $ 0.12 $ 0.09 $ 0.10 $ 0.11
------------------------------------------------------------------------------------------------------------------
1,587 1,589 1,565 1,733 1,737 1,769
------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
-------------------------------------------------------
1996 1995 1994 1993 1992 1991
-------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$1,027 $ 734 $ 518 $ 454 $ 475 $ 516
-------------------------------------------------------
22% 19% 12% 10% 13% 18%
-------------------------------------------------------
13% 11% 7% 6% 7% 9%
-------------------------------------------------------
33% 33% 32% 31% 32% 33%
-------------------------------------------------------
$3,858 $3,563 $2,905 $2,771 $2,674 $2,330
-------------------------------------------------------
$ 64 $ 96 $ 124 $ 180 $ 348 $ 401
-------------------------------------------------------
2.0 2.2 2.0 2.4 2.6 2.5
-------------------------------------------------------
3% 5% 8% 11% 23% 33%
-------------------------------------------------------
1,495 1,587 1,502 1,634 1,600 1,542
-------------------------------------------------------
$ 1.53 $ 1.34 $ 1.09 $ 1.01 $ 0.93 $ 0.79
-------------------------------------------------------
</TABLE>
Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
All historical financial information has been restated to reflect the merger
with Forte Software, Inc. (Forte) on October 19, 1999. The merger was accounted
for as a pooling of interests and, as such, the historical consolidated
financial statements of the Company have been restated to include the financial
position, results of operations and cash flows of Forte for all periods
presented.
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 our expectations on capital spending in
certain countries and industries, our expectations to invest in our services
business, our products and services gross margins expectations for fiscal year
2001, our expectations regarding the competitiveness of our product and service
offerings and any possible repricing actions, our expectations relating to our
future investments and expenses relating to research and development, our
expectations to continue hiring personnel in certain areas, our expected
effective income tax rate for fiscal 2001, our expectations to leverage our cost
structure to improve our profitability and productivity, statements regarding
our liquidity and capital resources, our expectations regarding the Euro, and as
set forth in the section entitled "Purchased in-process research and
development," statements regarding percentage of completion, expected product
release dates, dates for which we expect to begin generating benefits from
projects, projected revenues, costs of revenue, selling, general, and
administrative expenses and maintenance, research and development information,
and discount rates we used to calculate discounted cash flows, and our
expectations to continue and successfully complete product development as well
as realize our expected economic return. 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,
increased competition, adverse changes in general economic conditions, including
adverse changes in the specific markets for our products, adverse business
conditions, adverse changes in customer order patterns, lack of acceptance of
new products, pricing pressures, lack of success in technological advancements,
risks associated with foreign operations, failure to reduce costs or improve
operating efficiencies, and our ability to attract, hire, and retain key and
qualified employees. With respect to risks related to purchased in-process
research and development identified above, there can be no assurance that any of
the new products discussed 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 or release of such products into the market, the complexity of the
technology, our ability to successfully manage product introductions, lack of
customer acceptance, competition and changes in technological trends, and
fluctuations in market or general economic conditions.
Financial Review 18
<PAGE> 22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
NET REVENUES
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------
(Dollars in millions) 2000 CHANGE 1999 CHANGE 1998
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Products net revenue $13,421 32% $10,171 17% $ 8,675
Percentage of total net revenues 85.4% 86.2% 88.0%
Services net revenue $ 2,300 41% $ 1,635 38% $ 1,187
Percentage of total net revenues 14.6% 13.8% 12.0%
Total net revenues $15,721 33% $11,806 20% $ 9,862
-------------------------------------------------------------------------------------------------------------------------
</TABLE>
PRODUCTS NET REVENUE
Products net revenue is comprised of revenue generated from the sales of our
scalable computer systems and storage, high-speed microprocessors, and line of
high-performance software for operating network computing equipment. In fiscal
2000 and 1999, products net revenue grew 32% and 17%, respectively. Growth in
enterprise and workgroup server product lines accounted for approximately 60%
and 50% of the total increase in products net revenue during fiscal 2000 and
1999, respectively. To a lesser degree, revenue generated by our storage
products line and network service provider offerings in fiscal 2000 and 1999
contributed to each year's products net revenue growth. Desktop systems revenue
has declined slightly in dollars and has also therefore declined as a percentage
of products net revenue in both fiscal 2000 and 1999. We expect these product
mix trends to continue in fiscal 2001.
SERVICES NET REVENUE
Services net revenue is comprised of revenue generated from the sales of a full
range of services, including support, education and professional services. The
41% and 38% growth in services net revenue in fiscal 2000 and 1999,
respectively, is primarily the result of: (1) an overall shift towards premium
service and support contracts resulting from a larger installed base of high-end
server products; (2) a larger installed service base related to increased
product unit sales; and (3) increased revenues associated with our professional
and educational services.
19 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
NET REVENUES BY GEOGRAPHIC AREA
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------
(Dollars in millions) 2000 CHANGE 1999 CHANGE 1998
-----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Domestic $ 8,308 33% $ 6,256 16% $ 5,388
Percentage of net revenues 52.8% 53.0% 54.6%
EMEA (Europe, Middle East, Africa) $ 4,454 29% $ 3,447 26% $ 2,733
Percentage of net revenues 28.3% 29.2% 27.7%
Japan $ 1,344 28% $ 1,047 16% $ 899
Percentage of net revenues 8.6% 8.9% 9.1%
ROW (Rest of World) $ 1,615 53% $ 1,056 25% $ 842
Percentage of net revenues 10.3% 8.9% 8.6%
Total net revenues $15,721 33% $11,806 20% $ 9,862
-----------------------------------------------------------------------------------------------------------------------
</TABLE>
The revenue growth in the EMEA, Japan, and ROW regions during fiscal 2000 and
1999 is primarily due to continued strong demand for our network computing
products and services. To a lesser degree, the increase in international
revenues is due to our expanded presence in numerous emerging markets. We
experienced revenue growth in all EMEA and ROW regions during fiscal 2000 and
1999, with the concentration of growth in the United Kingdom, Germany, Southern
Europe, and emerging markets during fiscal 2000 and in Germany, Southern Europe,
and emerging markets during fiscal 1999. Although we have experienced U.S.
dollar revenue growth in the EMEA, Japan, and ROW marketplaces 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 flows could suffer.
GROSS MARGIN
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------
(Dollars in millions) 2000 CHANGE 1999 CHANGE 1998
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Products gross margin $ 7,325 34% $ 5,475 17% $4,683
Percentage of products net revenue 54.6% 53.8% 54.0%
Services gross margin $ 847 28% $ 661 42% $ 466
Percentage of services net revenue 36.8% 40.4% 39.3%
Total gross margin $ 8,172 33% $ 6,136 19% $5,149
Percentage of net revenues 52.0% 52.0% 52.2%
--------------------------------------------------------------------------------------------------------------------
</TABLE>
PRODUCTS GROSS MARGIN
In fiscal 2000, products gross margin increased as a percentage of products net
revenue by 0.8 points as compared to fiscal 1999. This increase is primarily due
to the continued change in revenue mix from lower margin desktop systems to
higher margin enterprise and workgroup servers. This positive impact on our
products gross margin was partially offset by the effects of competitive pricing
actions, new product introductions, and higher component costs. Fiscal 1999
products gross margin was relatively flat compared to fiscal 1998. In fiscal
2001, we expect products gross margin will continue to be affected by product
mix, market conditions, new product introductions, and component costs. On an
overall basis, we expect products gross margin to decline slightly during fiscal
2001.
Financial Review 20
<PAGE> 24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
SERVICES GROSS MARGIN
The 3.6 point decrease in services gross margin as a percentage of services net
revenue in fiscal 2000 over fiscal 1999 reflects the impact of: (1)
infrastructure modifications; (2) implementing improvements in existing service
delivery technologies and processes; and (3) increasing field support headcount
to support expected future growth in services. The 1.1 point increase in
services gross margin as a percentage of services net revenue in fiscal 1999
over fiscal 1998 reflects: (1) increased market penetration in enterprise data
center accounts; (2) an overall shift towards premium service and support
contracts resulting from a larger installed base of high-end server products;
(3) continued growth in professional and educational services revenues; and
(4) increased economies of scale in certain geographic markets. We expect to
continue investing in our services business by hiring field employees,
increasing availability of spares inventory in order to improve customer service
response time, and evaluating other infrastructure-related initiatives. We are
currently targeting our services gross margin to remain in the mid-to-high 30%
range for fiscal 2001.
We continuously evaluate the competitiveness of our product and service
offerings. These evaluations could result in repricing actions in the near term.
Our future operating results would be adversely affected if 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, or if we were unsuccessful in achieving component cost reductions,
operating efficiencies, and increasing volumes.
OPERATING EXPENSES
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------
(Dollars in millions) 2000 CHANGE 1999 CHANGE 1998
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Research and development $ 1,630 27% $ 1,280 24% $ 1,029
Percentage of net revenues 10.4% 10.8% 10.4%
Selling, general, and administrative $ 4,137 29% $ 3,215 14% $ 2,830
Percentage of net revenues 26.3% 27.2% 28.7%
Purchased in-process research and development $ 12 (90%) $ 121 (31%) $ 176
Percentage of net revenues 0.1% 1.1% 1.8%
--------------------------------------------------------------------------------------------------------------------------
</TABLE>
RESEARCH AND DEVELOPMENT (R&D) EXPENSES
The 27% and 24% increases in R&D expenses during fiscal 2000 and 1999,
respectively, reflect our continued development of a broad line of scalable and
reliable systems, including servers, workstations, storage technologies, and
SPARC(TM) microprocessors, as well as software products which utilize the
Java(TM) platform, Solaris Operating Environment software, and Jini(TM)
connection technology. Furthermore, R&D expenses have increased due to
additional development of products acquired through acquisitions and increased
compensation and compensation-related costs related to higher levels of R&D
staffing. The increases in R&D spending reflect our belief that to maintain our
competitive position in a market characterized by rapid rates of technological
advancement, we must continue to invest significant resources in new systems,
software, and microprocessor development, as well as continue to enhance
existing products. All of our R&D costs are expensed as incurred. We are
planning to continue to increase our R&D spending in fiscal 2001 and expect R&D
expenses as a percentage of net revenues to remain in the 10-11% range.
21 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
SELLING, GENERAL, AND ADMINISTRATIVE (SG&A) EXPENSES
SG&A expenses as a percent of total net revenues declined from 28.7% in 1998 to
27.2% in 1999 to 26.3% in 2000 as a result of higher revenues and operating
efficiencies. The dollar increase in SG&A expenses is primarily attributable to:
(1) compensation resulting from higher levels of headcount, principally in the
sales organization; (2) annual salary adjustments; (3) increased commissions and
bonuses; and (4) increased marketing costs related to promotional programs. We
also made additional investments aimed at improving our internal business
processes. We are focused on ensuring that we have a flexible and scalable
support model and cost structure that supports our growing business. We will
continue to focus on our cost structure, gradually decreasing our level of SG&A
expenses expressed as a percentage of total net revenues.
PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT
OVERVIEW
Purchased in-process research and development (IPRD) of $12 million, $121
million, and $176 million in fiscal 2000, 1999, and 1998, respectively,
represents the write-off of in-process technologies associated with our
acquisitions of Star Division Corporation (Star) and Star Division
Software-Entwicklung und Vertriebs GmbH (Star Office GmbH), Trustbase Limited
(Trustbase) and JCP Computer Services Limited (JCP), and Innosoft International,
Inc. (Innosoft) in fiscal 2000; NetDynamics, Inc. (NetDynamics), Maxstrat
Corporation (Maxstrat), iPlanet, Inc. (iPlanet), and Beduin Communications
Corporation Incorporated (Beduin) in fiscal 1999; and Diba, Inc. (Diba),
Integrity Arts, Inc. (Integrity Arts), Chorus Systems, S.A. (Chorus), Red Cape
Software, Inc. (Red Cape), and Encore Computer Corporation (Encore) in fiscal
1998 (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 IPRD had no alternative future uses.
Accordingly, these amounts were expensed on the respective acquisition dates of
each of the Acquired Companies. Also see Note 3, "Acquisitions" in the Notes to
the Consolidated Financial Statements.
VALUATION OF IPRD
GENERAL
We used independent third-party sources to calculate the amounts allocated to
IPRD. In calculating IPRD, the independent third party used established
valuation techniques accepted in the high-technology industry. These
calculations gave consideration to relevant market sizes and growth factors,
expected industry trends, the anticipated nature and timing of new product
introductions by us and our competitors, individual product sales cycles, and
the estimated lives of each of the products' underlying technology. The value of
the IPRD reflects the relative value and contribution of the acquired research
and development. We gave consideration to the R&D's stage of completion, the
complexity of the work completed to date, the difficulty completing the
remaining development, costs already incurred, and the projected cost to
complete the project in determining the value assigned to IPRD.
APPROACH USED FOR VALUATION OF IPRD IN THE PURCHASE ACQUISITIONS PRESENTED
The values assigned to developed technologies related to each acquisition were
based upon discounted cash flows related to the future products' projected
income stream. Elements of the projected income stream included revenues, cost
of sales (COS), SG&A expenses, and R&D expenses. The discount rates used in the
present value calculations were generally derived from a weighted average cost
of capital, adjusted upward to reflect the additional risks inherent in the
development life cycle, including the useful life of the technology,
profitability levels of the technology, and the uncertainty of technology
advances that are known at the date of each acquisition. Since each acquired
entity's IPRD is unique, the discount rate, revenue, COS, R&D, and SG&A
assumptions used varied on a case-by-case basis. We did not expect to achieve a
material amount of expense reductions or synergies, therefore the valuation
assumptions did not include significant anticipated cost savings.
