<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 1999
or
( ) Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from __________ to __________
Commission File No. 1-14196
STERLING COMMERCE, INC.
(Exact name of registrant as specified in its charter)
Delaware 75-2623341
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
300 Crescent Court, Suite 1200
Dallas, Texas 75201
(Address of principal executive offices, including zip code)
(214) 981-1100
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
As of April 30, 1999, 95,275,460 shares of the Company's Common Stock, $.01 par
value, were outstanding.
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STERLING COMMERCE, INC.
TABLE OF CONTENTS
Part I - Financial Information
<TABLE>
<CAPTION>
Item 1. Financial Statements (Unaudited)
Page
----
<S> <C>
Sterling Commerce, Inc. Consolidated Balance Sheets at March 31, 1999 and
September 30, 1998 ........................................................... 3
Sterling Commerce, Inc. Consolidated Statements of Income for the Three and
Six Months Ended March 31, 1999 and 1998...................................... 4
Sterling Commerce, Inc. Consolidated Statement of Stockholders' Equity for the
Six Months Ended March 31, 1999............................................... 5
Sterling Commerce, Inc. Consolidated Statements of Cash Flows for the Six Months
Ended March 31, 1999 and 1998................................................. 6
Sterling Commerce, Inc. Notes to Consolidated Financial Statements................ 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results Results of Operations............................................ 12
Part II - Other information
Item 4. Submission of Matters to a Vote of Security Holders ..................... 18
Item 6. Exhibits and Reports on Form 8-K......................................... 18
</TABLE>
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STERLING COMMERCE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share information)
<TABLE>
<CAPTION>
A S S E T S
March 31, September 30,
1999 1998
-------------- -------------
(unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................................. $ 279,473 $ 354,948
Marketable securities..................................................... 325,484 183,451
Accounts and notes receivable, net........................................ 156,609 151,256
Deferred income taxes..................................................... 10,777 11,627
Prepaid expenses and other current assets................................. 29,670 18,013
------------- -------------
Total current assets................................................ 802,013 719,295
Property and equipment, net of accumulated depreciation of
$69,034 at March 31, 1999 and $57,542 at September 30, 1998............... 83,742 74,391
Computer software, net of accumulated amortization of $65,250
at March 31, 1999 and $62,257 at September 30, 1998....................... 96,597 91,409
Excess cost over net assets acquired, net of accumulated
amortization of $9,165 at March 31, 1999 and $2,339
at September 30, 1998..................................................... 55,748 63,382
Other assets 19,230 18,527
------------- -------------
$ 1,057,330 $ 967,004
============= =============
L I A B I L I T I E S A N D S T O C K H O L D E R S ' E Q U I T Y
Current liabilities:
Accounts payable and accrued liabilities.................................. $ 76,406 $ 90,599
Income taxes payable...................................................... 4,238 7,992
Deferred revenue.......................................................... 80,956 71,744
------------- -------------
Total current liabilities........................................... 161,600 170,335
------------- -------------
Deferred income taxes......................................................... 40,952 30,335
Other noncurrent liabilities.................................................. 20,854 18,419
Stockholders' equity:
Preferred stock, $.01 par value; 50,000 shares authorized;
no shares issued and outstanding
Common stock, $.01 par value; 300,000 and 150,000 shares
authorized at March 31, 1999 and September 30, 1998,
respectively; 96,044 and 94,511 shares issued at March 31, 1999
and September 30, 1998, respectively.................................... 960 945
Additional paid-in capital................................................ 758,207 714,156
Retained earnings......................................................... 98,828 31,756
Accumulated other comprehensive income.................................... (1,424) 1,058
Treasury stock, at cost; 785 shares at March 31, 1999..................... (22,647)
------------- -------------
Total stockholders' equity.......................................... 833,924 747,915
------------- -------------
$ 1,057,330 $ 967,004
============= =============
</TABLE>
See accompanying notes.
