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 July 4, 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.
43,420,640 common shares were issued and outstanding as of August 4, 1998.
SEQUENT COMPUTER SYSTEMS, INC.
PART I. FINANCIAL INFORMATION
Page No.
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - July 4, 1998 and
January 3, 1998 3
Consolidated Statements of Operations - Three months
and six months ended July 4, 1998 and June 28, 1997 4
Consolidated Statements of Shareholders' Equity -
December 28, 1996 through July 4, 1998 5
Consolidated Statements of Cash Flows - Six months ended
July 4, 1998 and June 28, 1997 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Matters 18
Item 6. Exhibits and Reports on Form 8-K 19
(a) Exhibit 27 - Financial Data Schedule 21
(b) No reports on Form 8-K were filed by the Company during
the fiscal quarter Ended July 4, 1998.
Item 1. CONSOLIDATED FINANCIAL STATEMENTS
SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
July 4, 1998 January 3, 1998
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 145,275 $ 133,299
Restricted deposits 40,284 68,791
Receivables, net 239,930 328,884
Inventories 108,489 112,228
Prepaid royalties and other 28,024 28,147
Total current assets 562,002 671,349
Property and equipment, net 122,734 134,728
Capitalized software costs, net 68,460 66,244
Other assets, net 34,310 18,524
Total assets $ 787,506 $ 890,845
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable $ 41,040 $ 69,893
Accounts payable and other 113,180 132,325
Accrued payroll 12,277 22,843
Unearned revenue 40,262 40,946
Income taxes payable 3,934 3,134
Current obligations under capital leases
and debt 2,279 2,310
Total current liabilities 212,972 271,451
Other accrued expenses 8,708 8,700
Long-term obligations under capital leases
and debt 8,821 9,910
Total liabilities 230,501 290,061
Shareholders' equity:
Common stock, $.01 par value, 100,000 shares
authorized, 43,640 and 42,962 shares outstanding 436 430
Paid-in capital 519,218 508,858
Retained earnings 44,672 99,402
Foreign currency translation adjustment (7,321) (7,906)
Total shareholders' equity 557,005 600,784
Total liabilities and shareholders' equity $ 787,506 $ 890,845
See notes to consolidated financial statements.
<TABLE>
SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS - Unaudited
(in thousands, except per share amounts)
<CAPTION>
Three Months Ended Six Months Ended
July 4, 1998 June 28, 1997 July 4, 1998 June 28, 1997
<S> <C> <C> <C> <C>
Revenue:
Product $ 120,301 $ 154,422 $ 238,746 $ 259,989
Service 65,376 56,231 129,999 108,038
Total revenue 185,677 210,653 368,745 368,027
Costs and expenses:
Cost of products sold 82,541 78,590 145,447 129,045
Cost of service revenue 48,159 42,198 95,495 80,997
Research and development 19,692 16,476 36,756 31,918
Selling, general and administrative 58,237 59,583 107,857 109,833
Restructuring charges 62,898 -- 62,898 --
Total costs and expenses 271,527 196,847 448,453 351,793
Operating income (loss) (85,850) 13,806 (79,708) 16,234
Interest, net 1,261 (786) 1,882 (2,036)
Other, net (493) (432) (1,427) (574)
Income (loss) before provision
(benefit)for income taxes (85,082) 12,588 (79,253) 13,624
Provision (benefit) for income taxes (26,330) 3,991 (24,523) 4,319
Net income (loss) $ (58,752) $ 8,597 $ (54,730) $ 9,305
Net income (loss) per share
- basic $ (1.34) $ 0.25 $ (1.26) $ 0.27
Net income (loss) per share
- diluted $ (1.34) $ 0.23 $ (1.26) $ 0.25
Shares used in the calculation
of net income (loss) per share
- basic 43,729 34,929 43,457 34,678
Shares used in the calculation of net
income (loss) per share - diluted 43,729 37,553 43,457 37,114
</TABLE>
See notes to consolidated financial statements.
<TABLE>
SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
<CAPTION>
Foreign
currency
Common Stock Paid-in Retained translation
Shares Amount capital earnings adjustment Total
<S> <C> <C> <C> <C> <C> <C>
Balance, December 28, 1996 34,188 $ 342 $315,316 $ 60,715 $ (1,564) $374,809
Common shares issued 8,198 82 181,580 - - 181,662
Tax benefit of option exercises - - 3,021 - - 3,021
Conversion of debentures 576 6 8,941 - - 8,947
Net income - - - 38,687 - 38,687
Foreign currency translation
adjustment - - - - (6,342) (6,342)
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
</TABLE>
See notes to consolidated financial statements.
SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - Unaudited
(in thousands)
Six Months Ended
July 4, 1998 June 28, 1997
Cash flow from operating activities:
Net income (loss) $ (54,730) $ 9,305
Reconciliation of net income to cash and
cash equivalents provided by operating
activities -
Depreciation and amortization 44,325 40,342
Restructuring charges not affecting cash 60,259 -
Deferred income taxes (22,670) 2,300
Changes in assets and liabilities -
Receivables, net 88,954 (27,487)
Inventories 3,739 (7,771)
Prepaid royalties and other (14,421) (3,164)
Accounts payable and other (30,208) 5,989
Accrued payroll (10,566) (1,738)
Unearned revenue (684) 20,601
Income taxes payable 800 208
Other, net (17,840) 2,693
Net cash provided by operating
activities 46,958 41,278
Cash flow from investing activities:
Restricted deposits 28,507 (1,694)
Purchases of property and equipment, net (24,610) (32,492)
Capitalized software costs (20,217) (16,911)
Net cash used for investing activities (16,320) (51,097)
Cash flow from financing activities:
Notes payable, net (28,854) 18,964
Payments under capital lease obligations
and debt (1,125) (1,164)
Stock issuance proceeds 15,311 11,002
Stock repurchase (4,945) -
Net cash provided (used) by
financing activities (19,613) 28,802
Effect of exchange rate changes on cash 951 (2,274)
Net increase in cash and cash equivalents 11,976 16,709
Cash and cash equivalents at beginning of
period 133,299 37,979
Cash and cash equivalents at end of period $ 145,275 $ 54,688
See notes to consolidated financial statements.
SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
July 4, 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 changes had no impact on previously reported results of
operations.
Recently Issued Accounting Standards
In October 1997, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 97-2, Software Revenue Recognition,
which supersedes SOP 91-1, Software Revenue Recognition. This Statement did
not significantly impact the Company's revenue recognition policies nor
reported earnings.
In April 1998, the AICPA issued Statement of Position (SOP) 98-1, Accounting
for the Costs of Computer Software Developed or Obtained for Internal Use.
This Statement is effective for fiscal years beginning after December 15, 1998
and requires certain costs incurred for internal software development to be
capitalized over their useful life. Early adoption is suggested. The Company
adopted SOP 98-1 beginning May 3, 1998. The Statement does not significantly
impact the Company's accounting for computer software development projects or
reported earnings.
In June 1998, the Financial Accounting Standards Board (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. This statement is
effective for companies with fiscal years beginning with 2000. The Company is
evaluating FAS 133 to determine its impact on the consolidated financial
statements.
Accounts Receivable
At July 4, 1998, accounts receivable in the accompanying consolidated balance
sheet is net of $40 million received by the Company under its agreement to
sell its domestic accounts receivable.
Inventories
Inventories consist of the following:
(in thousands)
July 4, January 3,
1998 1998
Raw materials $ 15,398 $ 16,375
Work-in-progress 1,395 3,155
Finished goods 91,696 92,698
$ 108,489 $ 112,228
Property and Equipment
Property and equipment consist of the following:
(in thousands)
July 4, January 3,
1998 1998
Land $ 6,304 $ 5,037
Operational equipment 204,224 209,372
Furniture and office equipment 84,275 89,569
Leasehold improvements 24,738 22,889
319,541 326,867
Less accumulated depreciation (196,807) (192,139)
$ 122,734 $ 134,728
Research and Development
Amortization of capitalized software costs, generally based on a three-year
life, was $15.5 million and $13.1 million for the six months ended July 4,
1998 and June 28, 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. At July 4, 1998, there was no
outstanding balance. At June 28, 1997, $30.8 million was outstanding. The
interest rate on this borrowing at June 28, 1997 was 7.2%.
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 July 4, 1998, maximum borrowings allowed
under the agreement were approximately $81.5 million. The maximum borrowing
limit is denominated in specified foreign currencies and fluctuates with the
change in foreign exchange rates. Amounts outstanding were $40.3 million and
$46.3 million at July 4, 1998 and June 28, 1997, respectively.