Financial Review 22
<PAGE> 26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
VALUATION ASSUMPTIONS
The following table summarizes the significant assumptions underlying the
valuations related to the IPRD from each of the Acquired Companies in fiscal
years 2000, 1999, and 1998 (dollars in millions).
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------------
ESTIMATED
COST TO
COMPLETE PERCENTAGE AVERAGE PERCENTAGE OF REVENUE
TECHNOLOGY COMPLETE REVENUE --------------------------------- DISCOUNT
AT TIME OF AT TIME OF GROWTH AVERAGE AVERAGE AVERAGE RATE
ACQUIRED COMPANY/BUSINESS IPRD ACQUISITION ACQUISITION RATE COS SG&A R&D USED
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
FISCAL 2000
Innosoft $ 3.1 $ 0.3 80% 18% 22% 35% 1% 18%
Trustbase Companies $ 4.9 $ 1.2 67% 39% 15% 33% 2% 30%
Star Companies $ 3.5 $ 7.5 60% 36% 20% 40% 3% 23%
FISCAL 1999
Maxstrat $ 28.7 $ 8.0 70% 12% 50% 20% 2% 25%
Beduin $ 3.6 $ 0.4 65% 36% 15% 25% 2% 40%
iPlanet $ 8.4 $ 6.0 30% 37% 15% 30% 4% 25%
NetDynamics $ 80.0 $ 5.7 60% 43% 17% 31% 1% 20%
FISCAL 1998
Red Cape $ 14.1 $ 7.4 15% 25% 7% 25% 2% 25%
Encore $ 97.0 $ 30.0 60% 55% (1) 2% -- 30%
Chorus(TM) micro kernel $ 12.0 $ 0.2 50% 37% (1) 2% -- 25%
Chorus-Other IPRD $ 1.1 $ 3.0 20% 19% 23% 34% 3% 25%
Integrity Arts $ 29.9 $ 16.0 5% 64% -- 55% 1% 38%
Diba $ 22.3 $105.0 10% 15% 24% 21% 5% 36%
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) The average COS was not relevant in these valuations since a license rate
approach was utilized. A license rate valuation approach estimates what a third
party would have paid in licensing fees for the developed technologies, which
equates to what Sun would avoid paying in such licensing fees. The license rate
assumptions (as a percentage of revenue) used for Encore were 12% in 1999, 10%
in 2000, and 6% in 2001-2005. The license rate assumptions (as a percentage of
revenue) used for Chorus(TM) micro kernel were 21% in 1999, 19% in 2000, 17% in
2001, and 15% in 2002-2005.
23 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW OF PURCHASED IPRD IN FISCAL 2000, 1999, AND 1998
Included below are further details regarding the nature of the significant
amounts of purchased technology acquired during fiscal 2000, 1999, and 1998.
Given the uncertainties of the commercialization process, no assurance can be
given that deviations from our estimates will not occur. At the time of the
acquisitions, we believed there was 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, the complexity of the 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.
FISCAL 2000
Innosoft
On March 30, 2000, we acquired all of the outstanding capital stock of Innosoft,
a California corporation, by means of a merger transaction pursuant to which all
of the outstanding capital stock and options of Innosoft were converted into the
right to receive cash and shares of our common stock. The total purchase price
for Innosoft was approximately $42 million.
At the acquisition date, Innosoft was engaged in developing software
technologies for standards-based Internet mail, messaging, collaboration, and
directory services.
As of the acquisition date, Innosoft had made substantial progress in the areas
of product definition, architecture design, and coding to complete the Innosoft
Distributed Directory Server 5.0 product. This product was made commercially
available in May 2000. The competitive features of this product are being
incorporated into the iPlanet(TM) Directory Server 5.0 product, with expected
commercial availability in February 2001. Additional products acquired from
Innosoft include the LDAP Proxy Server 2.0 and the DirectoryPortal 1.0 product,
both of which shipped commercially in December 1999. The LDAP Proxy Server was
rebranded as the iPlanet Directory Access Router and version 2.1 shipped
commercially in June 2000.
TRUSTBASE AND JCP (COLLECTIVELY THE "TRUSTBASE COMPANIES")
On January 31, 2000, we acquired all of the outstanding capital stock of
Trustbase, the United Kingdom parent company of JCP, by means of a stock
purchase transaction pursuant to which all of the shares of Trustbase were
converted into the right to receive cash. JCP is a developer of highly secure
public key infrastructure enabling technology. The total purchase price for the
Trustbase Companies was approximately $21 million.
At the acquisition date, the Trustbase Companies were engaged in development
activity associated with the iPlanet Trustbase(TM) Transaction Manager, a
software messaging framework that supports the functions required to be deployed
as an Identrus Transaction Coordinator. The Identrus Transaction Coordinator is
a messaging specification jointly developed by Trustbase and a consortium of the
world's leading banks (Identrus) that enables business-to-business e-commerce
through financial institutions.
At the acquisition date, the Trustbase Companies had made substantial progress
in the areas of product definition, architecture design, and coding. Remaining
efforts necessary to complete the iPlanet Trustbase Transaction Manager related
primarily to additional coding, testing, and implementation. We anticipate pilot
deployments of the product during the October to November 2000 time frame, with
a general availability version currently scheduled for release in December 2000.
STAR AND STAROFFICE GMBH (COLLECTIVELY THE "STAR COMPANIES")
On August 5, 1999, we acquired Star, by means of a merger transaction pursuant
to which all of the shares of Star were converted into the right to receive cash
for total consideration of approximately $60 million. Simultaneously with the
acquisition of Star, Sun acquired certain assets and liabilities of StarOffice
GmbH, a related party of Star, for total cash consideration of approximately $14
million.
At the acquisition date, the Star Companies were conducting development, coding,
and testing activities associated with the completion of a new technology that
would enable their most recent version of the StarOffice(TM) suite to be
utilized in a portal environment (the "StarOffice Product Offering"). The
StarOffice Product Offering is an updated office productivity suite that
provides word processing, spreadsheet, graphics design, presentation, and
data-base applications.
At the acquisition date, the Star Companies had made substantial progress in the
areas of product definition, architecture design, and coding. Remaining efforts
necessary to complete the StarOffice Product Offering related primarily to
additional coding, testing, and implementation. An early access/beta version of
the StarOffice Product Offering was made available in the third quarter of
fiscal 2000, with general availability scheduled for release in the first half
of fiscal 2001.
Financial Review 24
<PAGE> 28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
SIGNIFICANT IPRD PRIOR TO FISCAL 2000
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). 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 Fiber 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
specification, design, and implementation. Remaining efforts necessary to
complete the Noble Product Offering related primarily to coding, testing, and
addressing additional implementation issues. See "Overall Status of IPRD and
Intangible Assets Acquired During Fiscal 2000, 1999, and 1998" for an update on
the product offerings.
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(TM) New Product Offering) was to employ a new server-side component
model, based on the Enterprise JavaBeans(TM) (EJB(TM)) architecture, which
allowed 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 was significantly different from the
business logic architecture in NetDynamics' existing product offering which was
tightly integrated with the presentation interface. The EJB architecture allowed
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 included significant security
enhancements and performance improvements and the addition of new platform
adaptor components for legacy systems integration.
At the acquisition date, NetDynamics had made substantial progress in the areas
of specification, design, and implementation. Remaining efforts necessary to
complete the NetDynamics New Product Offering related primarily to coding,
testing, and addressing additional implementation issues. See "Overall Status of
IPRD and Intangible Assets Acquired During Fiscal 2000, 1999, and 1998" for an
update on the product offerings.
ENCORE
At the acquisition date (November 24, 1997), Encore was conducting development
and engineering activities associated with its Intershare and DASD-NET products
(Encore Products). We anticipated that completion of the Encore Products
acquisition would help us establish a viable position in the computer
mainframe/open systems storage market. In addition, Encore's current products
and technology were expected to help facilitate efforts to develop a high-end
"intelligent" storage product, which could also be modified to address the
low-end storage market.
At the acquisition date, Encore needed to perform substantial development
efforts before reaching technological feasibility. These efforts included
converting the box-system architecture to a storage-area network, developing an
alternative to the interconnect technology used by Encore which would provide
the price and performance required to compete within the marketplace, and
resolving several design issues during the porting phase of development. See
"Overall Status of IPRD and Intangible Assets Acquired During Fiscal 2000, 1999,
and 1998" for an update on the product offerings.
INTEGRITY ARTS
At the time of the acquisition (September 22, 1997), Integrity Arts was
conducting development and engineering activities associated with creating an
industry standard "smart card" virtual machine and application programming
interface (Integrity Products). We anticipated that completion of the Integrity
Products would help us establish the Java architecture as the standard platform
for smart card device applications.
At the acquisition date, Integrity Arts needed to perform substantial
development efforts before reaching technological feasibility. These efforts
included development of smart card software architecture and development tools
and data security schemes. See "Overall Status of IPRD and Intangible Assets
Acquired During Fiscal 2000, 1999, and 1998" for an update on the product
offerings.
DIBA
At the time of the acquisition (August 29, 1997), Diba was conducting
development and engineering activities associated with providing turnkey
information appliance hardware and software designs to the consumer electronics
industry (Diba Products). We anticipated that completion of the Diba Products
would help reduce our time to market for such products.
25 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
At the acquisition date, Diba needed to perform substantial development efforts
before reaching technological feasibility. These efforts included the
development of prototypes with additional functionality beyond rudimentary
means, and the integration of Diba's technology with our Java platforms. See
"Overall Status of IPRD and Intangible Assets Acquired During Fiscal 2000, 1999,
and 1998" for an update on the product offerings.
OVERALL STATUS OF IPRD AND INTANGIBLE ASSETS ACQUIRED DURING FISCAL 2000, 1999,
AND 1998
The following table provides information regarding the status of IPRD projects
upon acquisition and as of June 30, 2000 (in millions):
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------
ESTIMATED ACTUAL OR
COST TO ACTUAL OR EXPECTED
COMPLETE EXPECTED PRODUCT
ACQUIRED AT TIME OF COSTS AT RELEASE
COMPANY/BUSINESS ACQUISITION COMPLETION DATE
------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Innosoft $ 0.3 $ 0.5 Q4FY2000
Trustbase
Companies $ 1.2 $ 1.3 Q2FY2001
Star Companies $ 7.5 $ 7.5 Q2FY2001
Maxstrat $ 8.0 $29.0 Q4FY2000
Beduin $ 0.4 $ 2.0 Q2FY2000
iPlanet $ 6.0 $ 5.0 Q4FY1999
NetDynamics $ 5.7 $17.4 Q3FY2000
Red Cape $ 7.4 $ 4.9 Q4FY2000
Encore $ 30.0 $49.0 Q1FY2000
Chorus $ 3.2 $10.1 Q2FY2000
Integrity Arts $ 16.0 $16.0 Q4FY1999
Diba $105.0 * *
------------------------------------------------------------------------------------------
</TABLE>
*We canceled our development efforts in fiscal 1999.
With the exception of the acquisitions discussed separately below, we believe
that the projections used in performing valuations with respect to each
acquisition are still materially valid; however, there can be no assurance that
the projected results will be achieved. We expect to continue the development of
each project not yet completed or canceled and believe that there is a
reasonable chance of successfully completing such development efforts. 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, 2000, 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 the aggregate, is not
considered material, except as discussed below.
In fiscal 2000, it was determined that the carrying value of certain intangible
assets acquired from NetDynamics and Encore became impaired due to changes in
circumstances from those present at the time these assets were acquired.
At the time of the acquisition, the technology acquired from NetDynamics was
expected to be utilized in a collaborative application. As of June 30, 2000, the
current and future plans for utilization of this technology have diminished
materially such that expected future cash flows from the use of NetDynamics'
technology were less than the carrying value of the underlying assets.
Accordingly, an impairment charge of approximately $32 million was recognized in
fiscal 2000 to reduce such carrying value to the present value of the future
expected cash flows.
The technology acquired from Encore was intended to accelerate our efforts to
develop a high-end intelligent storage product. Although all but one of the key
products utilizing the acquired technology from Encore commenced shipment in
fiscal 2000, certain factors, including delays and changes in packaging and
delivery strategy, have caused materially diminished revenue expectations
attributed to the technology acquired from Encore. As a result, future cash
flows from the use of Encore's technology was negligible. Accordingly, an
impairment charge of approximately $9 million was recognized in fiscal 2000 to
write-off the remaining carrying value.
In fiscal 1999, we canceled our development efforts with respect to the IPRD
technology acquired from Diba, which related to the completion of a set-top box
product. The decision to abandon Diba's in-process technology was based upon a
change in the long-term strategy for the underlying product. Accordingly, an
impairment charge of approximately $9 million was recognized in fiscal 1999 to
write-off the remaining carrying value.
Financial Review 26
<PAGE> 30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
GAIN ON SALE OF INVESTMENTS, NET
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
(Dollars in millions) 2000 CHANGE 1999 CHANGE 1998
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Gain on sale of investments, net $208 100% -- -- --
Percentage of net revenues 1.3% -- --
-----------------------------------------------------------------------------------------------------------------
</TABLE>
The gain on sale of investments in fiscal 2000 was related to the sale of
certain marketable strategic equity securities. There were no such gains in
fiscal 1999 or fiscal 1998. Our decision to sell marketable strategic equity
securities in the future will depend on numerous factors which are not
predictable.
INTEREST INCOME, NET
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
(Dollars in millions) 2000 CHANGE 1999 CHANGE 1998
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest income, net $170 100% $85 77% $48
Percentage of net revenues 1.1% 0.7% 0.5%
-----------------------------------------------------------------------------------------------------------------
</TABLE>
The growth of interest income, net of interest expense, in fiscal 2000 is
primarily the result of interest earnings on funds raised in our issuance of
$1.5 billion of unsecured senior debt securities and increased levels of cash
generated by operating activities. The growth in interest income, net of
interest expense, in fiscal 1999 is primarily the result of interest earnings on
increased levels of cash generated by operating activities.