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STERLING COMMERCE, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share information)
(unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended March 31, Ended March 31,
--------------------------- ---------------------------
1999 1998 1999 1998
----------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Revenue:
Products.......................................... $ 57,895 $ 39,419 $ 107,545 $ 76,860
Product support................................... 35,692 23,768 69,424 45,762
Services.......................................... 59,029 47,889 116,425 94,737
----------- ----------- ----------- -----------
152,616 111,076 293,394 217,359
Costs and expenses:
Cost of sales:
Products and product support.................. 15,738 9,952 32,367 18,928
Services...................................... 16,903 14,079 31,855 25,564
----------- ----------- ----------- -----------
32,641 24,031 64,222 44,492
Product development and enhancement expenses...... 9,597 6,392 18,817 14,040
Selling, general and administrative expenses...... 61,235 44,789 117,150 90,366
----------- ----------- ----------- -----------
103,473 75,212 200,189 148,898
----------- ----------- ----------- -----------
Income before other income and income taxes........... 49,143 35,864 93,205 68,461
Other income.......................................... 6,487 6,175 12,737 11,919
----------- ----------- ----------- -----------
Income before income taxes............................ 55,630 42,039 105,942 80,380
Provision for income taxes............................ 20,457 15,064 38,836 29,202
----------- ----------- ----------- -----------
Net income............................................ $ 35,173 $ 26,975 $ 67,106 $ 51,178
=========== =========== =========== ===========
Income per common share:
Basic............................................. $ 0.37 $ 0.30 $ 0.71 $ 0.57
=========== =========== =========== ===========
Diluted........................................... $ 0.36 $ 0.29 $ 0.69 $ 0.55
=========== =========== =========== ===========
</TABLE>
See accompanying notes.
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STERLING COMMERCE, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Six Months Ended March 31, 1999
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Accumulated
Common Stock Additional Other Treasury Stock Total
------------ Paid-in Retained Comprehensive -------------- Stockholder's
Shares Amount Capital Earnings Income Shares Amount Equity
------- ------ --------- --------- ---------- -------- ------ -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1998............ 94,511 $ 945 $ 714,156 $ 31,756 $ 1,058 $ 747,915
Net income............................... 67,106 67,106
Foreign currency translation
adjustment.............................. (2,451) (2,451)
Unrealized loss on marketable
securities.............................. (31) (31)
----------
Comprehensive income..................... 64,624
----------
Issuance of common stock pursuant to
employee stock plans, including
tax benefit of $5,374................... 1,533 15 44,051 5 $ 157 44,223
Purchase of treasury stock............... (790) (22,804) (22,804)
Other.................................... (34) (34)
------ ------ ---------- --------- -------- ---- ------ ----------
Balance at March 31, 1999................ 96,044 $ 960 $ 758,207 $ 98,828 $ (1,424) (785) $ (22,647) $ 833,924
====== ====== ========== ========= ======== ==== ========== ==========
</TABLE>
See accompanying notes.
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STERLING COMMERCE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Six Months
Ended March 31,
----------------------------------
1999 1998
------------ -------------
<S> <C> <C>
Operating activities:
Net income...................................................................... $ 67,106 $ 51,178
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization.......................................... 27,961 18,262
Provision for losses on accounts receivable............................ 2,005 584
Provision for deferred income taxes.................................... 11,467 3,841
Changes in operating assets and liabilities:
Accounts and notes receivable........................................ (7,358) (15,626)
Prepaid expenses and other current assets............................ (13,336) (7,789)
Accounts payable, accrued liabilities and income
taxes payable...................................................... (17,947) 3,747
Deferred revenue..................................................... 9,212 1,141
Other................................................................ 4,381 2,088
----------- ----------
Net cash provided by operating activities.............................. 83,491 57,426
----------- ----------
Investing activities:
Purchases of property and equipment............................................. (25,769) (20,859)
Purchases and capitalized cost of development of computer software.............. (12,552) (11,831)
Purchases of investments........................................................ (226,396) (124,260)
Sales of investments............................................................ 84,332 85,659
----------- ----------
Net cash used in investing activities.................................. (180,385) (71,291)
----------- ----------
Financing activities:
Issuance of common stock........................................................ 44,223 32,639
Purchase of treasury stock...................................................... (22,804)
----------- ----------
Net cash provided by financing activities.............................. 21,419 32,639
----------- ----------
Increase (decrease) in cash and cash equivalents................................... (75,475) 18,774
Cash and cash equivalents at beginning of period................................... 354,948 250,348
----------- ----------
Cash and cash equivalents at end of period......................................... $ 279,473 $ 269,122
=========== ==========
</TABLE>
See accompanying notes.
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STERLING COMMERCE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1999
(unaudited)
1. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of Sterling
Commerce, Inc. and its subsidiaries (collectively, the "Company") after
elimination of all significant intercompany balances and transactions. Certain
amounts for the comparative periods have been reclassified to conform to the
current year presentation. The financial statements have been prepared in
conformity with generally accepted accounting principles for interim financial
statements, which require management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
While management has based its assumptions and estimates on facts and
circumstances currently known, actual amounts may differ from such estimates.
The information included in this Form 10-Q should be read in conjunction with
Management's Discussion and Analysis and financial statements and notes thereto
included in the Sterling Commerce, Inc. 1998 Annual Report on Form 10-K.
