SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) Quarterly report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended October 3, 1998 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 number: 0-15627
SEQUENT COMPUTER SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Oregon 93-0826369
(State or other jurisdiction (I.R.S. Employer
of organization or incorporation) Identification Number)
15450 S.W. Koll Parkway
Beaverton, Oregon 97006-6063
(Address of principal executive offices, including zip code)
(503) 626-5700
(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 report), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
43,772,277 common shares were issued and outstanding as of November 12, 1998.
SEQUENT COMPUTER SYSTEMS, INC.
PART I. FINANCIAL INFORMATION
Page No.
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - October 3, 1998
and January 3, 1998 3
Consolidated Statements of Operations - Three months
and nine months ended October 3, 1998 and October 4, 1997 4
Consolidated Statements of Shareholders' Equity -
January 3, 1998 through October 3, 1998 5
Consolidated Statements of Cash Flows - Nine months ended
October 3, 1998 and October 4, 1997 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 19
Item 1. CONSOLIDATED FINANCIAL STATEMENTS
SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
October 3, 1998 January 3, 1998
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 157,606 $ 133,299
Restricted deposits 27,275 68,791
Receivables, net 226,481 328,884
Inventories 95,119 112,228
Prepaid royalties and other 25,509 28,147
Total current assets 531,990 671,349
Property and equipment, net 139,469 134,728
Capitalized software costs, net 70,893 66,244
Other assets, net 31,883 14,356
Total assets $ 774,235 $ 886,677
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable $ 28,755 $ 69,893
Accounts payable and other 106,183 128,157
Accrued payroll 14,463 22,843
Unearned revenue 43,396 40,946
Income taxes payable 5,840 3,134
Current obligations under capital leases 2,265 2,310
Total current liabilities 200,902 267,283
Other accrued expenses 8,736 8,700
Long-term obligations under capital leases 8,075 9,910
Total liabilities 217,713 285,893
Shareholders' equity:
Common stock, $.01 par value, 100,000
shares authorized, 43,770 and 42,962 shares
outstanding 438 430
Paid-in capital 517,014 508,858
Retained earnings 44,710 99,402
Foreign currency translation adjustment (5,640) (7,906)
Total shareholders' equity 556,522 600,784
Total liabilities and shareholders' equity $ 774,235 $ 886,677
See notes to consolidated financial statements.
SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS - Unaudited
(in thousands, except per share amounts)
<TABLE>
Three Months Ended Nine Months Ended
<CAPTION>
October 3, 1998 October 4, 1997 October 3, 1998 October 4, 1997
<S> <C> <C> <C> <C>
Revenue:
Product $ 130,491 $ 147,000 $ 369,237 $ 406,989
Service 70,907 60,320 200,906 168,358
Total revenue 201,398 207,320 570,143 575,347
Costs and expenses:
Cost of products sold 82,503 76,326 227,950 205,371
Cost of service revenue 51,013 43,968 146,508 124,965
Research and development 19,382 16,516 56,138 48,434
Selling, general and administrative 50,616 57,051 158,473 166,884
Restructuring charges (credits) (1,350) -- 61,548 --
Total costs and expenses 202,164 193,861 650,617 545,654
Operating income (loss) (766) 13,459 (80,474) 29,693
Interest, net 1,620 413 3,503 (1,624)
Other, net (799) (962) (2,227) (1,535)
Income (loss) before provision for
(benefit from) income taxes 55 12,910 (79,198) 26,534
Provision for (benefit from)
income taxes 17 2,612 (24,506) 6,931
Net income (loss) $ 38 $ 10,298 $ (54,692) $ 19,603
Net income (loss) per share - basic $ 0.00 $ 0.26 $ (1.26) $ 0.54
Net income (loss) per share - diluted $ 0.00 $ 0.24 $ (1.26) $ 0.50
Shares used in the calculation of net
income (loss) per share - basic 43,607 39,436 43,507 36,264
Shares used in the calculation of net
income (loss) per share - diluted 43,753 43,357 43,507 39,195
</TABLE>
See notes to consolidated financial statements.
SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
<TABLE>
Foreign
currency
Common Stock Paid-in Retained translation
Shares Amount capital earnings adjustment Total
<S> <C> <C> <C> <C> <C> <C>
Balance, January 3, 1998 42,962 $430 $508,858 $ 99,402 $(7,906) $600,784
Common shares issued 654 6 8,626 - - 8,632
Tax benefit of option exercises - - 256 - - 256
Net income - - - 4,022 - 4,022
Foreign currency translation
adjustment - - - - 1,252 1,252
Balance, April 4, 1998 (unaudited) 43,616 436 517,740 103,424 (6,654) 614,946
Common shares issued 424 4 6,343 - - 6,347
Common shares repurchased (400) (4) (4,941) - - (4,945)
Tax benefit of option exercises - - 76 - - 76
Net loss - - - (58,752) - (58,752)
Foreign currency translation
adjustment - - - - (667) (667)
Balance, July 4, 1998 (unaudited) 43,640 436 519,218 44,672 (7,321) 557,005
Common shares issued 601 6 2,763 - - 2,769
Common shares repurchased (471) (4) (5,004) - - (5,008)
Tax benefit of option exercises - - 37 - - 37
Net income - - - 38 - 38
Foreign currency translation
adjustment - - - - 1,681 1,681
Balance, October 3, 1998 (unaudited) 43,770 $438 $517,014 $44,710 $(5,640) $556,522
</TABLE>
See notes to consolidated financial statements.
SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - Unaudited
(in thousands)
<TABLE>
Nine Months Ended
October 3, 1998 October 4, 1997
<S> <C> <C>
Cash flow from operating activities:
Net income (loss) $ (54,692) $ 19,603
Reconciliation of net income (loss)
to cash and cash equivalents provided
by operating activities -
Depreciation and amortization 65,639 61,413
Restructuring charges not affecting cash 57,058 --
Deferred income taxes (24,200) (4,536)
Changes in assets and liabilities -
Receivables, net 102,403 (65,996)
Inventories 17,109 (32,544)
Prepaid royalties and other (12,553) (1,246)
Accounts payable and other (25,888) 38,913
Accrued payroll (8,889) (9,263)
Unearned revenue 2,450 8,361
Income taxes payable 2,706 (1,325)
Other, net (20,690) 2,444
Net cash provided by operating activities 100,453 15,824
Cash flow from investing activities:
Restricted deposits 41,516 (7,652)
Purchases of property and equipment, net (53,855) (50,108)
Capitalized software costs (29,959) (25,351)
Intangibles and other assets -- (3,565)
Net cash used for investing activities (42,298) (86,676)
Cash flow from financing activities:
Notes payable, net (41,138) (6,429)
Payments under capital lease obligations (1,883) (1,914)
Stock issuance proceeds 18,117 176,121
Stock repurchases (9,953) --
Net cash provided by (used for) financing activities (34,857) 167,778
Effect of exchange rate changes on cash 1,009 (1,436)
Net increase in cash and cash equivalents 24,307 95,490
Cash and cash equivalents at beginning of period 133,299 37,979
Cash and cash equivalents at end of period $ 157,606 $ 133,469
Supplemental schedule of noncash investing and financing
activities: Conversion of Subordinated Debentures to
Equity, net $ 8,947
</TABLE>
See notes to consolidated financial statements.
SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 3, 1998
Basis of Presentation
The accompanying consolidated financial statements are unaudited and have been
prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission and in the opinion of management include
all adjustments, consisting only of normal recurring adjustments, necessary
for a fair statement of the results for the interim periods. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. These
consolidated financial statements should be read in conjunction with the
audited financial statements and notes thereto included in the Company's
Annual Report on Form 10-K for the fiscal year ended January 3, 1998.
The Company's fiscal year is based on a 52-53 week year ending the Saturday
closest to December 31. The accompanying consolidated financial statements
include the accounts of Sequent Computer Systems, Inc. and its wholly-owned
subsidiaries (the Company or Sequent). All significant intercompany accounts
and transactions have been eliminated. The results for interim periods are
not necessarily indicative of the results for the entire year.
Management Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from these estimates. Significant estimates and
judgments made by management of the Company include matters such as
collectibility of accounts receivable, realizability of inventories and
recoverability of capitalized software costs, prepaid royalties and deferred
tax assets.
Reclassifications
Certain reclassifications have been made to amounts as previously reported in
prior periods. These reclassifications had no impact on previously reported
results of operations or shareholders' equity.
Recently Issued Accounting Standards
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information (FAS 131). The objective of the standard
is to provide information about the different types of business activities in
which an enterprise engages and the different economic environments in which
it operates. The Company adopted the standard effective January 4, 1998. FAS
131 does not need to be applied to interim periods in the initial year of
application; however, comparative information for interim periods in the
initial year of application will be reported in the financial statements for
interim periods in fiscal 1999. This Statement has no impact on reported
earnings and management expects that it will not have a material effect on the
Company's consolidated financial position or results of operations.
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, Accounting for Derivative Instruments and Hedging Activities (FAS 133).
This Statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives), and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the balance sheet and measure those instruments at
fair value. Changes in the fair value of derivatives are recorded each period
in current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, the
type of hedge transaction. This statement is effective for fiscal years
beginning after June 15, 1999 (January 1, 2000 for the Company). The Company
is currently assessing the impact that the adoption of FAS 133 will have on
its consolidated financial statements.
Accounts Receivable
At October 3, 1998, accounts receivable in the accompanying consolidated
balance sheet is net of $29.5 million received by the Company under its
agreement to sell its domestic accounts receivable.
Inventories
Inventories consist of the following:
(in thousands)
October 3, January 3,
1998 1998
Raw materials $ 14,699 $ 16,375
Work-in-progress 1,404 3,155
Finished goods 79,016 92,698
$ 95,119 $ 112,228
Property and Equipment
Property and equipment consist of the following:
(in thousands)
October 3, January 3,
1998 1998
Land $ 6,307 $ 5,037
Operational equipment 228,507 209,372
Furniture and office equipment 85,818 89,569
Leasehold improvements 27,440 22,889
348,072 326,867
Less accumulated depreciation (208,603) (192,139)
$ 139,469 $ 134,728
Research and Development
Amortization of capitalized software costs, generally based on a three-year
life, was $22.8 million and $20.1 million for the nine months ended October 3,
1998 and October 4, 1997, respectively.
Notes Payable
The Company has an unsecured line of credit agreement with a group of banks
which provides short-term borrowings of up to $80 million. The line of credit
agreement extends through April 3, 2001. There were no borrowings outstanding
under the line of credit at October 3, 1998 or January 3, 1998.
The Company has a short-term borrowing agreement with a foreign bank as a
hedge to cover certain foreign currency exposures. Borrowings under the
agreement are denominated in various foreign currencies. Proceeds from the
borrowings are converted into U.S. dollars and placed in a term deposit
account with the foreign bank. At October 3, 1998, maximum borrowings allowed
under the agreement were approximately $90.1 million. The maximum borrowing
limit is denominated in specified foreign currencies and fluctuates with the
change in foreign exchange rates. Amounts outstanding were $27.3 million and
$68.8 million at October 3, 1998 and January 3, 1998, respectively.
In addition to the above borrowing agreements, the Company has entered into
certain other miscellaneous borrowing arrangements with a foreign bank. At
October 3, 1998 and January 3, 1998, $1.5 million and $1.1 million were
outstanding, respectively.
Common Stock
During the second quarter of 1998, the Company announced a plan to repurchase
up to 4,000,000 shares of its outstanding common stock. As of October 3,
1998, the Company has repurchased 871,000 shares at an average price of $11.43
per share. Subsequent to October 3, 1998, 125,000 shares have been
repurchased at an average price of $10.13.
In the third quarter of 1997, the Company completed a public offering of its
common stock. Section 7(e) of the Underwriting Agreement requires that the
Company's Form 10-Q for the third quarter of 1998 include an earnings
statement for the twelve months ended October 3, 1998. The following
Statement of Operations is pursuant to that agreement:
CONSOLIDATED STATEMENTS OF OPERATIONS - Unaudited
(in thousands, except per share amounts)
Twelve Months Ended
October 3, 1998
Revenue:
Product $ 562,744
Service 265,938
Total revenue 828,682
Costs and expenses:
Cost of products sold 331,596
Cost of service revenue 193,137
Research and development 73,118
Selling, general and administrative 225,626
Restructuring charges 61,548
Total costs and expenses 885,025
Operating loss (56,343)
Interest, net 4,136
Other, net (3,013)
Loss before benefit from income taxes (55,220)
Benefit from income taxes 19,612
Net loss $ (35,608)
Net loss per share - basic $ (0.82)
Net loss per share - diluted $ (0.82)
Shares used in the calculation of net
loss per share - basic 43,331
Shares used in the calculation of net
loss per share - diluted 43,331
Income Taxes
The Company's general practice is to reinvest the earnings of its foreign
subsidiaries operations, unless it would be advantageous to the Company to
repatriate the foreign subsidiaries' retained earnings. The effective tax
rate differs from the statutory tax rate principally due to the benefit from
the Company's foreign sales corporation and the federal research and
experimentation tax credit.
Restructuring Charges
During the second quarter of 1998, the Company recorded restructuring charges
of $62.9 million in connection with management's decision to accelerate
changes in its business model to leverage the strength of its technology
roadmap and market position. Please refer to the discussion of restructuring
costs included in Management's Discussion and Analysis of Financial Condition
and Results of Operations.