In addition to the above borrowing agreements, the Company has entered into
certain other miscellaneous borrowing arrangements with a foreign bank. At
July 4, 1998 and June 28, 1997, $0.8 million and $1.7 million were
outstanding, respectively.
Obligations under Capital Leases and Long-Term Debt
In April 1992, the Company issued $20 million of 7.5% Convertible Subordinated
Debentures ("Convertible Debentures" or "Debentures") due March 31, 2000.
The Convertible Debentures were convertible into the Company's common stock at
the option of the holders at an initial conversion price of $15.81 per share.
In conjunction with the Company's equity offering in 1993, $9.9 million of the
Debentures was converted into 626,000 shares of common stock. In August 1995,
an additional $1.0 million of the Debentures was converted into 63,000 shares
of common stock. In August and September 1997, the remaining $9.1 million of
the Debentures was converted into 576,000 shares of common stock; thus, there
was no outstanding long-term debt related to the Debentures at January 3, 1998
or at July 4, 1998. The outstanding balance at June 28, 1997 was $9.1
million.
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. During this quarter,
the Company repurchased 400,000 shares at an average price of $12.35 per
share. Subsequent to July 4, 1998, the Company has repurchased an additional
321,000 shares at an average price of $11.26 per share.
During the second quarter of 1998, the Company provided employees with a stock
option re-pricing plan whereby the exercise price of those outstanding options
with a price greater than fair market value on July 13, 1998 could be
converted to an exercise price of $13 per share in exchange for an extended
vesting period. With the exception of two recently hired Vice Presidents, the
stock option repricing was not made available to Directors, Officers and Vice
Presidents of the Company. It is not anticipated that such stock option re-
pricing will have a significant impact on the shares used in the calculation
of either basic or diluted earnings per share.
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>
(in thousands) Three Months Ended Six Months Ended
July 4, June 28, July 4, June 28,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Net income (loss) $ (58,752) $ 8,597 $ (54,730) $ 9,305
Other comprehensive income (loss):
Foreign currency translation adjustment (667) 269 585 (2,801)
Total comprehensive income (loss) $ (59,419) $ 8,866 $ (54,145) $ 6,504
</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 Shares Per-Share Income Shares Per-Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
Three Three Three Six Six Six
Months Ended Months Ended Months Ended Months Ended Months Ended Months Ended
July 4, June 28, July 4, June 28, July 4, June 28, July 4, June 28, July 4, June 28, July 4, June 28,
1998 1997 1998 1997 1998 1997 1998 1997 1998 1997 1998 1997
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Basic EPS
Income (loss) available
to common shareholders $(58,752) $8,597 43,729 34,929 $(1.34) $0.25 $(54,730) $9,305 43,457 34,678 $(1.26) $0.27
Effect of Dilutive Securities
Stock options - 1,935 - 2,013
Employee stock purchase plan
and debentures - 689 - 423
Diluted EPS
Income (loss) available to
common shareholders
+ assumed conversions $(58,752) $8,597 43,729 37,553 $(1.34) $0.23 $(54,730) $9,305 43,457 37,114 $(1.26) $0.25
</TABLE>
Significant Customers
The Company operates primarily in one business segment, which includes 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. Approximately 18% and 25% of the Company's revenue was
from one customer for the quarters ended July 4, 1998 and June 28, 1997,
respectively.