Revenue
In accordance with Statement of Position 97-2 "Software Revenue
Recognition," as amended by Statement of Position 98-4 "Deferral of the
Effective Date of Certain Provisions of SOP 97-2" ("SOP 97-2"), revenue from
license fees for software products is recognized when the software is delivered,
when there is persuasive evidence that an arrangement exists, and when the fee
is fixed and determinable and collection is probable. If software products
transactions include the right to receive future products, a portion of the
software products revenue is deferred and recognized as such products are
delivered. Revenue from services is recognized as the services are performed.
Revenue from services earned but not invoiced at the end of a month is
recognized as revenue in such month and recorded as unbilled accounts receivable
until invoiced in the following month.
Product support contracts generally entitle the customer to telephone
support, "bug fixing" and the right to receive software updates as they are
released. Revenue from product support contracts, including product support
included in initial license fees, is recognized ratably over the contract
period. All significant costs and expenses associated with product support
contracts are expensed as incurred, which approximates ratable expenses over the
contract period.
When products, product support and services are billed prior to the time the
related revenue is recognized, deferred revenue is recorded and related costs
paid in advance are deferred.
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Earnings Per Common Share
The following table sets forth the computation of basic and diluted earnings
per share (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Three Months Six Months
Ended March 31, Ended March 31,
------------------------- ------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Basic:
Net income.................................. $ 35,173 $ 26,975 $ 67,106 $ 51,178
=========== =========== =========== ===========
Weighted average common shares outstanding.. 95,681 90,386 95,175 90,069
=========== =========== =========== ===========
Per share amount............................ $ 0.37 $ 0.30 $ 0.71 $ 0.57
=========== =========== =========== ===========
Diluted:
Net income.................................. $ 35,173 $ 26,975 $ 67,106 $ 51,178
=========== =========== =========== ===========
Weighted average common shares outstanding.. 95,681 90,386 95,175 90,069
Net effect of dilutive options (1).......... 2,760 4,122 2,783 3,717
----------- ----------- ----------- -----------
Total....................................... 98,441 94,508 97,958 93,786
=========== =========== =========== ===========
Per share amount............................ $ 0.36 $ 0.29 $ 0.69 $ 0.55
=========== =========== =========== ===========
</TABLE>
__________
(1) For the three and six months ended March 31, 1999, respectively,
approximately 1.0 million and 1.8 million, antidilutive stock options were
excluded from the computation of diluted earnings per share. For the three and
six months ended March 31, 1998, the amount of antidilutive stock options
excluded from the computation of diluted earnings per share was not significant.
Recent Accounting Pronouncements
Software Revenue Recognition
Effective October 1, 1998, the Company adopted SOP 97-2, which requires
each element of a software license arrangement to be separately identified and
accounted for based on the relative fair value of each element. Revenue cannot
be recognized on any element of the license arrangement if undelivered elements
are essential to the functionality of the delivered elements. Adoption of SOP
97-2, as amended, did not significantly affect the Company's results of
operations for the three and six months ended March 31, 1999, nor is it expected
to have a significant impact on results for the remainder of the year since the
Company's revenue recognition policies have historically been in substantial
compliance with the practices required by SOP 97-2.
On December 15, 1998, Statement of Position 98-9, "Modification of SOP 97-2,
"Software Revenue Recognition," with Respect to Certain Transactions"
("SOP 98-9") became effective. SOP 98-9 amends SOP 97-2 to require that an
entity recognize revenue for multiple element arrangements by means of the
"residual method" when (1) there is vendor-specific objective evidence ("VSOE")
of the fair values of all the undelivered elements that are not accounted for by
means of long-term contract accounting, (2) VSOE of fair value does not exist
for one or more of the delivered elements and (3) all revenue recognition
criteria of SOP 97-2 (other than the requirement for VSOE of the fair value of
each delivered element) are satisfied. VSOE is determined by the price charged
when each item is sold separately, or by deducting the fair value
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<PAGE>
of one or more items from the total fair value of the agreement or by using
objective evidence based upon the vendor's facts and circumstances.
The residual method requires revenue for multiple element arrangements to be
recognized as follows: (1) the total fair value of the undelivered elements, as
indicated by VSOE, is deferred and subsequently recognized in accordance with
SOP 97-2 and (2) the difference between the total arrangement fee and the amount
deferred for the undelivered elements is recognized as revenue related to the
delivered elements.
The provisions of SOP 98-9 extend the deferral of certain passages of SOP
97-2. All other provisions of SOP 98-9 will be effective for transactions that
are entered into in fiscal years beginning after March 15, 1999. Retroactive
application is prohibited. The Company is currently evaluating the requirements
of SOP 98-9 and the effects, if any, it may have on the Company's current
revenue recognition policies.