INCOME TAXES
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
(Dollars in millions) 2000 CHANGE 1999 CHANGE 1998
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Provision for income taxes $917 59% $575 41% $407
Percentage of net revenues 5.8% 4.9% 4.1%
-----------------------------------------------------------------------------------------------------------------
</TABLE>
Our effective income tax rate for fiscal 2000, 1999, and 1998 was 33.0% before
the impact of the non-tax deductible IPRD associated with the acquisitions of
Star and Innosoft for fiscal 2000; Maxstrat, iPlanet, and NetDynamics for fiscal
1999; and Red Cape, Diba, and Integrity Arts for fiscal 1998. Our effective
income tax rate including the income tax effect of IPRD was 33.1%, 35.8%, and
35.0% for fiscal 2000, 1999, and 1998, respectively.
We currently expect an effective tax rate of 34% for fiscal 2001. 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. Our expected rate is based on current
tax law and current estimates of earnings and is subject to change.
27 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OPERATING EBITDA
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
(Dollars in millions) 2000 CHANGE 1999 CHANGE 1998
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operating EBITDA $3,181 40% $2,272 31% $1,734
Percentage of net revenues 20.2% 19.2% 17.6%
-----------------------------------------------------------------------------------------------------------------
</TABLE>
Operating EBITDA represents earnings before interest, income taxes,
depreciation, amortization (including amortization of stock-based compensation),
and other non-operating items, such as gain on sale of investments and IPRD. We
believe that operating EBITDA is a useful measure of operating performance which
provides focus on business fundamentals that track critical longer term trends.
Though operating EBITDA as a measure of performance is significantly more
cash-like, it is not intended to represent, nor does it represent, cash flows
for the period, or funds available for dividends, reinvestment or other
discretionary uses. Operating EBITDA has been presented as a useful supplement,
not as a substitute for measures of performance prepared and presented in
accordance with generally accepted accounting principles.
In fiscal 2000, operating EBITDA grew to 20.2% of net revenues from 19.2% in
1999 and 17.6% in 1998. As our gross margin has remained essentially flat at 52%
over the three years, the improvement in operating EBITDA results primarily from
our ability to grow revenues without proportionate increases in operating
expenses. We are focused on continuing to increase this leverage on our cost
structure.
Financial Review 28
<PAGE> 32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------
(Dollars in millions) 2000 CHANGE 1999 CHANGE 1998
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Cash, cash equivalents, and investments $6,971 159% $2,692 102% $1,333
Percentage of total assets 49.3% 31.7% 23.0%
Cash provided by operating activities $3,754 50% $2,511 66% $1,515
Days sales outstanding (DSO) 48 59 58
Inventory turns 17.5 17.3 12.0
--------------------------------------------------------------------------------------------------------------------
</TABLE>
We ended fiscal 2000 with $6,971 million in cash, cash equivalents, and
investments. During fiscal 2000, we generated $3,754 million in cash flows from
operating activities, which represented our principal source of cash. Cash flows
from operating activities resulted primarily from our net income, changes in
operating working capital and income tax benefits from employee stock plans.
Throughout fiscal year 2000, we continued to improve upon our efficient asset
management. Days sales outstanding decreased to 48 days in fiscal 2000 from 59
days in fiscal 1999, while inventory turns remained fairly flat in both fiscal
2000 and 1999. As a result, we were able to improve our cash generated from
working capital assets. In addition, in August 1999, we issued $1,500 million of
unsecured debt securities.
The $5,254 million in cash provided by operating activities and generated from
the debt security offering was partially used to: (1) purchase investments (net
of proceeds from sales and maturities) totaling $3,085 million; (2) build
facilities and acquire capital additions to support increased head count,
primarily in our services, engineering, and marketing organizations for $982
million; and (3) acquire treasury stock for $631 million.
At June 30, 2000, we had a revolving credit facility ("Facility") with banks
aggregating $500 million. The Facility is available subject to compliance with
certain covenants. No amounts are outstanding under the Facility.
We currently have effective shelf registration statements on file with the
Securities and Exchange Commission that permit us 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, we issued $1.5
billion in unsecured debt securities in four tranches (the "Senior Notes"). The
Senior Notes are comprised of the following 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 has also entered into various interest-rate swap agreements to
modify the interest characteristics of the Senior Notes so that the interest
associated with the Senior Notes investments effectively becomes variable.
We believe that the liquidity provided by existing cash, cash equivalents, and
investments, along with the borrowing arrangements described above, will provide
sufficient capital to meet our requirements through fiscal 2001. We believe the
level of financial resources is a significant competitive factor in our industry
and we may choose at any time to raise additional capital through debt or equity
financings to strengthen our financial position, facilitate growth, and provide
us with additional flexibility to take advantage of business opportunities
that may arise.
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 adversely affect our business
and operating results.
Our competitors are some of the largest, most successful companies in the world.
They include Hewlett-Packard Company (HP), International Business Machines
Corporation (IBM), Compaq Computer Corporation (Compaq), and EMC Corporation
(EMC). Our future competitive performance depends on a number of factors,
including our ability to: continually develop and introduce new products and
services with better prices and performance than those offered by our
competitors; offer a wide
29 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
range of products and solutions from small single-processor systems to large
complex enterprise-level systems; offer solutions to customers that operate
effectively within a computing environment that includes hardware and software
from multiple vendors; offer products that are reliable and that ensure the
security of data and information; create products for which third party software
vendors will develop a wide range of applications; and offer high quality
products and services.
We also compete with systems manufacturers and resellers of systems based on
microprocessors from Intel Corporation (Intel) and Windows operating system
software from Microsoft Corporation (Microsoft). These competitors include Dell
Computer Corporation (Dell), HP, and Compaq, in addition to Intel and Microsoft.
This competition creates increased pressure, including pricing pressure, on our
workstation and lower-end server product lines. We expect this competitive
pressure to intensify considerably during fiscal year 2001, with the anticipated
releases of new software products from Microsoft and new microprocessors from
Intel.
The computer systems that we sell are made up of many products and components,
including workstations, servers, storage products, microprocessors, the
Solaris(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 operating results could be adversely
affected. 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 adversely affected.
Over the last three years, we have invested significantly in our storage
products business with a view to increasing the sales of these products both on
a stand-alone basis to customers using the systems of our competitors, and as
part of the systems that we sell. The intelligent storage products business is
intensely competitive. EMC is currently the leader in this market. To the extent
we are unable to penetrate this market and compete effectively, our business
and operating results could be adversely affected. In addition, we will be
making significant investments over the next few years to develop, market, and
sell software products under our alliance with America Online, Inc. (AOL) and
have agreed to significant minimum revenue commitments. These alliance products
are targeted at the e-commerce market and are strategic to our ability to
successfully compete in this market. If we are unable to successfully compete
in this market, our business and operating results could be adversely affected.
THE PRODUCTS WE MAKE ARE VERY COMPLEX 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 could be adversely affected. We must quickly develop,
introduce, and deliver in quantity new, complex systems, software, and hardware
products and components including products we plan to introduce during fiscal
2001 which incorporate our new UltraSPARC(TM) III architecture, the Solaris
Operating Environment, our Sun StorEdge(TM) storage products, and other software
products, such as those products under development or to be developed under our
alliance with AOL. The development process for these complicated products is
very uncertain. It requires high levels of innovation from both our product
designers and our suppliers of the components used in our products. The
development process is also lengthy and costly. If we fail to accurately
anticipate our customers' needs and technological trends, or are otherwise
unable to complete the development of a product on a timely basis, we will be
unable to introduce new products into the market on a timely basis, if at all,
and our business and operating results would be adversely affected. In addition,
the successful development of software products under our alliance with AOL
depends on many factors, including our ability to work effectively within the
alliance on complex product development and any encumbrances that may arise from
time to time may prevent us from developing, marketing, or selling these
alliance software products. If we are unable to successfully develop, market, or
sell the alliance software products or other software products, our business and
operating results could be adversely affected.
Software and hardware products such as ours may contain known as well as
undetected errors, and these defects may be found following introduction and
shipment of new products or enhancements to existing products. Although we
attempt to fix errors that we believe would be considered critical by our
customers prior to shipment, we may not be able to detect or fix all such
errors, and this could result in lost revenues and delays in customer
acceptance, and could be detrimental to our business and reputation.
The manufacture and introduction of our new hardware and software products is
also a complicated process. Once we have developed a new product we face several
challenges in the manufacturing process. We must be able to manufacture new
products in high enough volumes so that we can have an adequate supply of new
products to meet customer demand. We must be able to manufacture the new
products at acceptable costs. This requires us to be able to accurately forecast
customer
Financial Review 30
<PAGE> 34
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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 like the introduction of our
new UltraSPARC III architecture during fiscal 2001, so that we can minimize the
impact of customers delaying purchases of existing products in anticipation of
the new product release. We must also try to reduce the levels of older product
and component inventories to minimize inventory write-offs. Additionally, we may
decide to adjust prices of our existing products during this process 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 and existing
products, our business and operating results could be materially adversely
affected.
OUR RELIANCE ON SINGLE SOURCE SUPPLIERS COULD DELAY PRODUCT SHIPMENTS AND
INCREASE OUR COSTS.
We depend on many suppliers for the necessary parts and components to
manufacture our products. There are a number of vendors producing the parts and
components that we need. However, there are some components that can only be
purchased from a single vendor due to price, quality, or technology reasons. For
example, we depend on Sony for various monitors, and on Texas Instruments for
our SPARC microprocessors. If we were unable to purchase the necessary parts and
components from a particular vendor and we had to find a new supplier for such
parts and components, our new and existing product shipments could be delayed,
severely affecting our business and operating results.
OUR FUTURE OPERATING RESULTS DEPEND ON OUR ABILITY TO PURCHASE A SUFFICIENT
AMOUNT OF COMPONENTS TO MEET THE DEMANDS OF OUR CUSTOMERS.
We depend heavily on our suppliers to timely design, manufacture, and deliver
the necessary components for our products. While many of the components we
purchase are standard, we do purchase some components, specifically color
monitors and custom memory integrated circuits such as static random-access
memories (SRAMS) and video random-access memories (VRAMS), that require long
lead times to manufacture and deliver. Long lead times make it difficult for us
to plan component inventory levels in order to meet the customer demand for our
products. In addition, in the past, we have experienced shortages in certain of
our components (specifically dynamic random-access memories (DRAMS) and SRAMS).
If a component delivery from a supplier is delayed, if we experience a shortage
in one or more components, or if we are unable to provide for adequate levels of
component inventory, our new and existing product shipments could be delayed and
our business and operating results could 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 WHICH
INCLUDE THESE COMPONENTS, WE FACE A SUBSTANTIAL INVENTORY RISK.
As part of our component inventory planning, we frequently pay certain suppliers
well in advance of receipt of customer orders. For example, we often enter into
noncancelable purchase commitments with vendors early in the manufacturing
process of our microprocessors to make sure we have enough of these components
for our new products to meet customer demand. Because the design and
manufacturing process for these components is very complicated it is possible
that we could experience a design or manufacturing flaw that could delay or even
prevent the production of the components for which we have previously committed
to pay. We also face the risk of ordering too many components, or conversely,
not enough components, since the orders are based on the forecasts of customer
orders rather than actual orders. If we cannot change or be released from the
noncancelable purchase commitments, we could incur significant costs from the
purchase of unusable components, due to a delay in the production of the
components or as a result of inaccurately predicting component orders in advance
of customer orders. Our business and operating results could be adversely
affected as a result of these increased costs.
DELAYS IN PRODUCT DEVELOPMENT OR CUSTOMER ACCEPTANCE AND IMPLEMENTATION OF NEW
PRODUCTS AND TECHNOLOGIES COULD SERIOUSLY HARM OUR BUSINESS.
Generally, the computer systems we sell to customers incorporate hardware and
software products that we sell, such as UltraSPARC microprocessors, the Solaris
Operating Environment and Sun StorEdge storage products. Any delay in the
development of the software and hardware included in our systems could delay our
shipment of these systems. Delays in the development and introduction of our
products may occur for various reasons. For example, delays in software
development could delay shipments of related new hardware products.
In addition, if customers decided to delay the adoption and implementation of
new releases of our Solaris Operating Environment this could also delay customer
acceptance of new hardware products tied to that release. Adopting a new release
of an operating environment requires a great deal of time and money for a
customer to convert its systems to the new release. The customer must also work
with software vendors who port their
31 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
software applications to the new operating system and make sure these
applications will run on the new operating system. As a result, customers may
decide to delay their adoption of a new release of an operating system because
of the cost of a new system and the effort involved to implement it. Such delays
in product development and customer acceptance and implementation of new
products could adversely affect our business.
IF WE ARE UNABLE TO CONTINUE GENERATING SUBSTANTIAL REVENUES FROM INTERNATIONAL
SALES OUR BUSINESS COULD BE 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; currency exchange rate
fluctuations could result in lower demand for our products, as well as currency
translation losses; changes to and compliance with a variety of foreign laws and
regulations may increase our cost of doing business in these jurisdictions;
trade protection measures and import and export licensing requirements subject
us to additional regulation and may prevent us from shipping products to a
particular market, and increase our operating costs.
WE EXPECT OUR QUARTERLY REVENUES AND OPERATING RESULTS TO FLUCTUATE FOR A NUMBER
OF REASONS.
Future operating results will continue to be subject to quarterly fluctuations
based on a wide variety of factors, including:
SEASONALITY. Our sequential quarterly operating results usually fluctuate
downward in the first quarter of each fiscal year when compared to the
immediately preceding fourth quarter.