<TABLE>
Comprehensive Income
<CAPTION>
Three Months Ended Nine Months Ended
October 3, October 4, October 3, October 4,
(in thousands) 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Net income (loss) $ 38 $10,298 $(54,692) $19,603
Other comprehensive income (loss):
Foreign currency translation adjustment 1,681 (1,126) 2,266 (3,927)
Total comprehensive income (loss) $ 1,719 $ 9,172 $(52,426) $15,676
</TABLE>
The foreign currency translation adjustment represents the Company's only
significant other comprehensive income element. The cumulative translation
adjustment consists of unrealized gains/losses from translation adjustments
and intercompany foreign currency transactions that are of a long-term
investment nature. These items are reflected in the statement of
shareholders' equity in accordance with Statement of Financial Accounting
Standards No. 52, Foreign Currency Translation.
<TABLE>
Earnings Per Share
(in thousands, except per share amounts)
<CAPTION>
Income/(Loss) Shares Per-Share
(Numerator) (Denominator) Amount
Three Months Ended Three Months Ended Three Months Ended
Oct. 3, Oct. 4, Oct. 3, Oct. 4, Oct. 3, Oct. 4,
1998 1997 1998 1997 1998 1997
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Income (loss) available to
common shareholders $ 38 $ 10,298 43,607 39,436 $ 0.00 $ 0.26
Effect of Dilutive Securities
Stock options 30 3,709
Employee stock purchase plan
and debentures 116 212
Diluted EPS
Income (loss) available to
common shareholders
+ assumed conversions $ 38 $ 10,298 43,753 43,357 $ 0.00 $ 0.24
</TABLE>
<TABLE>
Income/(Loss) Shares Per-Share
(Numerator) (Denominator) Amount
Nine Months Ended Nine Months Ended Nine Months Ended
Oct. 3, Oct. 4, Oct. 3, Oct. 4, Oct. 3, Oct. 4,
1998 1997 1998 1997 1998 1997
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Income (loss) available to
common shareholders $(54,692) $19,603 43,507 36,264 $(1.26) $0.54
Effect of Dilutive Securities
Stock options -- 2,578
Employee stock purchase plan
and debentures -- 353
Diluted EPS
Income (loss) available to
common shareholders
+ assumed conversions $(54,692) $19,603 43,507 39,195 $(1.26) $0.50
</TABLE>
Significant Customers
The core business operations of the Company include the design, manufacture
and marketing of high-performance computer systems and operating environment
software. Project-oriented offerings include consulting and professional
services to help customers solve complex information technology problems. The
Company had no single customer that represented greater than 10% of total
revenue for the third quarter of 1998. Approximately 13% of the Company's
revenue in the third quarter of 1997 was from one customer.
Geographic Segment Information
Export and foreign revenue was $104.4 million (52% of total revenue) for the
three months ended October 3, 1998 and $290.1 million (51% of total revenue)
for the first nine months of 1998. Export and foreign revenue was $89.7
million and $267.3 million (43% and 46% of total revenue, respectively) for
the corresponding periods in 1997. The Company's United States operations
generated operating losses of $15 million for the three months ended October
3, 1998 and $25.6 million for the first nine months of 1998. Foreign
operations generated net operating profit of $12.9 million and $6.7 million
for the same periods, respectively. The results of comparable periods in 1997
were operating income of $21.1 million and $50 million for the United States
operations and net operating losses of $7.7 million and $20.3 million for
foreign operations.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Three Months Ended Nine Months Ended
(dollars in thousands) October 3, October 4, October 3, October 4,
1998 1997 1998 1997
Total Revenue $ 201,398 $ 207,320 $ 570,143 $ 575,347
Product $ 130,491 $ 147,000 $ 369,237 $ 406,989
Service 70,907 60,320 200,906 168,358
US $ 96,948 $ 117,580 $ 280,007 $ 307,973
International 104,450 89,740 290,136 267,374
Net Income (loss) $ 38 $ 10,298 $ (54,692) $ 19,603
OVERVIEW
The Company's total revenue declined slightly in the third quarter and
first nine months of 1998 compared to the same periods in 1997. During the
third quarter and first nine months of 1998, the Company recorded
approximately breakeven results and a net loss of $54.7 million, respectively.
Included in the $54.7 million loss is a pretax net restructuring charge of
$61.5 million ($62.9 million was recorded in the second quarter of 1998 and a
subsequent credit of $1.3 million was recorded in the third quarter of 1998).
Without the net restructuring charge, the Company would have recorded an
after-tax net loss of $12.2 million for the first nine months of 1998. The
Company's product revenue decreased in the third quarter and first nine months
of 1998 over the same periods in 1997. The main factor contributing to the
decrease in product revenue was a significant reduction in revenue from the
Company's largest domestic customer during the third quarter of 1998.
