<PAGE> 1
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 September 30, 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 Number 0-22495
PEROT SYSTEMS CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 75-2230700
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
12404 PARK CENTRAL DRIVE
DALLAS, TEXAS
75251
(Address of principal executive offices)
(Zip Code)
(972) 340-5000
(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. [X]Yes [ ]No
Number of shares of registrant's common stock outstanding as of October 29,
1999: 91,879,448
<PAGE> 2
PEROT SYSTEMS CORPORATION
FORM 10-Q
For the Quarter Ended September 30, 1999
<TABLE>
<CAPTION>
INDEX
Page
----
PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS (UNAUDITED)
<S> <C>
Condensed Consolidated Balance Sheets as of September 30, 1999 and
December 31, 1998.............................................................1
Condensed Consolidated Statements of Operations for the three and nine months
ended September 30, 1999 and 1998.............................................2
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 1999 and 1998.............................................3
Notes to Condensed Consolidated Financial Statements..................................4
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................................8
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK..................................................................14
PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS....................................................................15
ITEM 2: CHANGES IN SECURITIES................................................................15
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..................................16
ITEM 5: OTHER INFORMATION ...................................................................16
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K ....................................................16
SIGNATURES ....................................................................................17
EXHIBIT INDEX .................................................................................18
</TABLE>
<PAGE> 3
ITEM 1: FINANCIAL STATEMENTS
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1999 AND DECEMBER 31, 1998
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
ASSETS
September 30, 1999 December 31, 1998
------------------ -----------------
<S> <C> <C>
Current assets:
Cash and cash equivalents ............................................ $263,215 $144,907
Accounts receivable, net ............................................. 172,978 115,441
Prepaid expenses and other ........................................... 59,574 48,044
-------- --------
Total current assets ............................................. 495,767 308,392
Investments in and advances to unconsolidated companies.................. 48,872 16,324
Property, equipment and purchased software, net ......................... 35,322 39,508
Goodwill, net ........................................................... 1,529 5,587
Other assets ............................................................ 10,469 12,335
-------- --------
Total assets ..................................................... $591,959 $382,146
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities on capital lease obligations and long-term debt ... $ 521 $ 883
Accounts payable ..................................................... 45,429 41,824
Accrued liabilities .................................................. 121,137 118,147
Accrued compensation ................................................. 43,366 49,982
Other current liabilities ............................................ 18,555 25,817
-------- --------
Total current liabilities ........................................ 229,008 236,653
Capital lease obligations and long-term debt, less current maturities ... 262 661
Other long-term liabilities ............................................. 6,099 2,249
-------- --------
Total liabilities ................................................ 235,369 239,563
-------- --------
Stockholders' equity:
Common stock ......................................................... 917 820
Additional paid-in-capital ........................................... 221,957 72,936
Other stockholders' equity ........................................... 128,410 68,128
Accumulated other comprehensive income ............................... 5,306 699
-------- --------
Total stockholders' equity ....................................... 356,590 142,583
-------- --------
Total liabilities and stockholders' equity ....................... $591,959 $382,146
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
Page 1
<PAGE> 4
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(SHARES AND DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended September 30, Nine months ended September 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue ............................................ $304,788 $271,473 $861,412 $724,185
Costs and expenses:
Direct cost of services ....................... 231,230 215,193 660,516 575,083
Selling, general and administrative expenses... 44,366 37,063 125,361 103,114
Goodwill impairment ........................... -- 3,845 -- 3,845
-------- -------- -------- --------
Operating income ................................... 29,192 15,372 75,535 42,143
Interest income .................................... 2,802 1,406 7,743 2,985
Interest expense ................................... (34) (58) (439) (184)
Equity in earnings of unconsolidated affiliates .... 1,751 1,687 6,413 4,199
Other income (expense), net ........................ (158) 189 (541) 2,742
-------- -------- -------- --------
Income before taxes ................................ 33,553 18,596 88,711 51,885
Provision for income taxes ......................... 13,421 9,545 35,484 23,690
-------- -------- -------- --------
Net income .................................... $ 20,132 $ 9,051 $ 53,227 $ 28,195
======== ======== ======== ========
Basic and diluted earnings per common share:
Basic earnings per common share..................... $ 0.22 $ 0.12 $ 0.61 $ 0.37
Weighted average common shares outstanding ......... 89,832 77,128 87,042 76,674
Diluted earnings per common share................... $ 0.18 $ 0.09 $ 0.47 $ 0.29
Weighted average diluted common shares
outstanding ................................... 113,093 98,397 112,762 96,909
</TABLE>
The accompanying notes are an integral part of these financial statements.