INCREASES IN OPERATING EXPENSES. Our operating expenses will continue to
increase as we continue to expand our operations. Our operating results could
suffer if our revenues do not increase at least as fast as our expenses.
ACQUISITIONS/ALLIANCES. If, in the future, we acquire technologies, products, or
businesses, or we form alliances with companies requiring technology investments
or revenue commitments (such as our alliance with AOL), we will face a number of
risks to our business. The risks we may encounter include those associated with
integrating or comanaging operations, personnel, and technologies acquired or
licensed, and the potential for unknown liabilities of the acquired or combined
business. Also, we will include amortization expense of acquired intangible
assets in our financial statements for several years following these
acquisitions. Our business and operating results on a quarterly basis could be
adversely affected if our acquisition or alliance activities are not successful.
SIGNIFICANT CUSTOMERS. Sales to a single customer accounted for approximately
19%, 15%, and 14% of our fiscal 2000, 1999, and 1998 net revenues, respectively.
The major customer revenues in fiscal 2000, 1999, and 1998 were primarily
generated by two subsidiaries of an international organization: (1) a reseller
(16%, 14%, and 14% of net revenues in fiscal 2000, 1999, and 1998,
respectively), acquired by the international organization in fiscal 1999; and
(2) a finance/leasing company (3%, 1%, and none of net revenues in fiscal 2000,
1999, and 1998, respectively). Revenue is generated with the finance/leasing
company whenever a Sun customer elects to lease equipment; in such cases, Sun
sells the equipment to the leasing company. Our business could suffer if this
customer or any other significant customer terminated its business relationship
with us or significantly reduced the amount of business it did with us.
OUR ACQUISITION AND ALLIANCE ACTIVITIES COULD DISRUPT OUR ONGOING BUSINESS.
We intend to continue to make investments in companies, products, and
technologies, either through acquisitions or investment alliances. For example,
we have purchased several companies in the past and have also formed alliances,
including our alliance with AOL. Acquisitions and alliance activities often
involve risks, including: difficulty in assimilating the acquired operations and
employees; difficulty in managing product codevelopment activities with our
alliance partners; retaining the key employees of the acquired operation;
disruption of our ongoing business; inability to successfully integrate the
acquired technology and operations into our business and maintain uniform
standards, controls, policies, and procedures; and lacking the experience to
enter into new markets, products, or technologies.
Some of these factors are beyond our control. Failure to manage these alliance
activities effectively and to integrate entities or assets that we acquire could
affect our operating results or financial condition.
WE DEPEND ON KEY EMPLOYEES AND FACE COMPETITION IN HIRING AND RETAINING
QUALIFIED EMPLOYEES.
Our employees are vital to our success, and our key management, engineering, and
other employees are difficult to replace. We generally do not have employment
contracts with our key employees. Further, we do not maintain key person life
insurance on any of our employees. The expansion of high technology companies in
Silicon Valley and Colorado, as well as many other cities, has increased demand
and competition for qualified personnel. We may not be able to attract,
assimilate, or retain additional, highly qualified employees in the future.
These factors could adversely affect our business.
Financial Review 32
<PAGE> 36
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
THE LOCATION OF OUR FACILITIES SUBJECTS US TO THE RISK OF EARTHQUAKES.
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 affected in the event of a major earthquake.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET
RISK DISCLOSURES
We are exposed to market risk related to changes in interest rates, foreign
currency exchange rates, and equity security prices. To mitigate some of these
risks, we utilize derivative financial instruments. We do not use derivative
financial instruments for speculative or trading purposes. All of the potential
changes noted below are based on sensitivity analyses performed on our financial
position at June 30, 2000. Actual results may differ materially.
INTEREST RATE SENSITIVITY
Our investment portfolio consists primarily of fixed income instruments with an
average duration of less than 1.50 years. The primary objective of our
investments in debt securities is to preserve principal while maximizing yields,
without significantly increasing risk. These available-for-sale securities are
subject to interest rate risk and will decrease in value if market interest
rates increase. The sensitivity analysis applied to this investment portfolio
was based on a modeling technique that measures the hypothetical market value
changes that would result from a parallel shift in the yield curve of plus 150
basis points (BPS). The hypothetical 150 BPS increase in interest rates would
result in an approximate $88 million decrease in the fair value of our
investments in debt securities as of June 30, 2000.
We also entered into various interest-rate swap agreements to modify the
interest characteristics of the Senior Notes so that the interest associated
with the Senior Notes effectively becomes variable and thus matches the variable
interest rate associated with our cash and marketable securities.
FOREIGN CURRENCY EXCHANGE RISK
The majority of our revenue, expense, and capital purchasing activities are
transacted in U.S. dollars. However, since a portion of our operations consists
of manufacturing and sales activities outside of the U.S., we enter into
transactions in other currencies, primarily the Japanese yen, the British pound,
and the Euro. We enter into foreign exchange forward and option contracts to
hedge certain balance sheet exposures and intercompany balances against future
movements in foreign exchange rates. The gains or losses on the forward and
option contracts are largely offset by gains or losses on the underlying
transactions and, consequently, a sudden or significant change in foreign
exchange rates would not have a material impact on future net income or cash
flows. Based on our foreign currency exchange instruments outstanding at June
30, 2000, we estimate a maximum potential one-day loss in fair value of
approximately $27 million, using a Value-at-Risk (VAR) model. The VAR model
estimates were made assuming normal market conditions and a 95% confidence
level. We used a Monte Carlo simulation type model that valued foreign currency
instruments against a thousand randomly generated market price paths.
Anticipated transactions, firm commitments, receivables, and accounts payable
denominated in foreign currencies were excluded from the model. The VAR model is
a risk estimation tool, and as such is not intended to represent actual losses
in fair value that will be incurred by us. Additionally, as we utilize foreign
currency instruments for hedging anticipated and firmly committed transactions,
a loss in fair value for those instruments is generally offset by increases in
the value of the underlying exposure. Foreign currency fluctuations did not have
a material impact on our results of operations and financial position during
fiscal years 2000, 1999, and 1998.
EURO CONVERSION
On January 1, 1999, certain member countries of the European Union established
fixed conversion rates between their existing currencies and the Euro. The
transition period for the introduction of the Euro ends June 30, 2002. Issues
facing us as a result of the introduction of the Euro include converting
information technology systems, reassessing currency risk, negotiating and
amending licensing agreements and contracts, and processing tax and accounting
records. We continue to address these issues and do not currently expect the
Euro to have a material effect on our financial conditions or results of
operations.
EQUITY SECURITY PRICE RISK
We are exposed to price fluctuations on the marketable portion of equity
securities included in our portfolio of strategic investments. These investments
are generally in companies in the high-technology industry sector, many of which
are small capitalization stocks. We typically do not attempt to reduce or
eliminate the market exposure on these securities. A 20% adverse change in
equity prices would result in an approximate $60 million decrease in the fair
value of our available-for-sale strategic equity investments as of June 30,
2000. At June 30, 2000, one equity security represented approximately $114
million of the total value of the marketable strategic equity securities of $298
million.
33 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 37
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
---------------------------------------------------------------------------------------------------------------------
(In millions, except per share amounts) 2000 1999 1998
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net revenues:
Products $13,421 $10,171 $8,675
Services 2,300 1,635 1,187
---------------------------------------------------------------------------------------------------------------------
Total net revenues 15,721 11,806 9,862
---------------------------------------------------------------------------------------------------------------------
Cost of sales:
Cost of sales--products 6,096 4,696 3,992
Cost of sales--services 1,453 974 721
---------------------------------------------------------------------------------------------------------------------
Total cost of sales 7,549 5,670 4,713
---------------------------------------------------------------------------------------------------------------------
Gross margin 8,172 6,136 5,149
Operating expenses:
Research and development 1,630 1,280 1,029
Selling, general and administrative 4,137 3,215 2,830
Purchased in-process research and development 12 121 176
---------------------------------------------------------------------------------------------------------------------
Total operating expenses 5,779 4,616 4,035
---------------------------------------------------------------------------------------------------------------------
Operating income 2,393 1,520 1,114
Gain on sale of investments, net 208 -- --
Interest income, net 170 85 48
---------------------------------------------------------------------------------------------------------------------
Income before income taxes 2,771 1,605 1,162
Provision for income taxes 917 575 407
---------------------------------------------------------------------------------------------------------------------
Net income $ 1,854 $ 1,030 $ 755
---------------------------------------------------------------------------------------------------------------------
Net income per common share--basic $ 1.18 $ 0.67 $ 0.50
---------------------------------------------------------------------------------------------------------------------
Net income per common share--diluted $ 1.10 $ 0.63 $ 0.47
---------------------------------------------------------------------------------------------------------------------
Shares used in the calculation of net income per common share--basic 1,576 1,544 1,507
---------------------------------------------------------------------------------------------------------------------
Shares used in the calculation of net income per common share--diluted 1,689 1,641 1,590
---------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
Financial Review 34
<PAGE> 38
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30,
-------------------------------------------------------------------------------------------------------------------------------
(In millions, except par value) 2000 1999
-------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 1,849 $ 1,101
Short-term investments 626 1,591
Accounts receivable, net of allowances of $534 in 2000 and $340 in 1999 2,690 2,310
Inventories 557 308
Deferred tax assets 673 506
Other current assets 482 372
-------------------------------------------------------------------------------------------------------------------------------
Total current assets 6,877 6,188
Property, plant and equipment, net 2,095 1,614
Long-term investments 4,496 --
Other assets, net 684 697
-------------------------------------------------------------------------------------------------------------------------------
$ 14,152 $ 8,499
===============================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings $ 7 $ 2
Accounts payable 924 756
Accrued payroll-related liabilities 751 520
Accrued liabilities and other 1,366 991
Deferred revenues and customer deposits 1,289 576
Income taxes payable 422 403
-------------------------------------------------------------------------------------------------------------------------------
Total current liabilities 4,759 3,248
Deferred income taxes 364 192
Long-term debt and other obligations 1,720 192
Commitments and contingencies -- --
Stockholders' equity:
Preferred stock, $0.001 par value, 10 shares authorized
(3 shares of which have been designated as Series A Preferred participating stock);
no shares issued and outstanding -- --
Common stock and additional paid-in-capital, $0.00067 par value, 3,600 shares authorized;
issued: 1,748 shares in 2000 and 1,746 shares in 1999 2,728 1,816
Treasury stock, at cost: 151 shares in 2000 and 180 shares in 1999 (1,438) (1,046)
Deferred compensation (15) --
Retained earnings 5,959 4,107
Accumulated other comprehensive income (loss) 75 (10)
-------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 7,309 4,867
-------------------------------------------------------------------------------------------------------------------------------
$ 14,152 $ 8,499
===============================================================================================================================
</TABLE>
See accompanying notes.
35 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 39
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
-----------------------------------------------------------------------------------------------------------------------------
(In millions) 2000 1999 1998
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 1,854 $ 1,030 $ 755
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 776 631 444
Tax benefits from employee stock plans 708 222 112
Adjustment to conform fiscal year end of pooled acquisition (1) -- --
Purchased in-process research and development 12 121 176
Gain on sale of investments, net (208) -- --
Changes in operating assets and liabilities:
Accounts receivable (378) (436) (179)
Inventories (249) 39 97
Other current and long-term assets (378) (535) (214)
Accounts payable 166 257 (14)
Other current and long-term liabilities 1,452 1,182 338
-----------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 3,754 2,511 1,515
-----------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of investments (9,808) (2,445) (977)
Proceeds from sales and maturities of investments 6,723 1,332 967
Acquisition of property, plant and equipment (982) (740) (835)
Acquisition of spare parts and other assets (69) (109) (92)
Payments for acquisitions, net of cash acquired (89) (130) (244)
-----------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (4,225) (2,092) (1,181)
-----------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of long-term debt 1,500 -- --
Increase (decrease) in short-term borrowings, net 4 (55) (79)
Proceeds from issuance of common stock, net 180 144 75
Proceeds from employee stock purchase plans 166 116 94
Acquisition of treasury stock (631) (358) (284)
-----------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 1,219 (153) (194)
-----------------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 748 266 140
Cash and equivalents, beginning of period 1,101 835 695
=============================================================================================================================
Cash and equivalents, end of period $ 1,849 $ 1,101 $ 835
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 53 $ 1 $ 1
Income taxes $ 276 $ 139 $ 335
-----------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
Financial Review 36
<PAGE> 40
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON
STOCK
AND
ADDITIONAL
COMMON PAID-IN
STOCK CAPITAL TREASURY STOCK
------- -------- ----------------------
(in millions) SHARES AMOUNT SHARES AMOUNT
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balances as of June 30, 1997 1,733 $1,298 (240) $ (915)
Net income -- -- -- --
Change in unrealized gain (loss) on
investments, net of related taxes -- -- -- --
Translation adjustments -- -- -- --
Total comprehensive income -- -- -- --
Issuance of stock, net of repurchases (1) 3 51 196
Treasury stock purchased -- -- (26) (284)
Tax benefit from employee stock
transactions and other -- 116 -- --
------------------------------------------------------------------------------------------------------
Balances as of June 30, 1998 1,732 1,417 (215) (1,003)
Net income -- -- -- --
Change in unrealized gain (loss) on
investments, net of related taxes -- -- -- --
Translation adjustments -- -- -- --
Total comprehensive income -- -- -- --
Issuance of stock, net of repurchases -- -- 55 315
Treasury stock purchased -- -- (20) (358)
Tax benefit from employee stock
transactions and other -- 253 -- --
Issuance of common stock dividends -- 1 -- --
Purchase acquisitions 14 145 -- --
------------------------------------------------------------------------------------------------------
Balances as of June 30, 1999 1,746 1,816 (180) (1,046)
Net income -- -- -- --
Change in unrealized gain (loss) on
investments, net of related taxes -- -- -- --
Translation adjustments -- -- -- --
Total comprehensive income -- -- -- --
Issuance of stock, net of repurchases -- 110 41 239
Treasury stock purchased -- -- (12) (631)
Tax benefit from employee stock
transactions and other -- 742 -- --
Purchase acquisitions 1 58 -- --
Issuance of common stock dividends -- 1 -- --
Adjustment to conform fiscal year
end of pooled acquisition 1 1 -- --
------------------------------------------------------------------------------------------------------
Balances as of June 30, 2000 1,748 $2,728 (151) $(1,438)
------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE TOTAL
DEFERRED RETAINED INCOME STOCKHOLDERS'
(in millions) COMPENSATION EARNINGS (LOSS) EQUITY
-----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balances as of June 30, 1997 $ -- $ 2,401 $ 17 $ 2,801
Net income -- 755 -- 755
Change in unrealized gain (loss) on
investments, net of related taxes -- -- 20 20
Translation adjustments -- -- (17) (17)
---------
Total comprehensive income -- -- -- 758
Issuance of stock, net of repurchases -- (22) -- 177
Treasury stock purchased -- -- -- (284)
Tax benefit from employee stock
transactions and other -- -- -- 116
-----------------------------------------------------------------------------------------------------------
Balances as of June 30, 1998 -- 3,134 20 3,568
Net income -- 1,030 -- 1,030
Change in unrealized gain (loss) on
investments, net of related taxes -- -- (19) (19)
Translation adjustments -- -- (11) (11)
---------
Total comprehensive income -- -- -- 1,000
Issuance of stock, net of repurchases -- (56) -- 259
Treasury stock purchased -- -- -- (358)
Tax benefit from employee stock
transactions and other -- -- -- 253
Issuance of common stock dividends -- (1) -- --
Purchase acquisitions -- -- -- 145
-----------------------------------------------------------------------------------------------------------
Balances as of June 30, 1999 -- 4,107 (10) 4,867
Net income -- 1,854 -- 1,854
Change in unrealized gain (loss) on
investments, net of related taxes -- -- 126 126
Translation adjustments -- -- (40) (40)
---------
Total comprehensive income -- -- -- 1,940
Issuance of stock, net of repurchases -- -- -- 349
Treasury stock purchased -- -- -- (631)
Tax benefit from employee stock
transactions and other -- -- -- 742
Purchase acquisitions (15) -- -- 43
Issuance of common stock dividends -- (1) -- --
Adjustment to conform fiscal year
end of pooled acquisition -- (1) (1) (1)
-----------------------------------------------------------------------------------------------------------
Balances as of June 30, 2000 $(15) $ 5,959 $ 75 $ 7,309
-----------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
37 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. 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 and storage 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 categories across geographically diverse
markets.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 the current year presentation.
