Sun Microsystems (trends, ratios stock performance) (LO3) Sun Microsystems is a leading supplier of computer-related products, including servers, workstations, storage devices, and network switches.*

In the letter to stockholders as part of the 2001 annual report, President and CEO Scott G. McNealy offered the following remarks:

Fiscal 2001 was clearly a mixed bag for Sun, the industry, and the economy as a whole. Still, we finished with revenue growth of 16 percentand thats significant. We believe its a good indication that Sun continued to pull away from the pack and gain market share. For that, we owe a debt of gratitude to our employees worldwide, who aggressively brought costs down even as they continued to bring exciting new products to market.

The statement would not appear to be telling you enough. For example, McNealy says the year was a mixed bag with revenue growth of 16 percent. But what about earnings? You can delve further by examining the income statement in Exhibit 4. Also, for additional analysis of other factors, consolidated balance sheet(s) are presented in Exhibit 5 on page 94.

Referring to Exhibit 4, compute the annual percentage change in net income per common share-diluted (second numerical line from the bottom) for 19981999, 19992000, and 20002001.

Also in Exhibit 4, compute net income/net revenue (sales) for each of the four years. Begin with 1998.

What is the major reason for the change in the answer for Question 2 between 2000 and 2001? To answer this question for each of the two years, take the ratio of the major income statement accounts to net revenues (sales).

Cost of sales

Research and development

Selling, general and administrative expense

Provision for income tax

Compute return on stockholders equity for 2000 and 2001 using data from Exhibits 1 and 2.

Exhibit 4

SUN MICROSYSTEMS INC.

Summary Consolidated Statement of Income (in millions)

2001

2000

1999

1998

Dollars

Dollars

Dollars

Dollars

Net revenues......................................................................

$18,250

$15,721

$11,806

$9,862

Costs and expenses:

Cost of sales.............................................................

10,041

7,549

5,670

4,713

Research and development........................................

2,016

1,630

1,280

1,029

Selling, general and administrative............................

4,544

4,072

3,196

2,826

Goodwill amortization...............................................

261

65

19

.4

In-process research and development.......................

77

12

121

176

Total costs and expenses....................................................

16,939

13,328

10,286

8,748

Operating Income...............................................................

1,311

2,393

1,520

1,114

Gain (loss) on strategic investments...................................

(90)

208

Interest income, net............................................................

363

170

85

48

Litigation settlement...........................................................

Income before taxes...........................................................

1,584

2,771

1,605

1,162

Provision for income taxes.................................................

603

917

575

407

Cumulative effect of change in accounting principle, net...........................................

(54)

Net income.........................................................................

$ 927

$ 1,854

$ 1,030

$ 755

Net income per common sharediluted.............................

$ 0.27

$ 0.55

$ 0.31

$ 0.24

Shares used in the calculation of net income per common sharediluted....................................................................

3,417

3,379

3,282

3,180

Analyze your results to Question 4 more completely by computing ratios 1, 2a, 2b, and 3b (all from this chapter) for 2000 and 2001. Actually, the answer to ratio 1 can be found as part of the answer to question 2, but it is helpful to look at it again.

What do you think was the main contributing factor to the change in return on stockholders equity between 2000 and 2001? Think in terms of the Du Pont system of analysis.

The average stock prices for each of the four years shown in Exhibit 4 were as follows:

1998 11

1999 16

2000 28

2001 9

Compute the price/earnings (P/E) ratio for each year. That is, take the stock price shown above and divide by net income per common stock-dilution from Exhibit 4.

Why do you think the P/E has changed from its 2000 level to its 2001 level?

A brief review of P/E ratios can be found under the topic of Price-Earnings Ratio Applied to Earnings per Share in Chapter 2.

Comprehensive Problem 2 (Continued)

Exhibit 5

SUN MICROSYSTEMS, INC

Consolidated Balance Sheets (in millions)

Assets

2001

2000

Current assets:

Cash and cash equivalents...........................................................................................................

$ 1,472

$ 1,849

Short-term investments................................................................................................................

387

626

Accounts receivable, net allowances of $410 in 2001 and $534 in 2000...........................................................................................................................

2,955

2,690

Inventories...................................................................................................................................

1,049

557

Deferred tax assets.......................................................................................................................

1,102

673

Prepaids and other current assets.................................................................................................

969

482

Total current assets..................................................................................................................

$7,934

$6,877

Property, plant and equipment, net....................................................................................................

2,697

2,095

Long-term investments.....................................................................................................................

4,677

4,496

Goodwill, net of accumulated amortization of $349 in 2001 and $88 in 2000.................................................................................................................................

2,041

163

Other assets, net................................................................................................................................

832

521

$18,181

$14,152

Liabilities and Stockholders Equity

Current liabilities:

Short-term borrowings.................................................................................................................

$ 3

$ 7

Accounts payable.........................................................................................................................

1,050

924

Accrued payroll-related liabilities.................................................................................................

488

751

Accrued liabilities and other.........................................................................................................

1,374

1,155

Deferred revenues and customer deposits....................................................................................

1,827

1,289

Warranty reserve..........................................................................................................................

314

211

Income taxes payable...................................................................................................................

90

209

Total current liabilities.............................................................................................................

$5,146

$4,546

Deferred income taxes......................................................................................................................

744

577

Long-term debt and other obligations................................................................................................

1,705

1,720

Total debt.................................................................................................................................

$ 7,595

$ 6,843

Commitments and contingencies

Stockholders equity:

Preferred stock, $0.001 par value, 10 shares authorized (1 share which has been designated as Series A Preferred participating stock): no shares issued and outstanding................................

Common stock and additional paid-in-capital, $0.00067 par value, 7,200 shares authorized; issued: 3,536 shares in 2001 and 3,495 shares in 2000................................................................................

6,238

2,728

Treasury stock, at cost: 288 shares in 2001 and 301 shares in 2000................................................

(2,435)

(1,438)

Deferred equity compensation..........................................................................................................

(73)

(15)

Retained earnings..............................................................................................................................

6,885

5,959

Accumulated other comprehensive income (loss).............................................................................

(29)

75

Total stockholders equity..............................................................................................................

$10,586

$7,309

$18,181

$14,152

The book values per share for the same four years discussed in the preceding question were:

$1.18

$1.55

$2.29

$3.26

Compute the ratio of price to book value for each year.

Is there any dramatic shift in the ratios worthy of note?