Offsetting the reduction in product revenue were increases in service revenue,
including the positive impact of solid growth in the Company's professional
service organization.
REVENUE
During the third quarter of 1998, the Company experienced a significant
decrease in product revenue from its largest domestic customer. This decline
contributed to the Company's decrease in total product revenue of 11% and 9%
in the third quarter and first nine months of 1998, respectively, over the
same periods in 1997. The Company's product revenue in 1998 was also
negatively impacted by the transition from its Pentium Pro-based NUMA-Q
products to its new Pentium II Xeon-based NUMA product line. The Company
began shipment of its new product line late in the third quarter of 1998.
Decreases in product revenue were partially offset by increases in service
revenue, particularly from the Company's professional service organization.
Revenue increases in professional services were approximately 37% and 33% in
the third quarter and first nine months of 1998 over the same periods in 1997.
Continued growth in the number and size of new projects, with both new and
existing customers, contributed to the overall increase in revenue within the
Company's professional services organization.
<TABLE>
The following table sets forth certain operating data as a percentage of
total revenue:
<CAPTION>
Three Months Ended Nine Months Ended
October 3, October 4, October 3, October 4,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Revenue:
End-user products 64.8% 70.6% 64.7% 69.9%
OEM products - 0.3 0.1 0.8
Service 35.2 29.1 35.2 29.3
Total revenue 100.0 100.0 100.0 100.0
Cost of products and service 66.3 58.0 65.7 57.4
Gross profit 33.7 42.0 34.3 42.6
Operating expenses:
Research and development 9.6 8.0 9.8 8.4
Selling, general and administrative 25.1 27.5 27.8 29.0
Restructuring charges (credits) (0.6) - 10.8 -
Total operating expenses 34.1 35.5 48.4 37.4
Operating income (loss) (0.4) 6.5 (14.1) 5.2
Interest income (expense), net 0.8 0.2 0.6 (0.3)
Other expense, net (0.4) (0.5) (0.4) (0.3)
Income (loss) before provision for
(benefit from) income taxes 0.0 6.2 (13.9) 4.6
Provision for (benefit from) income taxes 0.0 1.2 (4.3) 1.2
Net income (loss) 0.0% 5.0% (9.6)% 3.4%
</TABLE>
<TABLE>
COST OF SALES/GROSS MARGINS
<CAPTION>
Three Months Ended Nine Months Ended
October 3, October 4, October 3, October 4,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Cost of product sold as a percentage
of product revenue 63.2% 51.9% 61.7% 50.5%
Cost of service as a percentage
of service revenue 71.9% 72.9% 72.9% 74.2%
Total cost of sales as a percentage
of total revenue 66.3% 58.0% 65.7% 57.4%
</TABLE>
The factors influencing gross margins in a given period generally include
unit volumes (which affect economies of scale), product configuration mix,
changes in component and manufacturing costs, product pricing and the mix
between product and service revenue.
Total cost of sales as a percentage of total revenue increased in the
third quarter and first nine months of 1998 over the same periods in 1997.
Product margins were lower in the third quarter and first nine months of 1998
due to competitive pricing pressures and the impact of the product transition
at the end of the third quarter. The Company's Pentium Pro-based product
line was nearing the end of its product life cycle, which resulted in heavier
discounting of the products sold during the third quarter of 1998. The
Company's new Xeon-based NUMA-Q products were announced to the marketplace
near the end of the third quarter; however, formal introduction and shipment
of the products did not begin until the fourth quarter of 1998. Additionally,
product margins were also impacted by certain non-recurring charges for
inventory obsolescence provisions made during the second quarter of 1998. The
Company's total product gross margins were approximately 37% and 38% in the
third quarter and first nine months of 1998, respectively, and service gross
margins were approximately 28% and 27%, respectively, during the same periods
in 1998. The Company's total gross margins were positively impacted by
service margins, particularly from the professional service organization,
which increased slightly during the third quarter and first nine months of
1998 over the same periods in 1997.
RESEARCH AND DEVELOPMENT
Three Months Ended Nine Months Ended
(dollars in millions) October 3, October 4, October 3, October 4,
1998 1997 1998 1997
Research and development expense $19.4 $16.5 $56.1 $48.4
As a percentage of total revenue 9.6% 8.0% 9.8% 8.4%
Software costs capitalized $ 9.7 $ 8.6 $29.9 $25.4
Research and development expense continued to increase in amount, by
approximately 18% and 16% in the third quarter and first nine months of 1998,
respectively, compared to the same periods in 1997, as the Company continued
to make enhancements to its NUMA-Q architecture, specifically with the
development of its new Xeon-based product line. During the third quarter of
1998, increases to capitalized software costs were related to continued
investments in new software technology.