As discussed in Note 3, on October 19, 1999, Sun completed its merger with Forte
Software, Inc. (Forte). This merger was accounted for as a pooling of interests
and, accordingly, the historical consolidated financial statements of the
Company have been restated to include the financial position, results of
operations, and cash flows of Forte for all periods presented.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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
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.
INVESTMENTS
Investments are comprised of marketable securities, marketable strategic equity
securities and preferred stock and other strategic equity holdings. Marketable
securities consist primarily of commercial paper, corporate bonds, floating-rate
notes, and asset-backed and mortgage-backed securities with original maturities
beyond three months. All marketable securities are held in the Company's name
and custodied primarily with one major financial institution. 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. Short-term
investments are marketable securities with maturities of less than one year from
the balance sheet date. At June 30, 2000 and 1999, all of the Company's
marketable securities are classified as available-for-sale and are carried at
fair market value.
Marketable strategic equity securities represent equity holdings in public
companies and are classified as available-for-sale when there are no
restrictions on Sun's ability to immediately liquidate such securities.
Preferred stock and other strategic equity holdings represent equity holdings in
nonpublic companies and investments in venture capital funds. These investments
are carried at the lower of cost or net realizable value due to their illiquid
nature.
Unrealized gains and losses are included as a separate component of
stockholders' equity, net of any related tax effect. The specific identification
method is used to determine the cost of investments disposed of, with realized
gains and losses reflected in gain on sale of investments, net.
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, which have not been
material, are included in income and expense and generally offset the change in
the deferred compensation liability.
INVENTORIES
Inventories (See Note 5, "Balance Sheet Details") 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.
PROPERTY, PLANT, AND EQUIPMENT, NET
Property, plant, and equipment (See Note 5, "Balance Sheet Details") are stated
at cost. Depreciation is provided principally on the straight-line method over
the estimated useful lives of the assets. Useful lives for machinery and
equipment, furniture and fixtures, and buildings and related building
improvements are 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, NET
Other assets, net (See Note 5, "Balance Sheet Details") consist primarily of
acquired intangibles, prepaid expenses and spare parts. Intangible assets and
spare parts are amortized using the straight-line method over their useful lives
ranging from six months to seven years. Amortization expense for fiscal 2000,
1999, and 1998 was $192 million, $78 million, and $42 million, respectively.
Financial Review 38
<PAGE> 42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. During the year ended June 30, 2000, the Company recognized
impairments totaling approximately $49 million in connection with the impairment
of goodwill and other intangible assets ($9 million in fiscal 1999 and none in
1998). The $49 million impairment expense for fiscal 2000 was charged to cost of
sales ($9 million) and selling, general, and administrative expense ($40
million).
CAPITALIZED SOFTWARE
Costs related to internally developed software and software purchased for
internal use, which are required to be capitalized pursuant to Statement of
Position (SOP) No. 98-1, "Accounting for Costs of Computer Software Developed or
Obtained for Internal Use," have not been material to the Company to date.
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 the 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 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 sales are recorded. Option
contracts that have no intrinsic value 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 into income over the life of the contract. Amounts receivable and
payable on certain forward foreign exchange contracts are recorded as other
current assets or accrued liabilities, respectively.
The Company does not use derivative financial instruments for speculative
trading purposes, nor does it hold or issue leveraged derivative financial
instruments.
CONCENTRATION OF CREDIT RISK
The majority of cash and cash equivalents are maintained with three major
financial institutions in the United States. Deposits with these banks may
exceed the amount of insurance provided on such deposits. Generally, these
deposits may be redeemed upon demand and, therefore, bear minimal risk.
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of marketable securities, foreign exchange
contracts, interest rate instruments and 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, 2000 and 1999. The Company's trade
receivables are derived primarily from sales of hardware and software products
and services to end user 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. The Company provided
amounts for doubtful accounts of $55 million and $18 million at June 30, 2000
and 1999, respectively.
39 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
REVENUE RECOGNITION
The Company recognizes revenue when the earnings process is complete, evidenced
by an agreement between the Company and the customer, there has been delivery
and acceptance, collectibility is probable, and pricing is fixed and
determinable. If significant obligations remain after delivery, revenue is
deferred until such obligations are fulfilled. For software arrangements,
revenue is deferred if vendor specific objective evidence of fair value does not
exist for any undelivered elements. Revenue from service agreements is generally
recognized ratably over the service period or as the services are rendered.
Allowances are established for anticipated product returns, price protection,
cooperative marketing, and sales incentive programs.
In addition, the Company sells products to leasing companies who lease these
products to third parties. In arrangements where the leasing companies have
recourse from the Company in the event of default by the third parties, the
Company recognizes the product revenue (and the related cost of product) as the
payments are made to the leasing company by the end user (generally ratably over
the lease term) and the amount of recourse to the Company is reduced. At June
30, 2000, the Company had $192 million in deferred revenue ($89 million of which
is considered long-term) for sales to leasing companies that were subject to
recourse and $65 million of related unamortized cost.
RESEARCH AND DEVELOPMENT EXPENDITURES
Costs related to research, design, and development of products are charged to
research and development expenses as incurred. Software development costs are
capitalized beginning when a product's technological feasibility has been
established and ending when a product is available for general release to
customers. Generally, the Company's products are released soon after
technological feasibility has been established. As a result, costs subsequent to
achieving technological feasibility have not been significant and all software
development costs have been expensed.
ADVERTISING COSTS
Advertising costs are charged to expense when incurred. Advertising expense was
$326 million, $246 million, and $235 million for fiscal years 2000, 1999, and
1998, respectively.
SELF-INSURANCE
The Company is self-insured up to specific levels for certain liabilities.
Accruals are provided each year based on historical claim experience 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 $27.5 million.
INCOME TAXES
Income tax expense is based on pretax financial accounting income. Deferred tax
assets and liabilities are determined based on the difference between the
financial statement and tax basis of assets and liabilities using enacted tax
rates in effect for the year in which the differences are expected to reverse.
COMPUTATION OF NET INCOME PER COMMON SHARE
Basic net income per common share is computed using the weighted average number
of common shares outstanding during the period. Diluted net income per common
share is computed using the weighted average number of common and dilutive
common equivalent shares outstanding during the period. Dilutive common
equivalent shares consist primarily of stock options.
STOCK DIVIDEND
In April and December 1999, the Company effected two-for-one splits of its
common stock paid in the form of stock dividends. All share and per share data
have been adjusted to reflect the splits for all periods presented.
FOREIGN CURRENCY TRANSLATION
The Company translates the assets and liabilities of international non-U.S.
functional currency subsidiaries into dollars at the current rates of exchange
in effect during each period. Revenues and expenses are translated using rates
that approximate those in effect during the period. Gains and losses from
translation adjustments are included in stockholders' equity in the consolidated
balance sheet caption "Accumulated other comprehensive income (loss)." Currency
transaction gains or losses, derived on monetary assets and liabilities stated
in a currency other than the functional currency, 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.
STOCK-BASED COMPENSATION
As permitted by Statement of Financial Accounting Standards (SFAS) No. 123,
"Accounting for Stock-Based Compensation," the Company measures compensation
expense for its stock-based employee compensation plans using the intrinsic
value method prescribed by Accounting Principles Board Opinion No. 25 (APB 25),
"Accounting for Stock Issued to Employees" (See Note 12, "Employee Benefit
Plans").
COMPREHENSIVE INCOME
The Company's comprehensive income is comprised of net income, foreign currency
cumulative translation adjustments, and unrealized gains and losses on
available-for-sale investments, net of related taxes. Comprehensive income is
reflected in the consolidated statements of stockholders' equity.
Financial Review 40
<PAGE> 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEGMENT REPORTING
Under SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information," the Company is required to use the "management" approach to
reporting segments. 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. SFAS No. 131
also requires disclosures about products and services, geographic areas, and
major customers (See Note 13, "Industry Segment, Geographic, and Customer
Information").
RECENT PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements". SAB 101 summarizes certain of the SEC's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
The SEC has indicated that they intend to issue additional written guidance to
further supplement SAB 101. Accordingly, the Company is continuing to evaluate
the potential impact of SAB 101 on the Company's results of operations and
financial position. Based on the SEC's latest timeline for implementing SAB 101,
the Company would be required to comply with the guidelines in the fourth
quarter of fiscal 2001.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments and
hedging activities. It requires the Company to recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. It further provides criteria for derivative instruments to be
designated as fair value, cash flow, or foreign currency hedges, and establishes
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 will adopt SFAS No. 133 in
fiscal 2001. Management does not believe the adoption of SFAS No. 133 will have
a material effect on the Company's results of operations or financial position.
3. ACQUISITIONS
POOLING OF INTERESTS
On October 19, 1999, the Company completed its merger with Forte Software, Inc.,
a software company that designs, develops, markets, and supports a set of
products for developing, deploying, and managing production applications in
distributed environments, including client/server and the Internet. Under the
terms of the merger agreement, the Company issued 12.7 million shares of Sun
common stock (with a fair market value of $47.03 per share on such date) in
exchange for all of Forte's common stock. In addition, Sun issued 2.7 million
stock options in exchange for Forte's previously outstanding stock options. The
number of Sun shares was calculated using an exchange ratio of 0.6 shares of Sun
stock for each share of Forte common stock. The transaction was accounted for as
a pooling of interests and, accordingly, the historical consolidated financial
statements of the Company have been restated to include the financial position,
results of operations, and cash flows of Forte for all periods presented.
Prior to the merger, Forte's fiscal year ended March 31. Restated consolidated
financial statements of the Company combine the June 30, 1999 and 1998 results
of the Company with the March 31, 1999 and 1998 results of Forte, respectively.
No adjustments were necessary to conform accounting policies of the entities.
However, Forte's historical results have been adjusted to reflect a decrease in
income taxes due to the elimination of a previously provided valuation allowance
on its deferred tax assets. There were no intercompany transactions requiring
elimination in any period presented. In order for both companies to operate on
the same fiscal year for 2000, Forte's results of operations for the three-month
period ended June 30, 1999, which are not material to the Company, have been
reflected as an adjustment to retained earnings in fiscal 2000.
41 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table shows the historical results of the Company and Forte for
the periods prior to the consummation of the merger of the entities (in
millions):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 26, 1999 YEARS ENDED JUNE 30,
------------------ ---------------------------
(UNAUDITED) 1999 1998
------------------ -------- --------
<S> <C> <C> <C>
Revenues:
Sun $ 3,122 $ 11,726 $ 9,791
Forte 24 80 71
Total $ 3,146 $ 11,806 $ 9,862
Net Income:
Sun, as previously reported $ 271 $ 1,031 $ 763
Forte, as previously reported 1 (1) (14)
Total 272 1,030 749
Adjustment to reflect restatement of valuation allowances -- -- 6
Net Income, as restated $ 272 $ 1,030 $ 755
</TABLE>
PURCHASE ACQUISITIONS
During the three years ended June 30, 2000, the Company completed fourteen
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.
The amounts allocated to purchased in-process research and development (IPRD)
were determined through established valuation techniques in the high-technology
computer industry and were expensed upon acquisition because technological
feasibility had not been established and no future alternative uses existed.