Comprehensive Income
On October 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("FAS 130"). FAS 130
requires the presentation of comprehensive income and its components in a full
set of general-purpose financial statements. The purpose of reporting
comprehensive income is to report changes in equity that result from
transactions and other economic events, excluding transactions with owners in
their capacity as owners. The Company's comprehensive income consists of net
income, foreign currency translation adjustments and unrealized gain or loss on
marketable securities; however, the adoption of FAS 130 had no impact on the
financial position or results of operations of the Company.
Comprehensive income for the three and six months ended March 31, 1999 and
1998 is as follows:
<TABLE>
<CAPTION>
Three Months Six Months
Ended March 31, Ended March 31,
----------------------------- ------------------------------
1999 1998 1999 1998
------------- ------------ ------------- ------------
<S> <C> <C> <C> <C> <C>
Net income................................... $ 35,173 $ 26,975 $ 67,106 $ 51,178
Foreign currency translation adjustment ..... (2,822) 149 (2,451) 177
Unrealized gain (loss) on marketable
securities, net of tax................... (14) 160 (31) 146
------------- ------------ ------------- ------------
Comprehensive income ........................ $ 32,337 $ 27,284 $ 64,624 $ 51,501
============= ============= ============= =============
</TABLE>
2. Unaudited Interim Financial Statements
The interim consolidated financial information contained herein is unaudited
but, in the opinion of management, includes all adjustments (consisting only of
normal recurring entries) necessary for a fair presentation of the financial
position, results of operations and cash flows for the periods presented.
Results of operations for the periods presented herein are not necessarily
indicative of results of operations for the entire year.
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3. General Information
Sterling Commerce, Inc. was incorporated in December 1995. The Company is a
leading provider of electronic commerce ("EC") products, services and solutions
worldwide. The Company develops, markets and supports EC software products, and
provides EC services, that enable businesses to engage in business-to-business
electronic communications and transactions. The Company, through its
predecessors and subsidiaries, has been providing EC solutions for over 25
years and has more than 42,000 customers in many industries, including banking,
healthcare, manufacturing, pharmaceuticals, retailing, telecommunications and
transportation.
4. 1999 Business Combinations and Reorganizations
Reorganization and Unusual Costs
During the first six months of fiscal 1999, approximately $7.0 million,
including approximately $2.2 million of employee termination costs, were
disbursed from the September 30, 1998 balance of accrued reorganization and
unusual costs. The balance remaining in accrued reorganization and unusual
costs at March 31, 1999 was approximately $11.9 million, which is classified as
accounts payable and accrued liabilities.
Research and Development Costs
In its acquisition of XcelleNet, Inc., completed July 21, 1998, the Company
acquired certain in-process research and development. The Company had estimated
at September 30, 1998 that further expenditures of approximately $8.5 million
would be required during the following 18 months to develop the acquired
research and development into commercially viable products. The Company has
continued these development efforts during the six months ended March 31, 1999,
and believes its previous estimates remain reasonable.
5. Stockholders' Equity
Common Stock
At the Company's Annual Meeting of Stockholders held on March 4, 1999, the
stockholders of the Company approved an amendment to the Company's Certificate
of Incorporation which increased the number of shares of common stock, par value
$.01 per share ("Common Stock") authorized for issuance from 150 million shares
to 300 million shares.
Preferred Stock
The Company is authorized to issue up to 50 million shares of preferred stock,
par value $.01 per share ("Preferred Stock"). On March 4, 1999, pursuant to
the terms of the Rights Agreement, dated as of December 18, 1996, the Board of
Directors of the Company designated an additional 1.5 million shares of
Preferred Stock, as Series A Junior Participating Preferred Stock ("Series A
Junior Preferred Stock"). At March 31, 1999, 3 million shares of Series A
Junior Preferred Stock were authorized to be issued.
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Treasury Stock
On March 1, 1999, the Company's Board of Directors approved a stock repurchase
program authorizing the repurchase by the Company of up to 5 million shares of
its outstanding Common Stock. Purchases will be made in open market, negotiated
or block transactions from time to time as market and business conditions
warrant. During the three months ended March 31, 1999, the Company purchased
approximately 0.8 million shares of Common Stock at an average price of $28.87
per share.
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<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Results of Operations
Three Months Ended March 31, 1999 and 1998
Total revenue increased $41.5 million or 37% in the second quarter of fiscal
1999 compared to the same period in fiscal 1998. Products revenue increased
$18.5 million or 47%, product support revenue increased $11.9 million or 50% and
services revenue increased $11.1 million or 23%. The increase in products and
product support revenues was due primarily to increased licensing of CONNECT and
GENTRAN software products, including remote and mobile management software
products and product support not offered by the Company during the same period
of fiscal 1998. The increase in services revenue was primarily from growth in
Managed Services and COMMERCE services customer volume, the addition of new
customers and, increased demand for education and consulting services and price
increases.