SELLING, GENERAL AND ADMINISTRATIVE
Three Months Ended Nine Months Ended
(dollars in millions) October 3, October 4, October 3, October 4,
1998 1997 1998 1997
Selling, general and administrative $50.6 $57.1 $158.5 $166.9
As a percentage of total revenue 25.1% 27.5% 27.8% 29.0%
Comparing the third quarter and first nine months of 1998 to the same
periods in 1997, selling, general and administrative expenses decreased 11%
and 5%, respectively. Factors contributing to the decrease included the
effects of cost control measures implemented by the Company during 1998 and
from cost savings achieved through the Company's restructure which took place
in the second quarter of 1998. The overall decrease to the Company's selling,
general and administrative expenses resulted primarily from reductions in
payroll, employee training and travel expenses.
RESTRUCTURING CHARGES
During the second quarter of 1998, the Company recorded restructuring
charges of $62.9 million in connection with management's decision to
accelerate changes in its business model to leverage the strength of its
technology roadmap and market position. As part of the restructuring process,
which was substantially completed during the second quarter of 1998, the
Company has reorganized its operations to focus on vertical markets where the
Company has demonstrated success with continuing business and can focus on
solid relationships with key partners. In addition, the Company plans to
broaden its product offerings, including an emphasis on its Intel-based
architecture, as well as developing a new product family expected to be
introduced by the end of the year. The restructuring charges of $62.9 million
included employee termination and other related costs ($7.2 million);
facilities and office space costs ($13.7 million); write-offs of non-strategic
assets, principally prepaid software licenses ($27.2 million), capital assets
($7.9 million), capitalized software ($2.5 million), goodwill ($2.5 million),
and other assets, principally prepaid expenses ($1.9 million).
The employee termination costs resulted from the elimination of 265
positions worldwide. The employee groups covered by such elimination
encompass all functions within the Company. All termination costs pertaining
to the eliminated positions are included as restructuring costs in the
accompanying Statements of Operations. Approximately 39% of the employee
termination costs accrued during the second quarter of 1998 were paid prior to
the end of the quarter. During the third quarter of 1998, an additional 37%
of employee termination costs were paid.
Excluding employee termination costs from the total restructuring
charges, there are no material incremental future cash outlays resulting from
the restructuring. In addition, a change in the restructuring estimate during
the third quarter resulted in a $1.3 million credit. It is anticipated that
the restructuring actions taken in the second quarter will yield annualized
operating cost reductions of approximately $40 million during 1998 and 1999.
The following table presents a summary of the restructuring charges
recorded in the second and third quarters of 1998 and the resulting net
balance sheet amounts recorded as of October 3, 1998. The balance of accrued
restructuring costs of $16.5 million at October 3, 1998 is included in
Accounts Payable and Other in the accompanying balance sheet.
<TABLE>
Second Third
Restructuring Quarter Write-offs/ Balance at Quarter Write-offs/ Balance at
(dollars in millions) Costs Expenditures Adjustments July 4, 1998 Expenditures Adjustments October 3, 1998
<S> <C> <C> <C> <C> <C>
Employee termination
and related $ 7.2 $ (2.5) $ (0.3) $ 4.4 $ (2.5) $ (0.2) $ 1.7
Prepaid software licenses 27.2 - (24.9) 2.3 - (0.6) 1.7
Facilities 13.7 (0.1) - 13.6 (0.7) 0.1 13.0
Capital assets 7.9 - (7.9) - - 0.1 0.1
Capitalized software 2.5 - (2.5) - - - -
Goodwill 2.5 - (2.5) - - - -
Other assets 1.9 - (1.9) - - - -
$ 62.9 $ (2.6) $ (40.0) $ 20.3 $ (3.2) $ (0.6) $ 16.5
</TABLE>
INTEREST AND OTHER, NET
Three Months Ended Nine Months Ended
(dollars in millions) October 3, October 4, October 3, October 4,
1998 1997 1998 1997
Interest income $ 2.3 $ 1.9 $ 6.9 $ 3.4
Interest expense $ 0.7 $ 1.5 $ 3.4 $ 5.0
Other expense, net $(0.8) $(1.0) $(2.2) $(1.5)
Interest income is primarily generated from invested cash and cash
equivalents and restricted deposits held at foreign and domestic banks. The
increase in interest income in the third quarter and first nine months of 1998
is a result of investments of cash proceeds from the Company's stock offering
in August 1997. Interest expense includes costs related to foreign currency
hedging loans, interim short-term borrowings, capital lease obligations and,
in 1997, convertible debentures. The decrease in interest expense in 1998
over 1997 is attributed to the decrease in the use of the Company's line of
credit in 1998 resulting from use of proceeds received from the August 1997
stock offering and the conversion of the Company's Convertible Subordinated
Debentures to shares of common stock in August and September 1997.