Research and development costs to bring the products from the acquired companies
to technological feasibility, individually or in the aggregate, are not expected
to have a material impact on the Company's future results of operations or cash
flows. Amounts allocated to goodwill and other intangibles are amortized on a
straight-line basis over periods not exceeding five years.
Financial Review 42
<PAGE> 46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the Company's purchase transactions for the three years ended June
30, 2000, is included in the following table (in millions, except share
amounts):
<TABLE>
<CAPTION>
ENTITY NAME AND DEVELOPED
DESCRIPTION OF BUSINESS ACQUIRED DATE CONSIDERATION GOODWILL TECHNOLOGY
-------------------------------- ---- ------------- -------- ----------
<S> <C> <C> <C> <C>
FISCAL 2000 ACQUISITIONS
Ed Learning Systems, Inc. and 6/00 $ 10.3 $ 7.6 --
eTech, Inc.
Dot-com learning solutions
Innosoft International, Inc. 3/00 $ 42.4 $30.7 $ 5.6
Internet mail, directory and
messaging services
Trustbase Limited and 1/00 $ 20.5 $ 7.4 $ 5.0
JCP Computer Services Limited
Financial e-commerce
applications
NetBeans Ceska Republica a.s. 10/99 $ 9.0 $ 8.0 $ 0.7
Java technology-based
development environment
Star Division Corporation 8/99 $ 75.5 $67.5 $ 3.3
and Star Division Software-
Entwicklung und Vertriebs GmbH
Office productivity
applications
FISCAL 1999 ACQUISITIONS
Maxstrat Corporation 1/99 $101.5 $61.5 $ 8.6
Network storage
hardware/software
Beduin Communications 10/98 $ 8.4 $ 0.7 $ 3.1
Corporation
Java technology-based
consumer applications
iPlanet, Inc. 9/98 $ 30.0 $17.8 $ 3.3
Java technology-based
Internet applications
NetDynamics, Inc. 8/98 $148.2 $48.2 $20.0
Enterprise Application
Platform
FISCAL 1998 ACQUISITIONS
Red Cape Software, Inc. 5/98 $ 16.7 -- $ 0.9
Policy-based storage
management software
Encore Computer Corporation 11/97 $186.2 $ 5.8 $56.0
Open systems storage
Chorus Systems, S.A. 10/97 $ 26.5 -- $ 6.5
JavaOS(TM) kernel technology
Integrity Arts, Inc. 9/97 $ 30.2 -- --
Java Card(TM) application
programming interface
Diba, Inc. 8/97 $ 29.7 $ 1.6 $ 3.9
Turnkey information
appliance software
</TABLE>
<TABLE>
<CAPTION>
ENTITY NAME AND OTHER
DESCRIPTION OF BUSINESS ACQUIRED WORKFORCE INTANGIBLES IPRD FORM OF CONSIDERATION
-------------------------------- --------- ----------- ---- ---------------------
<S> <C> <C> <C> <C>
FISCAL 2000 ACQUISITIONS
Ed Learning Systems, Inc. and $1.7 -- -- -$ 2.4 cash
eTech, Inc. -$ 7.9 99,000 shares
Dot-com learning solutions common stock issued
Innosoft International, Inc. $1.3 $0.5 $ 3.1 -$ 4.1 cash
Internet mail, directory and -$ 34.9 406,000 shares
messaging services common stock issued
-$ 3.4 38,000 vested options
assumed
Trustbase Limited and $1.1 $0.3 $ 4.9 -$ 9.1 cash
JCP Computer Services Limited -$ 5.9 note payable
Financial e-commerce -$ 5.5 liabilities assumed
applications
NetBeans Ceska Republica a.s. $0.1 $0.1 -- -$ 8.8 cash
Java technology-based -$ 0.1 liabilities assumed
development environment -$ 0.1 3,000 vested options
assumed
Star Division Corporation $1.0 $0.2 $ 3.5 -$ 66.3 cash
and Star Division Software- -$ 8.5 liabilities assumed
Entwicklung und Vertriebs GmbH -$ 0.7 48,000 vested options
Office productivity assumed
applications
FISCAL 1999 ACQUISITIONS
Maxstrat Corporation -- -- $28.7 -$ 99.0 cash
Network storage -$ 2.5 114,000 vested options
hardware/software assumed
Beduin Communications $0.1 $0.7 $ 3.6 -$ 8.4 cash
Corporation
Java technology-based
consumer applications
iPlanet, Inc. -- -- $ 8.4 -$ 28.6 cash
Java technology-based -$ 1.2 108,000 vested options
Internet applications assumed
-$ 0.2 liabilities assumed
NetDynamics, Inc. -- -- $80.0 -$132.5 10,987,000 shares
Enterprise Application common stock issued
Platform -$ 8.3 688,000 vested options
assumed
-$ 7.4 liabilities assumed
FISCAL 1998 ACQUISITIONS
Red Cape Software, Inc. $0.4 $0.6 $14.1 -$ 15.8 cash
Policy-based storage -$ 0.9 liabilities assumed
management software
Encore Computer Corporation $3.9 -- $97.0 -$186.2 cash
Open systems storage
Chorus Systems, S.A. $1.7 $1.7 $13.1 -$ 26.5 cash
JavaOS(TM) kernel technology
Integrity Arts, Inc. $0.3 -- $29.9 -$ 29.9 cash
Java Card(TM) application -$ 0.3 liabilities assumed
programming interface
Diba, Inc. -- -- $22.3 -$ 25.7 cash
Turnkey information -$ 4.0 liabilities assumed
appliance software
</TABLE>
43 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUBSEQUENT ACQUISITIONS (UNAUDITED)
On July 11, 2000, the Company acquired certain assets categorized as
intellectual property from Dolphin Interconnect Solutions Inc., a Delaware
holding company, and its subsidiaries, Dolphin Interconnect Solutions AS, a
corporation organized under the laws of Norway, and Dolphin Interconnect
Solutions North America, Inc., a Delaware corporation, for total cash
consideration of approximately $19 million. The Company acquired these assets to
strengthen its presence in the Infiniband interconnect architecture business.
This transaction will be accounted for as a purchase and the purchase price will
be allocated to tangible assets and identifiable intangible assets, with any
excess being allocated to goodwill.
On July 28, 2000, the Company acquired Gridware, Inc., a California corporation
(Gridware), and its German subsidiary, Gridware GmbH, (Gridware GmbH), by means
of a merger transaction pursuant to which all of the outstanding capital stock
and options of Gridware were converted into the right to receive shares and
options to purchase shares of the Company's common stock. Gridware develops
resource management software used primarily in compute-intensive, technical
computing environments, such as electronic design automation (EDA), mechanical
computer aided design/engineering (MCAD/MCAE), and software development. The
total consideration of approximately $20 million was comprised of approximately
190,000 unregistered shares of the Company's common stock and the assumption of
vested options. This transaction will be accounted for as a purchase and the
purchase price will be allocated to tangible assets and identifiable intangible
assets, with any excess being allocated to goodwill.
4. 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 service 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,
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 $317 million, $331 million, and $236 million in
fiscal 2000, 2001, and 2002, respectively. In addition, the terms of the SDMA
require Sun to pay AOL approximately $278.5 million ($164.6 million remaining at
June 30, 2000) 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
$72 million at June 30, 2000 ($165 million at June 30, 1999) is reflected in
the consolidated balance sheet caption "Long-term debt and other obligations."
5. BALANCE SHEET DETAILS
At June 30, Inventories are comprised of the following (in millions):
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Raw materials $169 $113
Work in process 82 51
Finished goods 306 144
-------------------------------------------
$557 $308
===========================================
</TABLE>
At June 30, Property, plant, and equipment, net, are comprised of the following
(in millions):
<TABLE>
<CAPTION>
2000 1999
------- -------
<S> <C> <C>
Machinery and equipment $ 2,137 $ 1,557
Furniture and fixtures 212 173
Leasehold improvements 335 288
Land, buildings, and building
improvements 1,008 859
----------------------------------------------------------------
3,692 2,877
Less accumulated depreciation
and amortization (1,597) (1,263)
----------------------------------------------------------------
$ 2,095 $ 1,614
================================================================
</TABLE>
Financial Review 44
<PAGE> 48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At June 30, Other assets, net, are comprised of the following (in millions):
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Intangible assets, net of
accumulated amortization
of $268 in 2000 and
$107 in 1999 $205 $205
Prepaid expenses 231 287
Other 248 205
------------------------------------------------------
Total $684 $697
======================================================
</TABLE>
At June 30, Deferred revenues and customer deposits are comprised of the
following (in millions):
<TABLE>
<CAPTION>
2000 1999
------ ------
<S> <C> <C>
Deferred service revenues $ 875 $ 432
Customer deposits and other
deferred revenue 414 144
-----------------------------------------------------------
$1,289 $ 576
===========================================================
</TABLE>
At June 30, the components of Accumulated other comprehensive income (loss), net
of related taxes, are comprised of the following (in millions):
<TABLE>
<CAPTION>
2000 1999
----- -----
<S> <C> <C>
Unrealized gain on
investments, net $ 125 $ --
Cumulative translation
adjustments (50) (10)
------------------------------------------------------------
Accumulated other
comprehensive income (loss) $ 75 $ (10)
============================================================
</TABLE>
6. FAIR VALUE OF FINANCIAL INSTRUMENTS
The cost of cash equivalents and marketable securities approximate fair value
due to the short period of time to maturity. The fair value of marketable
strategic equity securities is determined using quoted market prices for those
securities. 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 currency 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 agreements 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.
45 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At June 30, the fair value of the Company's short-term and long-term investments
is as follows (in millions):
<TABLE>
<CAPTION>
2000 1999
--------------------------------------------------------- ----------
GROSS GROSS
UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE FAIR VALUE
------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Corporate notes and bonds $ 2,882 $ 2 $ (5) $ 2,879 $ 1,265
Asset and mortgage-based securities 1,237 1 (3) 1,235 --
U.S. government notes and bonds 439 1 (1) 439 334
Money market funds 400 -- -- 400 185
State and local government debt 383 1 (1) 383 237
Other investments 89 -- -- 89 33
--------------------------------------------------------------------------------------------------------------------------
Total marketable securities 5,430 5 (10) 5,425 2,054
Marketable strategic equity securities 88 211 (1) 298 --
==========================================================================================================================
$ 5,518 $ 216 $ (11) $ 5,723 $ 2,054
Less cash equivalents (838) (463)
--------------------------------------------------------------------------------------------------------------------------
Total marketable investments 4,885 1,591
Less short-term investments (626) (1,591)
--------------------------------------------------------------------------------------------------------------------------
Total long-term marketable investments 4,259 --
Long-term strategic preferred stock and
other equity holdings, at cost 237 --
==========================================================================================================================
Total long-term investments $ 4,496 $ --
==========================================================================================================================
</TABLE>
At June 30, 1999, the cost of the Company's marketable securities did not differ
significantly from their respective fair values. Accordingly, there were no
significant gross unrealized gains or losses.
During fiscal 2000, the Company invested in certain public and privately-held
companies, which are classified in the above investment table as marketable
strategic equity securities and strategic preferred stock and other equity
holdings (strategic equity investments). These investments are generally
long-term in nature.
At June 30, 2000, the cost and estimated fair values of short-term and long-term
marketable investments (excluding strategic equity investments and cash
equivalents) by contractual maturity are as follows (in millions):
<TABLE>
<CAPTION>
COST FAIR VALUE
------ ----------
<S> <C> <C>
Less than one year $ 575 $ 576
Due in 1-2 years 2,411 2,406
Due in 2-5 years 1,142 1,142
Due after 5 years 464 463
-------------------------------------------------
Total $4,592 $4,587
=================================================
</TABLE>
Financial Review 46
<PAGE> 50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At June 30, the fair value of the Company's borrowing arrangements and other
financial instruments is as follows (in millions):
<TABLE>
<CAPTION>
2000 1999
----------------------- ------------------------
ASSET (LIABILITY) ASSET (LIABILITY)
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Short-term borrowings $ (7) $ (7) $ (2) $ (2)
7.0% - 7.65% Senior Debt (1,500) (1,479) -- --
Forward foreign exchange contracts 4 4 5 5
Foreign currency option contracts -- -- -- 9
Interest-rate swap agreements -- (29) -- --
</TABLE>
7. DERIVATIVE FINANCIAL INSTRUMENTS
At June 30, outstanding notional amounts for derivative financial instruments
are as follows (in millions):
<TABLE>
<CAPTION>
2000 1999
------ ------
<S> <C> <C>
Forward foreign exchange
contracts $2,976 $ 845
Foreign currency option
contracts 653 476
Swaps hedging debt 1,500 --
</TABLE>
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 2.
At June 30, 2000 and 1999, the Company had forward foreign exchange contracts of
less than three months duration, to exchange principally Japanese yen, British
pounds, and Euros for U.S. dollars in the total gross notional amount of $2,976
million and $845 million, respectively. Of these notional amounts, forward
contracts to purchase foreign currency represented $556 million and $126 million
and forward contracts to sell foreign currency represented $2,420 million and
$719 million, at June 30, 2000 and 1999, respectively. The Company also has
purchased foreign currency options of less than two months duration, to exchange
principally Japanese yen, British pounds, and Euros for U.S. dollars. Finally,
the Company entered into various interest-rate swap agreements of the same
notional amount and maturity as the Company's Senior Debt Securities so that the
interest associated with the Senior Debt Securities effectively becomes variable
(Notes 6 and 8).
8. BORROWING ARRANGEMENTS
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, certificate of deposit, or Eurodollar rates, at the
Company's option. Under the agreement, Sun is required to maintain various
financial ratios. Sun was in compliance with all covenants at June 30, 2000.