Geographic Segment Information
Export and foreign revenue was $85.3 million (46% of total revenue) for the
three months ended July 4, 1998 and $185.7 million (50% of total revenue) for
the first six months of 1998. Export and foreign revenue was $97.9 million
and $177.6 million (47% and 48% of total revenue, respectively) for the
corresponding periods in 1997. The Company's United States operations
generated operating losses of $13.5 million for the three months ended July 4,
1998 and $10.7 million for the first six months of 1998. Foreign operations
generated net operating losses of $9.5 million and $6.2 million for the same
periods, respectively. The results of comparable periods in 1997 were
operating income of $20.4 million and $21.7 million for the United States
operations and net operating losses of $6.6 million and $6.9 million for
foreign operations.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Three Months Ended Six Months Ended
(dollars in thousands) July 4, June 28, July 4, June 28,
1998 1997 1998 1997
Total Revenue $ 185,677 $ 210,653 $ 368,745 $ 368,027
Product $ 120,301 $ 154,422 $ 238,746 $ 259,989
Service 65,376 56,231 129,999 108,038
US $ 100,363 $ 112,727 $ 183,060 $ 190,393
International 85,314 97,926 185,685 177,634
Net Income (loss) $ (58,752) $ 8,597 $ (54,730) $ 9,305
OVERVIEW
Total revenue was $185.7 million and $368.7 million for the second
quarter and first six months of 1998, respectively. Total revenue for the
same periods in 1997 was $210.7 million and $368.0 million. The Company
recorded a net loss in the second quarter and first six months of 1998 of
$58.8 million and $54.7 million, respectively, which included a pretax
restructuring charge in the second quarter of $62.9 million. Without the
restructuring charge, the Company would have reported an after-tax net loss of
$15.3 million and $11.3 million for the same periods in 1998. For the same
periods in 1997, the Company recorded net income of $8.6 million and $9.3
million. Primary objectives for management's decision to restructure its
operations during the second quarter of 1998 include an increased focus on
vertical markets and relationships with key partners, as well as aligning
resources to strengthen the Company's product technology and roadmap. In
addition to the second quarter restructuring charge, the Company's reported
net loss was also the result of a significant decrease in product revenue as
compared to the same quarter in 1997. The Company's total revenue decreased
approximately 12% in the second quarter of 1998 over the same quarter in 1997,
including a decrease in product revenue of 22%. Comparing the first six
months of 1998 to the same period in 1997, total revenue remained relatively
flat, with decreases in product revenues being fully offset by service revenue
increases.
REVENUE
A significant decrease in product revenue caused the decrease in total
revenue during the second quarter of 1998 compared to the same period in 1997.
Sales in the Company's European and Asia Pacific operations were down
significantly in the second quarter of 1998, combined with a substantial
reduction in sales to the Company's largest domestic customer as compared to
the second quarter of 1997. These decreases were partially offset by
increases in service revenue, particularly from the Company's professional
services organization. Revenue increases in professional services were
approximately 27% and 31% in the second quarter and the first half of 1998
over the same periods in 1997. A significant increase in the number and size
of new projects during 1998, with both new and existing customers, was the
primary factor in the significant growth within this segment of the Company's
business.
<TABLE>
The following table sets forth certain operating data as a percentage of
total revenue:
<CAPTION>
Three Months Ended Six Months Ended
July 4, June 28, July 4, June 28,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Revenue:
End-user products 64.8% 73.3% 63.2% 69.5%
OEM products - - 1.5 1.1
Service 35.2 26.7 35.3 29.4
Total revenue 100.0 100.0 100.0 100.0
Cost of products and service 70.4 57.3 65.3 57.1
Gross profit 29.6 42.7 34.7 42.9
Operating expenses:
Research and development 10.6 7.8 10.0 8.7
Selling, general and administrative 31.4 28.3 29.2 29.8
Restructuring charges 33.9 - 17.1 -
Total operating expenses 75.9 36.1 56.3 38.5
Operating income (loss) (46.3) 6.6 (21.6) 4.4
Interest income (expense), net 0.7 (0.4) 0.5 (0.5)
Other (expense), net (0.2) (0.2) (0.4) (0.2)
Income (loss) before (provision for)
benefit from income taxes (45.8) 6.0 (21.5) 3.7
(Provision for) benefit from income taxes 14.2 (1.9) 6.7 (1.2)
Net income (loss) (31.6)% 4.1% (14.8)% 2.5%
</TABLE>
COST OF SALES/GROSS MARGINS
Three Months Ended Six Months Ended
July 4, June 28, July 4, June 28,
1998 1997 1998 1997
Cost of product sold as a percentage
of product revenue 68.6% 50.9% 60.9% 49.6%
Cost of service as a percentage
of service revenue 73.7% 75.0% 73.5% 75.0%
Total cost of sales as a percentage
of total revenue 70.4% 57.3% 65.3% 57.1%
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
significantly in the second quarter and first six months of 1998 over the same
periods in 1997. In the second quarter of 1998, product cost of sales
reflects increased sales of third-party products which yield substantially
lower margins than Sequent products. Product cost of sales was also higher in
the second quarter and first six months of 1998 due to certain non-recurring
charges for inventory obsolescence provisions taken during the second quarter.
