Question

Case #1 – Sun Microsystems – Questions (pp. 92-95)

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 percent—and that’s significant. We believe it’s 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.

1. Referring to Exhibit 4, compute the annual percentage change in net income per common share-diluted (second numerical line from the bottom) for 1998–1999, 1999–2000, and 2000–2001.
2. Also in Exhibit 4, compute net income/net revenue (sales) for each of the four years. Begin with 1998.
3. 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

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

Comprehensive Problem 2 (Continued)

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 share—diluted............................	$   0.27	$    0.55	$    0.31	$ 0.24
Shares used in the calculation of net income per common share—diluted....................................................................	3,417	3,379	3,282	3,180

5. 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.

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

1998                11¼

1999                16¾

2000                28½

2001                9½

1. 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.
2. 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.

Answer 1

	2001	2000	1999	1998
Net income	927.00	1,854.00	1,030.00	755.00
Shares outstanding	3,417	3,379	3,282	3,180
EPS	0.271	0.549	0.314	0.237
% change from previous year	-50.56%	74.83%	32.18%
Net income	927.00	1,854.00	1,030.00	755.00
Net revenue	18,250	15,721	11,806	9,862
net income/ net sales	5.08%	11.79%	8.72%	7.66%
Total Sales	18,250	15,721	11,806	9,862
Cost of sales	10,041	7,549	5,670	4,713
Cost of sales/ Total sales	0.55	0.48	0.48	0.48
R&D Cost	2,016	1,630	1,280	1,029
R&D Cost/ Total sales	0.11	0.10	0.11	0.10
SG&A	4,544	4,072	3,196	2,826
SG&A/ Total sales	0.25	0.26	0.27	0.29
I-Tax provision	603	917	575	407
I-Tax provision/ Total sales	0.03	0.06	0.05	0.04
Shares outstanding	3,417	3,379	3,282	3,180
Average share price	9.25	28.50	16.75	11.25
Equity	31,607.25	96,301.50	54,973.50	35,775.00
Average stockholders equity	63,954.38	75,637.50	45,374.25
Net income	927.00	1,854.00	1,030.00	755.00
Return of equity	1.45%	2.45%	2.27%
Net income per share	0.27	0.55	0.31	0.24
PE ratio	34.10	51.94	53.37	47.38

Comments on ratios-
EPS has been very volatile and has dropped by 50% in 2001 as compared to 2000.
Net income margin has decreased this year from ~12% to 5%.
Cost of sales as a portion of total sales has increased as compared to previous year by almost 15%
R&D cost as a portion of total sales has remained almost steady
SG&A cost as a portion of total sales has remained almost steady. In fact there is slight drop over 4 years
Income tax provision as a portion of total sales has remained almost steady. In fact there is slight drop over 4 years
Return on stockholders equity has decreased in 2001 as compared to 2000.

Du Pont analysis
We cant perform the full Du Pont analysis as we do not have the total assets in any of these years. However, we can assume that the total assets remained constant or almost steady and look at the net income/ net sales ration i.e. the net profit margin ratio. Net income margin has decreased more than half this year from ~12% to 5%. Hence, we can consider that ROE has been largely affected by the change in net income margin or profit margin. This, by the way, is in direct contradiction of claims by the company management stating the company is gaining market share and also bringing the cost down.

PE ratio analysis
PE ratio has decreased by almost 30% in 2001 as compared to that in 2000. This is because the earnings per share has decreased by almost 50% while the share price has dropped to ~25% in 2001 as compared to that in 2000. Since the price decreased a lot more than the earnings, the impact on PE ratio is not as drastic as compared to earnings.