The Company's recurring revenue includes revenue from annual and multi-year
product support agreements having terms ranging generally from one to three
years, fixed-term product lease and rental agreements having terms ranging
generally from month-to-month to year-to-year and COMMERCE service agreements
that are cancelable upon 30 days' notice. The Company includes the entire
portion of the recognized revenue from COMMERCE service agreements in recurring
revenue, although no assurances can be given that such agreements will not be
canceled. Recurring revenue increased $18.4 million or 31% in the second
quarter of fiscal 1999 compared to the same period of fiscal 1998 and
represented 51% of total revenue in the second quarter of fiscal 1999 compared
to 53% in the same period of fiscal 1998.
Internet-related revenue is revenue primarily derived from products and
services in the CONNECT, GENTRAN and COMMERCE families that are implemented
directly on the Internet or used with Internet-based technologies including
extranet and intranet configurations. Examples include Web-based EC message
management software, software for the movement and management of information
over extranets and intranets, revenue from the management of business
communities over extranets and related consulting services. The Company's
Internet-related revenues increased 71% to $51.1 million in for the second
quarter of fiscal 1999 from $29.8 million for in the same period of fiscal
1998. For the three months ended March 31, 1999, 64% of the Company's products
revenue was derived from products designed for operating platforms other than
mainframe operating platforms, compared to 58% for the three months ended March
31, 1998. The Company's revenue from sources outside the United States
represented 23% of total revenue in the second quarter of fiscal 1999, compared
to 19% in the second quarter of fiscal 1998.
Total costs and expenses for the three months ended March 31, 1999 increased
$28.3 million or 38% on revenue growth of 37% when compared to the three months
ended March 31, 1998. The increase in total costs and expenses is due to a 37%
increase in selling, general and administrative expenses, a 36% increase in cost
of sales and a 50% increase in product development and enhancement expenses.
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<PAGE>
Total cost of sales increased $8.6 million or 36% when compared with the same
period of fiscal 1998. As a percentage of total revenue, total cost of sales
decreased to 21% in the second quarter of fiscal 1999 from 22% for the same
period of fiscal 1998. Cost of sales for products and product support increased
$5.8 million or 58% due to increased costs associated with supporting expanding
software licensing, a larger installed customer base and higher amortization
costs for software products. Cost of sales for products and product support as
a percentage of revenue increased to 10% in the second quarter of fiscal 1999
from 9% in the same period of fiscal 1998. Cost of sales for services increased
$2.8 million or 20% primarily due to increased consulting related to Managed
Services, increased costs to support a growing customer base and greater
customer volume, and also due to higher costs associated with providing
education and consulting services. As a percentage of total revenue, cost of
sales for services decreased to 11% for the second quarter of fiscal 1999
compared to 13% for the second quarter of fiscal 1998. Cost of sales includes
$9.6 million of depreciation and amortization for the second quarter of fiscal
1999 and $7.3 million of depreciation and amortization for the same period of
fiscal 1998.
Product development and enhancement expenses for the second quarter of fiscal
1999 increased $3.2 million or 50% to $9.6 million, net of $6.0 million
capitalized pursuant to Statement of Financial Accounting Standards No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed" ("FAS 86"), from $6.4 million, net of $4.1 million capitalized, for
the second quarter of fiscal 1998. This increase was primarily due to the
higher gross product development and enhancement expenses relating to products
under development during fiscal 1999. As a percentage of total revenue, product
development and enhancement expenses remained unchanged at 6% for the second
quarter of fiscal 1999 compared to the second quarter of fiscal 1998. Total
capitalized costs represented 38% of total product and enhancement expenses for
the quarter ended March 31, 1999 and 1998. Product development and enhancement
expenses and the capitalization rate may fluctuate from period to period
depending in part upon the number and status of software development projects in
process.
Selling, general and administrative expenses increased $16.4 million or 37%
when compared with the same period of fiscal 1998 primarily due to an increase
in sales, marketing and administrative support activities needed to support the
corresponding growth in revenue. Selling, general and administrative expenses
remained unchanged as a percentage of total revenue at 40% for the second
quarter fiscal 1999 and fiscal 1998.
Income before other income and income taxes was $49.1 million for the second
quarter of fiscal 1999 compared to $35.9 million for the same period of fiscal
1998. The increase is primarily due to a $41.5 million increase in revenue
offset by a $28.3 million increase in total costs and expenses.
Provision for income taxes increased $5.4 million for the second quarter of
fiscal 1999 compared to the same period of fiscal 1998 primarily due to the
increase in income before income taxes in the second quarter of fiscal 1999.