Other expense consists primarily of the discount from the sale of
accounts receivable and the net realized and unrealized foreign exchange gains
and losses.
INCOME TAXES
The provision for income taxes includes benefits related to the Company's
foreign sales corporation and the research and experimentation credit. The
effective tax rate benefit for the third quarter of 1998 was 30.9%, compared
to an effective tax rate of 20% for the corresponding period in 1997 and an
overall annual effective tax rate of 23.4% for 1997. The change in the
effective tax rate for the third quarter of 1998, when compared to the annual
effective tax rate for 1997, is due primarily to the impact of recording a tax
benefit related to the net operating loss reported for the second quarter.
LIQUIDITY AND CAPITAL RESOURCES
Working capital was $331.1 million at October 3, 1998 compared to $404.1
million at January 3, 1998. The Company's current ratio increased to 2.65:1
from 2.51:1 at January 3, 1998.
Cash and cash equivalents increased $24 million during the first nine
months of 1998. The Company's cash and cash equivalents were primarily
impacted by the $102 million decrease in accounts receivable. During the
third quarter, the Company focused resources on collection efforts,
substantially decreasing the number and size of outstanding accounts.
Offsetting the impact of the decrease in accounts receivable were investing
activities of $42 million and financing activities of $35 million.
The Company has a $40 million receivable sales facility with a group of
banks. At October 3, 1998, accounts receivable in the accompanying
consolidated balance sheet is net of $29.5 million received by the Company
under this agreement to sell its domestic accounts receivable. Additionally,
the Company entered into a specific transaction to factor certain foreign
receivables, without recourse, at an average rate of 8.75%. As of October 3,
1998, $3.5 million relating to this transaction was netted against accounts
receivable in the accompanying consolidated balance sheet.
The Company maintains an $80 million revolving line of credit agreement.
The line is unsecured and extends through April 3, 2001. The line contains
certain financial covenants and prohibits the Company from paying dividends
without the lenders' consent. At October 3, 1998, there was no outstanding
balance under the line of credit.
The Company maintains a short-term borrowing agreement with a foreign
bank to cover foreign currency exposures. Maximum borrowings allowed under
the foreign bank agreement were $90.1 million, of which $27.3 million was
outstanding at October 3, 1998 (based on currency exchange rates on such
date).
The Company also maintains a miscellaneous borrowing arrangement with a
foreign bank. At October 3, 1998 $1.5 million was outstanding under this
agreement.
Management expects that its cash resources, funds from operations and the
bank lines of credit will provide adequate resources to meet the Company's
anticipated operational cash requirements for at least the next twelve months.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's software programs and microcircuitry that have date-sensitive
features may recognize a date using "00" as the year 1900 rather than the
year 2000. This could result in a system failure or miscalculations causing
disruptions of operations. The Year 2000 Issue affects the Company's internal
systems as well as any of the Company's products that include date-sensitive
software.
Sequent is executing a company-wide Year 2000 Readiness Program
(Program) for the Company's products, on-going operations (operations),
mission-critical information systems (IS), and key suppliers (suppliers). The
Program's goal is to identify and conduct remediation of critical century date
change issues by the end of 1998. Ongoing remediation, testing, and
contingency planning are expected to continue throughout 1999. The Year 2000
Readiness Program is organized into six major phases: 1) exposure inventory,
2) risk assessment, 3) prioritization, 4) remediation (either by repair or
replacement), 5) contingency planning, and 6) testing/verification. These
stages have been largely completed for the Company's standard products and are
in progress for ongoing operational issues as well as critical suppliers. The
Program organization consists of a Steering Committee made up of Company
executives, a Year 2000 taskforce representing each of the Company's major
departments, and a Year 2000 Project Management Office. In addition, several
Focus Teams have been set up to deal with cross-functional issues related to
customers, partners, and suppliers. Operational program work is being done by
each of the Company's departments with oversight by a Year 2000 Program
Office. Operational program work includes the Company's critical business
computer applications, data, and infrastructure. Mission-critical third party
service and equipment suppliers are being contacted via written inquiry, as
well as direct discussion, to understand and mitigate potential risks.
The current status of the Company's Year 2000 Readiness Program is as
follows:
The Company's current line of hardware products, which are designed and
manufactured to the Company's specifications, are Year 2000 ready if utilized
with the appropriate version of the operating system software. The Company
cannot ensure that its software products do not contain undetected problems
associated with Year 2000 compliance. Such problems, should they occur, may
result in material adverse effects on future operating results. The Company's
Operations remediation phase is on schedule and approximately 70% complete.