There were no borrowings outstanding under this facility at June 30, 2000.
At June 30, 2000 and 1999, Sun's international subsidiaries had uncommitted
lines of credit aggregating approximately $760 million and $740 million,
respectively. The amounts drawn from these lines of credit as of June 30, 2000
and 1999, respectively, are reflected under short-term borrowings. Interest
rates and other terms of borrowing under these lines of credit vary from country
to country depending on local market conditions at the time of borrowing.
On July 14, 1999, the shelf registration statement which the Company filed with
the SEC on June 18, 1999, became effective. The shelf registration statement
registered senior and subordinated debt securities and common and preferred
stock with an aggregate initial offering price of up to $3 billion. The
securities registered by the Company were in addition to the $1 billion of
securities previously registered and declared effective under a separate 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 (the "Senior
Notes"). The Senior Notes are comprised of the following notes: $200 million
(due on August 15, 2002 and bearing interest at 7%), $250 mil-
47 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
lion (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 is
payable semi-annually starting January 2000. The Company 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 in addition to an amount,
determined by a quotation agent, representing the present value of the remaining
scheduled payments. As discussed in Note 7 "Derivative Financial Instruments,"
the Company also entered into various interest-rate swap agreements to modify
the interest characteristics of the Senior Notes so that the interest associated
with the Senior Notes effectively becomes variable.
Interest expense on borrowings of the Company was $84 million in fiscal 2000,
$1 million in fiscal 1999, and $2 million in fiscal 1998.
9. INCOME TAXES
For the years ended June 30, income before income taxes and the provision for
income taxes consist of the following (in millions):
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------
2000 1999 1998
----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Income before income taxes:
United States $1,647 $ 975 $ 575
Foreign 1,124 630 587
----------------------------------------------------------------------------------------
Total income before income taxes $2,771 $1,605 $1,162
----------------------------------------------------------------------------------------
Provision for income taxes:
Current:
United States federal $ 684 $ 381 $ 349
State 85 45 47
Foreign 234 130 106
----------------------------------------------------------------------------------------
Total current income taxes 1,003 556 502
----------------------------------------------------------------------------------------
Deferred:
United States federal (20) (2) (88)
State 12 7 (6)
Foreign (78) 14 (1)
----------------------------------------------------------------------------------------
Total deferred income taxes (86) 19 (95)
----------------------------------------------------------------------------------------
Provision for income taxes $ 917 $ 575 $ 407
----------------------------------------------------------------------------------------
</TABLE>
Financial Review 48
<PAGE> 52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, at June 30, are as follows
(in millions):
<TABLE>
<CAPTION>
-------------------------------------------------------------
2000 1999
-------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Inventory valuation $ 91 $ 80
Reserves and other accrued
expenses 235 215
Fixed asset basis differences 44 75
Compensation not currently
deductible 93 40
State income taxes -- 18
Deferred revenue 59 --
Other 99 78
-------------------------------------------------------------
Gross deferred tax assets 621 506
-------------------------------------------------------------
Deferred tax liabilities:
Net undistributed profits of
subsidiaries (214) (172)
Unrealized gain on
investments (85) --
Other (13) (20)
-------------------------------------------------------------
Gross deferred tax liabilities (312) (192)
-------------------------------------------------------------
Net deferred tax assets $ 309 $ 314
-------------------------------------------------------------
</TABLE>
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, for years ended June 30, are as follows (in
millions):
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------
2000 1999 1998
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Expected tax rate at 35% $ 970 $562 $407
State income taxes, net of federal tax benefit 63 32 27
Foreign earnings permanently reinvested in foreign operations (118) (82) (50)
Acquired in-process research and development 3 44 25
Other (1) 19 (2)
---------------------------------------------------------------------------------------------------------
Provision for income taxes $ 917 $575 $407
---------------------------------------------------------------------------------------------------------
</TABLE>
As of June 30, 2000, the Company has unrecognized deferred tax liabilities of
approximately $373 million related to cumulative net undistributed earnings of
foreign subsidiaries of approximately $1,204 million. These earnings are
considered to be permanently invested in operations outside the United States.
49 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The current federal and state provisions do not reflect the tax savings
resulting from deductions associated with the Company's various stock option
plans. These savings were $708 million, $222 million, and $112 million in fiscal
2000, 1999, and 1998, respectively, and were credited to stockholders' equity.
The Company's United States income tax returns for fiscal years ended June 30,
1995 and 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.
10. COMMITMENTS AND CONTINGENCIES
The Company leases certain facilities and equipment under noncancelable
operating leases. The future minimum annual lease payments are approximately
$161 million, $131 million, $111 million, $97 million, and $78 million for
fiscal years 2001, 2002, 2003, 2004, and 2005, respectively, and approximately
$246 million for years following fiscal 2005. Rent expense under the
noncancelable operating leases was $187 million in 2000, $170 million in 1999,
and $143 million in 1998.
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.
11. STOCKHOLDERS' EQUITY
STOCKHOLDERS' RIGHTS PLAN
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 $500, 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: (1) 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 (2) 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 $0.0025 per Right, at any time
prior to becoming exercisable, and in certain other circumstances. The Rights
expire on February 11, 2008.
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
2000, the Company repurchased 2.7 million shares at a cost of approximately $126
million under this program (9.5 million shares at a cost of approximately $199
million in 1999; 11.8 million 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 Long-Term Equity Incentive Plan. In June
1999, the Board renewed this repurchase plan for an additional three years. In
fiscal 2000, the Company repurchased 8.9 million shares at a cost of
approximately $505 million under this program (9.3 million shares at a cost of
approximately $159 million in 1999; 14.6 million shares at a cost of
approximately $157 million in 1998).
When the treasury shares are reissued, any excess proceeds over the average
acquisition cost of the shares are recorded as additional paid-in-capital. Any
excess of the average acquisition cost of the shares over the proceeds from
reissuance is charged to additional paid-in-capital to the extent of previous
credits on similar transactions, with any remaining amounts charged to retained
earnings.
12. EMPLOYEE BENEFIT PLANS
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 of non-statutory stock options to
eligible employees to purchase common stock, at or
Financial Review 50
<PAGE> 54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
Information with respect to stock option and stock purchase rights activity is
as follows:
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------
OUTSTANDING OPTIONS/RIGHTS
-------------------------------------------------------------------------------------------
SHARES WEIGHTED
AVAILABLE NUMBER AVERAGE
(In millions, except per share amounts) FOR GRANT OF SHARES EXERCISE PRICE
-------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at June 30, 1997 137 205 $ 3.86
Additional shares reserved 21 -- --
Grants and assumptions (60) 60 $ 9.46
Exercises -- (37) $ 2.14
Cancellations 8 (8) $ 5.32
-------------------------------------------------------------------------------------------
Balance at June 30, 1998 106 220 $ 5.57
Additional shares reserved 74 -- --
Grants and assumptions (46) 46 $20.04
Exercises -- (44) $ 3.26
Cancellations 13 (13) $ 7.54
-------------------------------------------------------------------------------------------
Balance at June 30, 1999 147 209 $ 8.98
Additional shares reserved 83 -- --
Grants and assumptions (66) 66 $65.65
Exercises -- (35) $ 4.97
Cancellations 11 (11) $17.89
-------------------------------------------------------------------------------------------
Balance at June 30, 2000 175 229 $25.57
-------------------------------------------------------------------------------------------
</TABLE>
51 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes significant ranges of outstanding and exercisable
options at June 30, 2000 (in millions, except per share amounts):
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------
OUTSTANDING OPTIONS OPTIONS EXERCISABLE
-----------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
REMAINING EXERCISE EXERCISE
RANGE OF EXERCISE PRICES SHARES LIFE IN YEARS PRICE SHARES PRICE
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 0.0070 - $ 9.2000 94 4.2 $ 4.87 61 $ 4.19
$ 9.2001 - $18.4000 50 6.1 $11.39 14 $10.85
$18.4001 - $27.6000 21 7.2 $24.78 3 $24.80
$27.6001 - $36.8000 17 7.2 $33.38 1 $29.51
$36.8001 - $46.0000 1 9.2 $42.87 -- --
$46.0001 - $55.2000 1 9.3 $46.93 -- --
$55.2001 - $64.4000 4 7.3 $56.16 -- --
$64.4001 - $73.6000 1 7.5 $73.41 -- --
$73.6001 - $82.8000 26 7.8 $80.00 -- --
$82.8001 - $92.0000 14 7.8 $91.22 1 $91.82
-----------------------------------------------------------------------------------------------------
229 5.8 $25.57 80 $ 6.41
-----------------------------------------------------------------------------------------------------
</TABLE>
At June 30, 1999, options to purchase 69.1 million shares were exercisable at a
weighted average and aggregate exercise price of $4.35 and $300 million,
respectively (At June 30, 1998, options to purchase 59.8 million shares were
exercisable at a weighted average and aggregate exercise price of $3.18 and $191
million, respectively). At June 30, 2000, the Company retains repurchase rights
to 2.5 million shares issued pursuant to stock purchase agreements and other
stock plans at a weighted average price of $0.01.
The weighted average fair value at date of grant for options granted during
2000, 1999, and 1998 was $39.10, $12.47 and $6.55 per option, respectively.
EMPLOYEE STOCK PURCHASE PLAN
To provide employees with an opportunity to purchase Sun common stock 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 5.2 million, 11.2 million, and 14.0 million shares of
common stock in fiscal 2000, 1999, and 1998, respectively. At June 30, 2000,
approximately 62.8 million shares remained available for future issuance.
EMPLOYEE 401(k) PLAN
The Company has a 401(k) plan known as the Sun Microsystems, Inc. Tax Deferred
Retirement Savings Plan (the "Plan"). The Plan is available to all regular
employees on the Company's U.S. payroll and provides employees with tax deferred
salary deductions and alternative investment options. Employees may contribute
up to 16% of their salary, subject to certain limitations. The Company expensed
$71 million, $54 million, and $47 million in the fiscal years ended June 30,
2000, 1999, and 1998, respectively, for its contributions to the Plan.
Contributions made by the Company vest 100% upon contribution.
STOCK-BASED COMPENSATION
SFAS No. 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 net income per common share
disclosures for stock-based awards made during the year as if the
fair-value-based method defined in SFAS No. 123 had been applied. For employee
stock options, the fair value of the stock options was estimated as of the date
of grant using the Black-Scholes option pricing model.
Financial Review 52
<PAGE> 56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value of options at the date of grant was estimated using the
Black-Scholes model with the following weighted average assumptions for years
ended June 30:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
OPTIONS EMPLOYEE STOCK PURCHASE PLAN
------------------------------------------------------------------------ ----------------------------------------
2000 1999 1998 2000 1999 1998
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Expected life (in years) 5.8 6.6 7.8 0.5 0.5 0.5
Interest rate 5.96% 5.06% 5.73% 4.75% 4.96% 5.45%
Volatility 52.05% 49.51% 49.60% 53.03% 54.22% 48.88%
Dividend yield -- -- -- -- -- --
------------------------------------------------------------------------------------------------------------------
</TABLE>
Stock-based compensation costs would have reduced pretax income by $473 million,
$195 million, and $133 million in 2000, 1999, and 1998, respectively, ($317
million, $130 million, and $89 million after tax and $0.18, $0.08, 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 and 1998 is not
representative of the pro forma effect on net income in 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
millions, except per share amounts):
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
-------------------------------------------------------------------------------------------------------------
2000 1999 1998
-------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Pro forma net income $1,537 $ 900 $ 666
-------------------------------------------------------------------------------------------------------------
Basic:
Pro forma shares used in the calculation of pro forma net income
per common share--basic 1,576 1,544 1,507
-------------------------------------------------------------------------------------------------------------
Pro forma net income per common share--basic $ 0.98 $ 0.58 $ 0.44
-------------------------------------------------------------------------------------------------------------
Diluted:
Pro forma shares used in the calculation of pro forma net income
per common share--diluted 1,666 1,623 1,546
-------------------------------------------------------------------------------------------------------------
Pro forma net income per common share--diluted $ 0.92 $ 0.55 $ 0.43
-------------------------------------------------------------------------------------------------------------
</TABLE>
13. INDUSTRY SEGMENT, GEOGRAPHIC, AND CUSTOMER INFORMATION
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
executive vice 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 SFAS No. 131.
In addition to the aforementioned divisions, finance and administration, as well
as other corporate groups also report to the President 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.
53 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Although the Company has various divisions, only Computer Systems and Storage
and Enterprise Services are considered reportable segments under the criteria of
SFAS No. 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 SFAS
No. 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 2.
Information on reportable segments for the three years ended June 30, 2000, is
as follows (in millions):
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------
COMPUTER SYSTEMS ENTERPRISE
AND STORAGE SERVICES OTHER TOTAL
---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
2000
Revenues $11,971 $2,300 $1,450 $15,721
Interdivision revenues -- 383 (383) --
Operating income 2,601 290 (498) 2,393
Capital additions 216 88 678 982
Accounts receivable 1,856 724 110 2,690
Inventory 531 2 24 557
Total assets 3,392 1,044 9,716 14,152
---------------------------------------------------------------------------------------
1999
Revenues 9,553 1,635 618 11,806
Interdivision revenues -- 321 (321) --
Operating income 1,644 220 (344) 1,520
Capital additions 204 34 502 740
Accounts receivable 1,746 447 117 2,310
Inventory 287 5 16 308
Total assets 4,316 724 3,459 8,499
---------------------------------------------------------------------------------------
1998
Revenues 8,251 1,187 424 9,862
Interdivision revenues 106 266 (372) --
Operating income 1,377 87 (350) 1,114
Capital additions 255 39 541 835
Accounts receivable 1,412 358 96 1,866
Inventory 313 7 26 346
Total assets 3,128 531 2,135 5,794
---------------------------------------------------------------------------------------
</TABLE>
Financial Review 54
<PAGE> 58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Sales to a single customer accounted for approximately 19%, 15%, and 14% of our
fiscal 2000, 1999, and 1998 net revenues, respectively. The major customer
revenues in fiscal 2000, 1999, and 1998 were primarily generated by two
subsidiaries of an international organization: (1) a reseller (16%, 14%, and 14%
of net revenues in 2000, 1999, and 1998, respectively), acquired by the
international organization in fiscal 1999; and (2) a finance/leasing company
(3%, 1%, and none of net revenues in fiscal 2000, 1999, and 1998, respectively).