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<PAGE>
Six Months Ended March 31, 1999 and 1998
Total revenue increased $76.0 million or 35% for the six months ended March
31, 1999 compared to the same period in fiscal 1998. Products revenue increased
$30.7 million or 40%, product support revenue increased $23.7 million or 52% and
services revenue increased $21.7 million or 23%. The increase in products and
product support revenues was due primarily to increased licensing of CONNECT and
GENTRAN software products, including remote and mobile management software
products and product support not offered by the Company during the same period
of fiscal 1998. The increase in services revenue was primarily from growth in
Managed Services and COMMERCE services customer volume, the addition of new
customers, and increase demand for education and consulting services.
Recurring revenue increased $35.8 million or 30% in the first six months of
fiscal 1999 compared to the same period of fiscal 1998 and represented 52% of
total revenue compared to 54% for the same period of fiscal 1998. Internet-
related revenues increased 56% to $90.7 million for the six months ended March
31, 1999 from $58.1 million in for the same period of fiscal 1998. For the six
months ended March 31, 1999, 67% of the Company's products revenue was derived
from products designed for operating platforms other than mainframe operating
platforms, compared to 58% for the six months ended March 31, 1998. The
Company's revenue from outside the United States represented 22% of total
revenue in the first six months of fiscal 1999, compared to 20% in the first six
months of fiscal 1998.
Total costs and expenses for the six months ended March 31, 1999 increased
$51.3 million or 34% on revenue growth of 35% compared to the same period last
year. The increase in total costs and expenses is due to a 30% increase in
selling, general and administrative expenses, a 44% increase in cost of sales
and a 34% increase in product development and enhancement expenses.
Total cost of sales increased $19.7 million or 44% when compared with the same
period of fiscal 1998. As a percentage of total revenue, total cost of sales
increased to 22% for the six months ended March 31, 1999 from 20% for the same
period of fiscal 1998. Cost of sales for products and product support increased
$13.4 million or 71% due to increased costs associated with supporting expanding
software licensing, a larger installed customer base and higher amortization
costs for software products. Cost of sales for products and product support as
a percentage of revenue increased to 11% for the six months ended March 31, 1999
from 9% in the same period of fiscal 1998. Cost of sales for services increased
$6.3 million or 25% primarily due to increased consulting related to Managed
Services, increased costs to support a growing customer base and greater
customer volume, and also due to higher costs associated with providing
education and consulting services. As a percentage of total revenue, cost of
sales for services decreased to 11% for the first six months of fiscal 1999
compared to 12% for the first six months of fiscal 1998. Cost of sales
includes $18.6 million of depreciation and amortization for the first six months
of fiscal 1999 and $13.7 million of depreciation and amortization for the same
period of fiscal 1998.
Product development and enhancement expenses for the six months ended March
31, 1999 increased $4.8 million or 34% to $18.8 million, net of $11.7 million
capitalized pursuant to FAS 86, from $14.0 million, net of $8.1 million
capitalized, for the six months ended March 31, 1998. The increase was
primarily due to the higher gross product development and enhancement
-14-
<PAGE>
expenses relating to products under development during fiscal 1999. As a
percentage of total revenue, product development and enhancement expenses
remained unchanged at 6% for the first six months of fiscal 1999 and 1998. Total
capitalized costs represented 38% and 37% of total product and enhancement
expenses for the six months ended March 31, 1999 and 1998, respectively. Product
development and enhancement expenses and the capitalization rate may fluctuate
from period to period depending in part upon the number and status of software
development projects in process.
Selling, general and administrative expenses increased $26.8 million or 30%
for the six months ended March 31, 1999 when compared with the same period of
fiscal 1998 due primarily to an increase in sales, marketing and administrative
support activities needed to support the corresponding growth in revenue.
Selling, general and administrative expenses decreased as a percentage of total
revenue to 40% compared to 42% for the same period of fiscal 1998.
Income before other income and income taxes was $93.2 million for the six
months ended March 31, 1999, compared to $68.5 million for the same period of
fiscal 1998. The increase is primarily due to a $76.0 million increase in
revenue offset by a $51.3 million increase in total costs and expenses.
Provision for income taxes increased $9.6 million for the six months ended
March 31, 1999, compared to the same period of fiscal 1998 primarily due to the
increase in income before income taxes in the six months ended March 31, 1999.
Liquidity and Capital Resources
The Company had $640.4 million of working capital at March 31, 1999, including
$279.5 million of cash and cash equivalents and $325.5 million of marketable
securities. Days sales outstanding, measured on a quarterly basis, improved to
92 days for the quarter ended March 31, 1999 compared with 94 days for the
quarter ended December 31, 1998 and compared with 94 days for the quarter ended
March 31, 1998. Increased collection activities have led to the decrease in days
sales outstanding.