Critical exposures have been identified and are expected to be resolved by the
first quarter of 1999. The Company's Supplier readiness program is managed
through its Strategic Sourcing group. Approximately 75% of the Company's
critical suppliers (and 65% of the remaining suppliers) have completed the
remediation process. The Company's Information Systems group is remediating
critical IS applications and infrastructure (worldwide). This process is
approximately 75% complete. Non-IS application remediation has been
outsourced. In both cases, the Program's goal is to identify and resolve
critical century date change by the end of the first quarter of 1999. In
addition, the Company has made available to its customers Year 2000 readiness
information concerning its products, services and support.
The total cost of the Program is currently estimated to be approximately
$10 million and is being funded through operating cash flows. The Company is
expensing costs associated with identification and resulting changes to these
systems, but does not expect the amounts to have a material effect on its
financial position or results of operations. These costs are not incremental
as the Company's IS development resources have been re-directed solely to the
Year 2000 remediation effort in 1998. As of October 3, 1998 the total amount
expended on the Program was approximately $4 million, with the majority of the
costs representing hardware and labor expenditures.
The Company has determined worst case scenarios as either 1) Year 2000
related failures in internal business critical information system applications
or 2) the development of service or product supply difficulties by business
critical suppliers. These circumstances are not considered probable, but have
been reviewed as part of the Company's due diligence efforts. In regards to
Year 2000 failures in internal applications (scenario 1), business critical
applications have been identified, assessed as to possible business impact of
their failure and are being repaired, upgraded or replaced based on the
severity of potential impact. For each of these applications, a business
continuity contingency plan is expected to be in place by the end of the first
half of 1999. In the case of service and product suppliers, an inventory has
been completed and the business critical suppliers have been identified. A
variety of risk reduction strategies have commenced, including but not limited
to, developing possible alternative suppliers, acquiring safety stock and
establishing enhanced testing programs and process audits. For the identified
business critical suppliers, the Company expects to establish a contingency
plan by mid 1999.
There can be no assurance, however, that the systems or products of other
companies on which the Company's systems also rely will be timely converted or
that any such failure to convert by a vendor, customer or another company
would not have an adverse effect on the Company's systems or results of
operations.
FORWARD-LOOKING STATEMENTS
Information in this report that is not historical information, including
information regarding product development, anticipated savings resulting from
the restructure and year 2000 issues, constitutes forward-looking statements
that involve a number of risks and uncertainties. A number of factors could
cause actual results to differ materially from the forward-looking statements.
New product development may be delayed or unsuccessful due to technical
difficulties encountered, resource constraints and other reasons. Factors
that affect year 2000 issues are set forth above. Additional information
regarding factors that may affect the Company's future results is set forth at
the end of Item 1 in the Company's Annual Report on Form 10-K for the year
ended January 3, 1998. The Company's forward-looking statements apply only as
of the date made. The Company undertakes no obligation to publicly release
the results of any revisions to forward-looking statements which may be made
to reflect events or circumstances after the date made or to reflect the
occurrence of unanticipated events.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 27 - Financial Data Schedule
(b) No reports on Form 8-K were filed by the Company during the fiscal
quarter Ended October 3, 1998.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SEQUENT COMPUTER SYSTEMS, INC.
________________________________
/s/Robert S. Gregg
Sr. Vice President of Finance and Legal and
Chief Financial Officer
Date: November 13, 1998
<TABLE> <S> <C>
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<S> <C>
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<FISCAL-YEAR-END> JAN-02-1999
<PERIOD-END> OCT-03-1998
<CASH> 157,606,000
<SECURITIES> 0
<RECEIVABLES> 230,698,000
<ALLOWANCES> 4,217,000
<INVENTORY> 95,119,000
<CURRENT-ASSETS> 531,990,000
<PP&E> 348,072,000
<DEPRECIATION> 208,603,000
<TOTAL-ASSETS> 774,235,000
<CURRENT-LIABILITIES> 200,902,000
<BONDS> 0
0
0
<COMMON> 438,000
<OTHER-SE> 517,014,000
<TOTAL-LIABILITY-AND-EQUITY> 774,235,000
<SALES> 130,491,000
<TOTAL-REVENUES> 201,398,000
<CGS> 82,503,000
<TOTAL-COSTS> 133,516,000
<OTHER-EXPENSES> 69,998,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,060,000
<INCOME-PRETAX> 55,000
<INCOME-TAX> 17,000
<INCOME-CONTINUING> 38,000
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