Finally, product gross margins on Sequent products were lower during the
second quarter of 1998 due to competitive pricing pressures and in
anticipation of the introduction of Sequent's new product family in the third
and fourth quarters of 1998. The Company's total gross margins were
positively impacted by service margins, particularly from the professional
service organization, which increased during the second quarter and first six
months of 1998 over the same periods in 1997. The Company's total product
gross margins were approximately 31% and 39% in the second quarter and first
six months of 1998, respectively, and service gross margins were approximately
26% and 27%, respectively, during the same periods in 1998.
RESEARCH AND DEVELOPMENT
Three Months Ended Six Months Ended
(dollars in millions) July 4, June 28, July 4, June 28,
1998 1997 1998 1997
Research and development expense $19.7 $16.5 $36.8 $31.9
As a percentage of total revenue 10.6% 7.8% 10.0% 8.7%
Software costs capitalized $ 8.0 $ 8.5 $17.7 $16.9
Research and development expense continued to increase in amount, by
approximately 19% and 15% in the second quarter and first six months of 1998,
respectively, compared to the same periods in 1997, as the Company continues
to make enhancements to its NUMA-Q architecture as well as development
activities on its new product family expected to be introduced late in 1998.
During the second quarter of 1998, increases to capitalized software costs
related to continued investments in new software technology were offset by
$2.5 million of write-offs associated with the second quarter restructuring.
SELLING, GENERAL AND ADMINISTRATIVE
Three Months Ended Six Months Ended
(dollars in millions) July 4, June 28, July 4, June 28,
1998 1997 1998 1997
Selling, general and administrative $58.2 $59.6 $107.9 $109.8
As a percentage of total revenue 31.4% 28.3% 29.2% 29.8%
Comparing the second quarter and first six months of 1998 to the same
periods in 1997, selling, general and administrative expenses decreased
slightly in amount. Factors contributing to the decrease included the effects
of cost control measures implemented by the Company during 1998 as well as a
decline in commissions associated with lower sales volume in the second
quarter of 1998. As a percentage of revenue, however, these expenses
increased slightly during the second quarter of 1998 mainly as a result of the
significant decrease in revenues.
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.
Excluding employee termination costs from the total restructuring
charges, there are no material incremental future cash outlays resulting from
the restructuring. It is anticipated that the restructuring actions taken in
the second quarter will yield annual operating cost reductions of $40 million,
beginning in the third and fourth quarters of 1998.
The following table presents a summary of the restructuring charges taken
in the second quarter of 1998 Statements of Operations, with the ending
balance sheet balances as of July 4, 1998. The balance of accrued
restructuring of $20.3 million is included in accounts payable and other in
the accompanying balance sheet.
<TABLE>
<CAPTION>
Restructuring Write-offs/ Balance at
(dollars in millions) Costs Expenditures Adjustments July 4, 1998
<S> <C> <C> <C> <C>
Employee termination and related $ 7.2 $ (2.5) $ (0.3) $ 4.4
Prepaid software licenses 27.2 - (24.9) 2.3
Facilities 13.7 (0.1) - 13.6
Capital assets 7.9 - (7.9) -
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
INTEREST AND OTHER, NET
Three Months Ended Six Months Ended
(dollars in millions) July 4, June 28, July 4, June 28,
1998 1997 1998 1997
Interest income $2.6 $0.8 $4.5 $1.5
Interest expense $1.3 $1.6 $2.7 $3.5
Other expense, net $0.5 $0.4 $1.4 $0.6
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 second quarter and first six months of 1998
is a result of investments of cash proceeds from the Company's stock offering
in August 1997. Interest expense during the periods covered includes costs
related to foreign currency hedging loans, interim short-term borrowings,
convertible debentures and capital lease obligations. 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 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 for the second quarter of 1998 was 31.0%, compared to an
effective tax rate of 31.7% 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 second quarter of 1998, when compared to the annual
effective tax rate for 1997, is due primarily to recording a tax benefit
related to the net operating loss reported for the quarter.
LIQUIDITY AND CAPITAL RESOURCES
Working capital was $349.0 million at July 4, 1998 compared to $399.9
million at January 3, 1998. The Company's current ratio increased to 2.6:1
from 2.5:1 since January 3, 1998.