Net cash flows from operations increased $26.1 million to $83.5 million in
the first six months of fiscal 1999 compared to the first six months of fiscal
1998 primarily due to higher operating profits and non-cash charges, and an
increase in deferred revenue and was offset by an increase in accounts
receivable, an increase in prepaid expenses and other current assets and a
decrease in accounts payable, accrued liabilities and income taxes payable. A
portion of the Company's cash flow from operations during the first six months
of fiscal 1999 and 1998 was used to fund software additions and capital
expenditures. Software expenditures during the six months ended March 31, 1999
were $12.6 million, of which $11.7 million were capitalized pursuant to FAS 86,
compared to $11.8 million of software expenditures in the same period of the
prior year, of which $8.1 million were capitalized pursuant to FAS 86. The
expenditures during this period were primarily for new products and enhancements
of existing products. Property and equipment purchases of $25.8 million in the
first six months of fiscal 1999 were primarily for purchases of equipment
upgrades for processing systems and computer equipment purchases to support the
continuing growth in revenue.
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<PAGE>
On March 1, 1999, the Company's Board of Directors approved a stock repurchase
program authorizing the repurchase by the Company of up to 5 million shares of
its outstanding Common Stock. Purchases will be made in open market, negotiated
or block transactions from time to time as market and business conditions
warrant. During the three months ended March 31, 1999, the Company purchased
approximately 0.8 million shares of Common Stock at an average price of $28.87
per share.
The Company maintains a Revolving Credit and Term Loan Agreement, as amended
(the "Credit Agreement") that provides for a domestic borrowing capacity of $20
million and an additional $10 million international borrowing capacity. An
underlying letter of credit facility provides for letters of credit up to the
full domestic borrowing capacity. The Credit Agreement, with a final maturity of
October 1, 1999, is unsecured and contains various restrictive covenants
including limitations on additional borrowings, payment of cash dividends and
certain acquisitions. The Credit Agreement also requires that the Company
maintain certain financial ratios. Borrowings under the Credit Agreement bear
interest at the higher of the lender's prime rate, the Federal Funds Effective
Rate plus one-half percent or, for borrowings obtained for fixed periods of
time, LIBOR plus one-half percent. As of March 31, 1999, there were no amounts
borrowed or outstanding under the Credit Agreement and amounts outstanding on
the underlying letter of credit facility were not significant.
At March 31, 1999, the Company's capital resource commitments consisted
primarily of commitments under lease arrangements for office space and
equipment. The Company presently intends to meet such obligations from cash
flows from operations. No significant commitments exist for future capital
expenditures. The Company believes available balances of cash and cash
equivalents and marketable securities combined with cash flows from operations
and amounts available under the Credit Agreement are sufficient to meet the
Company's working capital requirements for the foreseeable future.
Other Matters
Demand for many of the Company's products and services tends to improve with
increased inflation as customers strive to increase employee productivity and
reduce costs. However, the effect of inflation on the Company's relatively
labor-intensive cost structure could adversely affect its results of operations
to the extent the Company is not able to recover increased operating costs
through increased prices and sales.
The assets and liabilities of the Company's foreign operations are translated
into U.S. dollars at exchange rates in effect as of the respective balance sheet
dates, and revenue and expense accounts of these operations are translated at
average exchange rates during the month in which the underlying transaction
occurs. Unrealized translation gains and losses are included as an adjustment
to retained earnings. The Company has mitigated a portion of its currency
exposure through decentralized sales, marketing and support operations in which
all costs are local currency based. In addition, the Company may from time to
time employ external hedging strategies. The Company believes that its results
of operations and financial position will not be materially affected by the
recent decrease in the relative value of certain foreign currencies compared to
the U.S. dollar.
-16-
<PAGE>
The Company maintains a strategy of seeking to acquire businesses and products
to fill strategic market niches. This acquisition strategy contributes in part
to the Company's growth in revenue and operating profit. The impact of any
future acquisitions on continued growth in revenue and operating profit cannot
presently be determined.