Revenue is generated with the finance/leasing company whenever a Sun customer
elects to lease equipment; in such cases, Sun sells the equipment to the leasing
company. No other customer accounted for more than 10% of revenues. The revenues
from this customer are primarily generated in the Computer Systems and Storage
and Enterprise Services segments. The Company's significant operations outside
the United States include manufacturing facilities, design centers, and sales
offices in Europe, the Middle East, and Africa (EMEA), as well as Japan and Rest
of World. Intercompany transfers between operating segments and geographic areas
are primarily accounted for at prices that approximate arm's length
transactions. In fiscal year 2000, 1999, and 1998, sales from Computer Systems
and Storage to Enterprise Services are recorded at cost.
Information regarding geographic areas at June 30, and for each of the years
then ended, is as follows (in millions):
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------
UNITED REST OF
STATES EMEA JAPAN WORLD ELIMINATIONS TOTAL
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
2000
Sales to unaffiliated customers $8,308 $4,454 $1,344 $1,615 -- $15,721
Long-lived assets 2,353 565 74 126 (339) 2,779
-------------------------------------------------------------------------------------------------------------------------
1999
Sales to unaffiliated customers 6,256 3,447 1,047 1,056 -- 11,806
Long-lived assets 2,047 405 54 89 (284) 2,311
-------------------------------------------------------------------------------------------------------------------------
1998
Sales to unaffiliated customers 5,388 2,733 899 842 -- 9,862
Long-lived assets 1,432 333 45 69 (308) 1,571
-------------------------------------------------------------------------------------------------------------------------
</TABLE>
55 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. NET INCOME PER COMMON SHARE
The following table presents the calculation of basic and diluted earnings per
share for the years ended June 30 (in millions, except per share amounts):
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------
2000 1999 1998
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income $1,854 $1,030 $ 755
-----------------------------------------------------------------------------------------------------
Denominator:
Weighted average common shares--basic 1,576 1,544 1,507
Effect of dilutive securities (primarily stock options) 113 97 83
-----------------------------------------------------------------------------------------------------
Weighted average common shares--diluted 1,689 1,641 1,590
-----------------------------------------------------------------------------------------------------
Net income per common share--basic $ 1.18 $ 0.67 $ 0.50
-----------------------------------------------------------------------------------------------------
Net income per common share--diluted $ 1.10 $ 0.63 $ 0.47
-----------------------------------------------------------------------------------------------------
</TABLE>
15. QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------
FISCAL 2000 QUARTER ENDED
--------------------------------------------------------------------------------------------------------
(In millions, except per share amounts) JUNE 30 MARCH 26 DECEMBER 26 SEPTEMBER 26
--------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues $5,017 $4,005 $3,554 $3,145
Gross margin 2,612 2,092 1,834 1,634
Operating income 915 603 496 379
Net income 720 508 353 273
Net income per common share--basic $ 0.45 $ 0.32 $ 0.22 $ 0.17
Net income per common share--diluted $ 0.42 $ 0.30 $ 0.21 $ 0.16
--------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------
FISCAL 1999 QUARTER ENDED
--------------------------------------------------------------------------------------------------------
(In millions, except per share amounts) JUNE 30 MARCH 28 DECEMBER 27 SEPTEMBER 27
-------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues $3,537 $2,957 $2,803 $2,509
Gross margin 1,843 1,554 1,451 1,288
Operating income 564 384 374 198
Net income 395 262 261 112
Net income per common share--basic $ 0.25 $ 0.17 $ 0.17 $ 0.07
Net income per common share--diluted $ 0.24 $ 0.16 $ 0.16 $ 0.07
-------------------------------------------------------------------------------------------------------
</TABLE>
16. SUBSEQUENT EVENTS (UNAUDITED)
On August 18, 2000, the Company announced a 2-for-1 stock split. The
shareholders of record on November 9, 2000 will receive one additional share for
each share owned. The split, in the form of a stock dividend, will be paid on
December 5, 2000, pending shareholder approval of an increase in the total
authorized shares of the Company's common stock.
Financial Review 56
<PAGE> 60
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, 2000 and 1999, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended June 30, 2000. 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 auditing standards generally accepted
in the United States. 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, 2000 and 1999, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended June 30,
2000, in conformity with accounting principles generally accepted in the United
States.
/s/ ERNST & YOUNG LLP
Palo Alto, California
July 19, 2000
57 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 61
ABOUT YOUR INVESTMENT
STOCK SYMBOL
SUNW
STOCK MARKET
Sun stock trades on The Nasdaq Stock Market.
STOCK TRADING
The following table sets forth the per share high and low sales prices for each
quarter shown, as well as, the per share closing sales prices on the last
trading day of each quarter. In addition, the table shows the daily average
trading volume for each quarter listed.
FISCAL YEAR ENDED JUNE 30, 2000*
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
Q1 Q2 Q3 Q4
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
High $ 47.28 $ 81.88 $ 105.00 $ 98.81
Low 33.59 44.69 68.00 71.88
Close Sales Price 46.50 77.44 93.70 90.94
Daily Average Volume 18,152,301 23,330,081 17,176,571 18,868,122
</TABLE>
FISCAL YEAR ENDED JUNE 30, 1999*
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------
Q1 Q2 Q3 Q4
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
High $ 13.20 $ 22.09 $ 30.31 $ 35.88
Low 9.59 9.75 21.78 24.91
Close Sales Price 13.19 20.83 29.13 34.44
Daily Average Volume 23,151,187 29,538,430 36,036,374 22,059,817
</TABLE>
*Share prices are split adjusted for 2-1 stock split
STOCK OWNERSHIP PROFILE
(AS OF JUNE 30, 2000)
<TABLE>
<S> <C>
Institutional Investors 66%
Individual Investors** 34%
</TABLE>
** Includes:
2% for Section 16 Officers and Directors
If you have questions concerning stock certificates, change of address,
consolidation of accounts, transfer of ownership, or other stock account
matters, please contact Sun's transfer agent:
Fleet National Bank
c/o EquiServe Limited Partnership
P.O. Box 8040
Boston, Massachusetts 02266-8040 USA
+1 (800) 730-6001 (within the U.S.)
+1 (781) 575-3120 (outside the U.S.)
Internet address: www.equiserve.com
Sun has never declared cash dividends and presently intends to continue this
policy. Sun's principal credit agreements limit the payment of cash dividends
without the consent of its lenders.
About Your Investment 58
<PAGE> 62
INVESTOR RESOURCES
SUN ON THE WEB
Sun's home on the Internet's World Wide Web provides access to a wide range of
information about the company, its products, and its services--you can also
order our products online. Using any Web browser, you can visit Sun on the
Internet by entering the following address:
WWW.SUN.COM
SUN INVESTOR RELATIONS ON THE WEB
For more information related to investing in SUNW, we invite you to take
advantage of our Investor Relations site to assist you in your research. Please
visit the site at:
WWW.SUN.COM/ABOUTSUN/INVESTOR
[SCREENSHOT OF SUN MICROSYSTEMS WEB PAGE]
The following features can be found at this site:
- Financial Documents
- Financial Presentations
- News and Communication
- Answers to Frequently Asked Questions
- Links to Free Stock Quote Services
- Financial Analysts Covering SUNW
- Calendar of Events
An electronic version of the Annual Report and proxy statement are available.
They can be found at:
WWW.SUN.COM/ANNUALREPORT
WWW.SUN.COM/PROXY00
FOR MORE INFORMATION
To receive an Annual Report to stockholders or an Annual Report on Form 10-K
(available without charge), and for questions about Sun operations, recent
results, or historical performance, please contact:
INVESTOR RELATIONS
Mail Stop UPAL01-207
Sun Microsystems, Inc.
901 San Antonio Road
Palo Alto, California 94303-4900 USA
Phone: +1 (800) 801-SUNW (within the U.S.)
+1 (650) 336-0697 (outside the U.S.)
Fax: +1 (650) 336-0646
To receive faxed information such as earnings announcements, historical
financial results, and press releases, please call:
+1 (800) FAX-SUNW (within the U.S.)
+1 (201) 946-9049 (outside the U.S.)
59 Annual Report 2000 [SUN MICROSYSTEMS LOGO]
<PAGE> 63
CORPORATE INFORMATION/SUN WORLDWIDE
BOARD OF DIRECTORS
SCOTT G. McNEALY
Chairman of the Board of Directors and Chief Executive Officer,
Sun Microsystems, Inc.
JAMES L. BARKSDALE
Managing Partner, The Barksdale Group
L. JOHN DOERR
General Partner/Managing Director, Kleiner Perkins Caufield & Byers
JUDITH L. ESTRIN
Chief Executive Officer, Packet Design, Inc.
ROBERT J. FISHER
Member, Board of Directors, The Gap, Inc.
ROBERT L. LONG
Independent Management Consultant
M. KENNETH OSHMAN
Chairman of the Board of Directors, President,
and Chief Executive Officer, Echelon Corporation
NAOMI O. SELIGMAN
Senior Partner, Ostriker von Simson, Inc.
EXECUTIVE COMMITTEE
SCOTT G. McNEALY
Chief Executive Officer
EDWARD J. ZANDER
President and Chief Operating Officer
MICHAEL E. LEHMAN
Executive Vice President, Corporate Resources
and Chief Financial Officer
CRAWFORD W. BEVERIDGE
Executive Vice President and Chief Human Resources Officer
WILLIAM N. JOY
Cofounder and Chief Scientist
CORPORATE EXECUTIVE OFFICERS
WILLIAM T. AGNELLO
Senior Vice President, Workplace Resources
MEL FRIEDMAN
Senior Vice President, Customer Advocacy
LAWRENCE W. HAMBLY
Executive Vice President, Enterprise Services
H. WILLIAM HOWARD
Senior Vice President, Chief Information Officer
MASOOD A. JABBAR
Executive Vice President, Global Sales Operations
JOHN P. LOIACONO
Senior Vice President, Chief Marketing Officer
JOHN S. McFARLANE
Executive Vice President, Network Service Providers
MICHAEL H. MORRIS
Senior Vice President, General Counsel and Secretary
GREGORY M. PAPADOPOULOS
Senior Vice President and Chief Technology Officer
JANPIETER T. SCHEERDER
Executive Vice President, Storage Products
JONATHAN I. SCHWARTZ
Senior Vice President, Corporate Strategy and Planning
JOHN C. SHOEMAKER
Executive Vice President, System Products Group
PATRICIA C. SUELTZ
Executive Vice President, Software Products and Platforms
MARK E. TOLLIVER
Executive Vice President and President, iPlanet, Sun-Netscape Alliance
SUN WORLDWIDE
MANUFACTURING
2 countries
INTERNATIONAL RESEARCH & DEVELOPMENT
8 countries
INTERNATIONAL SALES, SERVICE, AND SUPPORT
53 countries
INTERNATIONAL DISTRIBUTORS
More than 170 countries
Corporate Information 60
<PAGE> 64
(C)2000 Sun Microsystems, Inc. All rights reserved. Sun, Sun Microsystems, the
Sun logo, The Network Is The Computer, We're the dot in .com, Write Once, Run
Anywhere, Solaris, the Solaris Logo, Java, the Java Coffee Cup Logo, Java Card,
JavaOS, Jini, the Jini logo, Jiro, the Jiro logo, iPlanet, the iPlanet logo,
iPlanet Trustbase, Trustbase, NetDynamics, Enterprise JavaBeans, EJB, Sun
Enterprise, Sun StorEdge, Chorus, Suntone, and StarOffice are trademarks or
registered trademarks of Sun Microsystems, Inc., in the United States and other
countries. All SPARC trademarks are used under license and are trademarks or
registered trademarks of SPARC International, Inc., in the United States and
other countries. Products bearing SPARC trademarks are based upon an
architecture developed by Sun Microsystems, Inc. UNIX is a registered trademark
in the United States and other countries, exclusively licensed through X/Open
Company, Ltd. Flexent is a trademark of Lucent Technologies, Inc.
<PAGE> 65
[SUN MICROSYSTEMS LOGO]
VISION + FOCUS + EXECUTION =
<PAGE> 66
(C)2000 Sun Microsystems, Inc. All rights reserved. Sun, Sun Microsystems, the
Sun logo, The Network Is The Computer, We're the dot in .com, Write Once, Run
Anywhere, Solaris, the Solaris Logo, Java, the Java Coffee Cup Logo, Java Card,
JavaOS, Jini, the Jini logo, Jiro, the Jiro logo, iPlanet, the iPlanet logo,
iPlanet Trustbase, Trustbase, NetDynamics, Enterprise JavaBeans, EJB, Sun
Enterprise, Sun StorEdge, Chorus, SunTone, and StarOffice are trademarks or
registered trademarks of Sun Microsystems, Inc., in the United States and other
countries. All SPARC trademarks are used under license and are trademarks or
registered trademarks of SPARC International, Inc., in the United States and
other countries. Products bearing SPARC trademarks are based upon an
architecture developed by Sun Microsystems, Inc. UNIX is a registered trademark
in the United States and other countries, exclusively licensed through X/Open
Company, Ltd. Flexent is a trademark of Lucent Technologies, Inc.