Cash and cash equivalents increased $12 million during the first six months
of 1998. The increase resulted primarily from the net loss of $54.7 million,
which includes non-cash restructuring charges of $60.3 million, and
depreciation and amortization of $44 million. Additional impacts included
decreases in accounts receivable ($89 million), accounts payable and other
($30 million) and accrued payroll ($11 million), increases in prepaid
royalties and other ($14 million), other assets ($18 million), and activity
from investing ($16 million) and financing ($20 million).
The Company has a $40 million receivable sales facility with a group of
banks. At July 4, 1998, accounts receivable in the accompanying consolidated
balance sheet is net of $40 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 July 4, 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 July 4, 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 $81.5 million, of which $40.3 million was
outstanding at July 4, 1998 (based on currency exchange rates on such date).
The Company also maintains a miscellaneous borrowing arrangement with a
foreign bank. At July 4, 1998 $0.8 million was outstanding under this
agreement.
Management expects that current 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. The Company is currently conducting a comprehensive review of its
computer systems and software products to identify the systems that could be
affected by the Year 2000 Issue and is in the process of implementing and
conducting the required processes to become Year 2000 compliant.
Additionally, the Company is evaluating Year 2000 compliance on products from
its suppliers and partners. Both internal and external resources are being
employed to identify, correct or reprogram, and test the systems for Year 2000
compliance. The total cost of the project 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. The amount
expensed in the second quarter of 1998 related to this issue was approximately
$500,000. 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.
Additionally, we cannot completely ensure that the Company's software products
do not contain undetected problems associated with Year 2000 compliance. Such
problems, should they occur, may result in adverse effects on future operating
results.
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the meeting of the shareholders of the Company held on May 20,
1998, the shareholders voted on and approved the following items:
</TABLE>
<TABLE>
<CAPTION>
Affirmative Negative Votes Broker
Votes Cast Votes Cast Abstaining Non-Votes
<S> <C> <C> <C> <C>
An amendment to the Company's
Employee Stock Purchase Plan 33,982,462 4,326,270 216,455 488,498
Election of Directors:
Karl C. Powell Jr. 37,451,269 1,562,416
Steve S. Chen 37,505,438 1,508,247
Frank C. Gill 37,518,272 1,495,413
John McAdam 37,523,897 1,489,788
Michael S. Scott Morton 37,512,336 1,501,349
Robert W. Wilmot 37,515,330 1,498,355
Approval of Price Waterhouse
as Certified Public Accountants of
the Company for next fiscal year 38,789,541 79,450 144,694
</TABLE>
Item 5. OTHER MATTERS
In accordance with amendments to Rule 14a-4 under the Securities Exchange
Act of 1934, if notice of a shareholder proposal to be raised at the 1999
annual meeting of shareholders is received at the principal executive offices
of the Company after February 24, 1999, proxy voting on that proposal, when
and if raised at the 1999 annual meeting, will be subject to the discretionary
voting authority of the designated proxy holders. Any shareholder proposals
to be considered for inclusion in proxy material for the Company's 1999 annual
meeting must be received at the principal executive offices of the Company not
later than December 11, 1998.
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 July 4, 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
By Robert S. Gregg
Sr. Vice President of Finance and Legal and
Chief Financial Officer
Date: August 14, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-02-1999
<PERIOD-END> JUL-04-1998
<CASH> 145,275,000
<SECURITIES> 0
<RECEIVABLES> 243,073,000
<ALLOWANCES> 3,143,000
<INVENTORY> 108,489,000
<CURRENT-ASSETS> 562,002,000
<PP&E> 319,541,000
<DEPRECIATION> 196,807,000
<TOTAL-ASSETS> 787,506,000
<CURRENT-LIABILITIES> 212,972,000
<BONDS> 8,821,000
0
0
<COMMON> 436,000
<OTHER-SE> 519,218,000
<TOTAL-LIABILITY-AND-EQUITY> 787,506,000
<SALES> 120,301,000
<TOTAL-REVENUES> 185,677,000
<CGS> 82,541,000
<TOTAL-COSTS> 130,700,000
<OTHER-EXPENSES> 77,929,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,421,000
<INCOME-PRETAX> (85,082,000)
<INCOME-TAX> (26,330,000)
<INCOME-CONTINUING> (58,752,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (58,752,000)
<EPS-PRIMARY> (1.34)
<EPS-DILUTED> (1.34)
</TABLE>