Forward-Looking Information
This report and other reports and statements published by the Company from
time to time (collectively, "Published Reports") contain, or may contain,
certain forward-looking statements and information that are based on the beliefs
of, and information currently available to, the Company's management, as well as
estimates and assumptions made by the Company's management. When used in
Published Reports, words such as "anticipate," "believe," "estimate," "expect,"
"future," "intend," "plan" and similar expressions, as they relate to the
Company or the Company's management, identify forward-looking statements. Such
statements reflect the current views of the Company with respect to future
events and are subject to certain risks, uncertainties and assumptions relating
to the Company's operations and results of operations, competitive factors and
pricing pressures, shifts in market demand, the performance and needs of the
industries served by the Company, the costs of product development and other
risks and uncertainties, including, in addition to any risks and uncertainties
specifically identified in the text surrounding such statements, those risks
discussed in the Sterling Commerce, Inc. 1999 Annual Report on Form 10-K under
the section titled "Risk Factors," uncertainties with respect to changes or
developments in social, economic, business, industry, market, legal and
regulatory circumstances and conditions and actions taken or omitted to be taken
by third parties, including the Company's stockholders, customers, suppliers,
business partners, competitors and legislative, regulatory, judicial and other
governmental authorities and officials. Should one or more of these risks or
uncertainties materialize, or should the underlying estimates or assumptions
prove incorrect, actual results or outcomes may vary significantly from those
anticipated, believed, estimated, expected, intended or planned.
-17-
<PAGE>
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of Stockholders held on March 4, 1999, the
following proposals were adopted by the margins indicated below:
Election of two Class C directors for three-year terms expiring at the
Company's Annual Meeting of Stockholders in 2002:
Name For Withheld
----- --- -----------
Sterling L. Williams 78,059,575 4,715,741
Sam Wyly 78,026,304 4,749,012
Amendment to the Company's Certificate of Incorporation increasing the number
of shares of Common Stock authorized for issuance, from 150 million shares to
300 million shares:
For Against Abstain
--- ------- -------
80,173,247 2,500,980 101,089
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of this Quarterly Report on Form
10-Q:
3.1 -- Fourth Amended and Restated Certificate of Incorporation and
Certificate of Designation, as amended (previously filed as an
exhibit to the Company's Registration Statement on Form S-8,
registration No. 333-74345, filed on March 12, 1999 and
incorporated herein by reference).
3.2 -- Amended and Restated Bylaws (previously filed as an exhibit to
the Company's Annual Report on Form 10-K filed on November 19,
1998 and incorporated herein by reference).
4.1 -- Form of Common Stock Certificate (previously filed as an exhibit
to the Company's Registration Statement No. 33-80595 and
incorporated herein by reference).
4.2 -- Rights Agreement, dated December 18, 1996, between Sterling
Commerce and The First National Bank of Boston, as Rights Agent
(previously filed as an exhibit to the Company's Current Report
on Form 8-K dated December 18, 1996 and incorporated herein by
reference).
27.1 -- Financial Data Schedule.
-18-
<PAGE>
(b) Reports on Form 8-K:
On March 2, 1999 the Company filed a Current Report on Form 8-K dated
March 1, 1999 which included information under Item 5 (Other Events).
Items 1, 2, 3, and 5 are not applicable and have been omitted.
-19-
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
STERLING COMMERCE, INC.
Date: May 6, 1999 By: /s/ Steven P. Shiflet
--------------------------------------
Steven P. Shiflet
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
-20-
<PAGE>
INDEX TO EXHIBITS
3.1 -- Fourth Amended and Restated Certificate of Incorporation and
Certificate of Designation, as amended (previously filed as an exhibit
to the Company's Registration Statement on Form S-8, registration No.
333-74345, filed on March 12, 1999 and incorporated herein by
reference).
3.2 -- Amended and Restated Bylaws (previously filed as an exhibit to the
Company's Annual Report on Form 10-K filed on November 19, 1998 and
incorporated herein by reference).
4.1 -- Form of Common Stock Certificate (previously filed as an exhibit to
the Company's Registration Statement No. 33-80595 and incorporated
herein by reference).
4.2 -- Rights Agreement, dated December 18, 1996, between Sterling Commerce
and The First National Bank of Boston, as Rights Agent (previously
filed as an exhibit to the Company's Current Report on Form 8-K dated
December 18, 1996 and incorporated herein by reference).
27.1 -- Financial Data Schedule.
-21-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM STERLING
COMMERCE, INC. FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> MAR-31-1999
<CASH> 279,473
<SECURITIES> 325,484
<RECEIVABLES> 156,609
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 802,013
<PP&E> 152,776
<DEPRECIATION> 69,034
<TOTAL-ASSETS> 1,057,330
<CURRENT-LIABILITIES> 161,600
<BONDS> 0
0
0
<COMMON> 960
<OTHER-SE> 832,964
<TOTAL-LIABILITY-AND-EQUITY> 833,924
<SALES> 293,394
<TOTAL-REVENUES> 293,394
<CGS> 64,222
<TOTAL-COSTS> 200,189
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 105,942
<INCOME-TAX> 38,836
<INCOME-CONTINUING> 67,106
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 67,106
<EPS-PRIMARY> 0.71
<EPS-DILUTED> 0.69
</TABLE>