Page 2
<PAGE> 5
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Nine months ended September 30,
1999 1998
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income .......................................................... $ 53,227 $ 28,195
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization .................................... 21,060 29,440
Other non-cash items ............................................. (6,334) (15,113)
Changes in current assets ........................................ (66,562) (62,294)
Changes in current liabilities ................................... 33,586 84,863
-------- --------
Net cash provided by operating activities ................. 34,977 65,091
-------- --------
Cash flows from investing activities:
Purchases of property, equipment and purchased software ............. (14,683) (18,884)
Proceeds from sale of property, equipment and purchased software .... 871 7,567
Proceeds from sale of nonmarketable equity securities ............... -- 5,162
Proceeds from sale of business ...................................... -- 893
Purchase of marketable equity securities ............................ (17,000) --
Investments in and advances to minority interests ................... -- 446
-------- --------
Net cash used in investing activities ..................... (30,812) (4,816)
-------- --------
Cash flows from financing activities:
Principal payments on debt and capital lease obligations ............ (718) (701)
Proceeds from issuance of common stock .............................. 111,725 3,045
Proceeds from issuance of treasury stock ............................ 5,731 2,926
Other ............................................................... 852 (766)
-------- --------
Net cash provided by financing activities ................. 117,590 4,504
-------- --------
Effect of exchange rate changes on cash and cash equivalents ............. (3,447) 2,076
-------- --------
Net increase in cash and cash equivalents ................................ 118,308 66,855
Cash and cash equivalents at beginning of period ......................... 144,907 35,298
-------- --------
Cash and cash equivalents at end of period ............................... $263,215 $102,153
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
Page 3
<PAGE> 6
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. GENERAL
The accompanying unaudited interim condensed consolidated financial statements
have been prepared in accordance with the rules and regulations of the
Securities and Exchange Commission ("SEC"). The interim condensed consolidated
financial statements include the consolidated accounts of Perot Systems
Corporation and its majority-owned subsidiaries (collectively, "the Company")
with all significant intercompany transactions eliminated. In the opinion of
management, all adjustments (consisting only of normal recurring adjustments)
necessary for a fair statement of the financial position, results of operations
and cash flows for the interim periods presented have been made. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles ("GAAP")
have been condensed or omitted pursuant to such SEC rules and regulations. These
financial statements should be read in conjunction with the audited financial
statements for the year ended December 31, 1998 as filed in the Company's Annual
Report on Form 10-K filed with the SEC on March 23, 1999. Operating results for
the three and nine month periods ended September 30, 1999 are not necessarily
indicative of the results for the year ending December 31, 1999. Dollar amounts
presented are in thousands, except as otherwise noted.
Certain of the 1998 amounts in the accompanying financial statements have been
reclassified to conform to the current presentation.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Financial Instruments
The Company accounts for its marketable equity securities in accordance with
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Management determines the
appropriate classification of marketable equity securities at the time of
purchase and re-evaluates such designation at each balance sheet date. All
marketable equity securities held by the Company have been classified as
available-for-sale and are carried at fair value, with unrealized holding gains
and losses, net of taxes, reported as a separate component of stockholders'
equity.
NOTE 3. MARKETABLE EQUITY SECURITIES
In May 1999, the Company purchased 1,000,000 common shares (approximately 3%
voting interest) in the initial public offering of TenFold Corporation
("TenFold") for $17,000 as part of a strategic alliance agreement with TenFold
to develop and deliver applications, products, and services to clients of the
Company and TenFold.
If the Company does not provide TenFold with opportunities to contract for
revenue of at least $15,000 in each of the two years following May 1, 1999, the
Company will pay TenFold 20% of the shortfall, subject to reduction in the
second year to the extent that the opportunities to contract for revenue
provided in the first or third year following May 1, 1999 exceed $15,000.
The investment is classified in "investments in and advances to unconsolidated
companies", and the unrealized gain of $5,605 (net of tax of $3,895) is
classified in "accumulated other comprehensive income" on the condensed
consolidated balance sheet.
There were no sales of marketable equity securities, and thus no realized gains
or losses, during the nine months ended September 30, 1999.
Page 4
<PAGE> 7
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 4. COMPREHENSIVE INCOME
The Company's total comprehensive income, net of tax, was as follows:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------- -------------------------
1999 1998 1999 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income ............................................ $20,132 $ 9,051 $53,227 $28,195
Foreign currency translation adjustments .............. 2,021 1,969 (998) 1,935
Unrealized gain (loss) on marketable equity securities,
net of tax of ($2,152) and $3,895, respectively .. (3,098) -- 5,605 --
------- ------- ------- -------
Total comprehensive income ............................ $19,055 $11,020 $57,834 $30,130
======= ======= ======= =======
</TABLE>
NOTE 5. STOCKHOLDERS' EQUITY
The components of "other stockholders' equity" were as follows:
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------ -----------------
<S> <C> <C>
Retained earnings ...................... $132,739 $79,512
Treasury stock ......................... -- (5,815)
Notes receivable from stockholders...... (1,261) (1,915)
Deferred compensation .................. (3,068) (3,654)
-------- -------
Total other stockholders' equity ....... $128,410 $68,128
======== =======
</TABLE>
Additional paid-in-capital increased by $149,021 during the nine months ended
September 30, 1999. The components of the increase include $108,052 from the
issuance of Class A common shares in the Company's initial public offering
("IPO"), $34,461 relating to tax benefits resulting from the exercise of options
to purchase shares of the Company's Class A Common Stock, $3,094 from the
exercise of options to purchase shares of the Company's Class B Common Stock by
UBS AG, and $3,027 from issuance of Class A common shares through the Employee
Stock Purchase Plan.
At September 30, 1999, there were 89,948,752 shares of the Company's Class A
Common Stock outstanding and 1,784,320 shares of the Company's Class B Common
Stock outstanding. At December 31, 1998, there were 77,126,048 shares of the
Company's Class A Common Stock outstanding, 934,320 shares of the Company's
Class B Common Stock outstanding and 3,940,302 shares of the Company's Class A
Common Stock held in treasury. These increases in common stock were due
primarily to the issuance of 7,475,000 IPO shares, the exercise of options to
purchase 5,188,381 Class A shares, and the exercise of options to purchase
850,000 Class B shares.
Page 5
<PAGE> 8
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 6. EARNINGS PER SHARE
The calculations of the basic and diluted earnings per share were as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NET SHARES PER SHARE
INCOME (IN THOUSANDS) AMOUNT
------ -------------- ------
<S> <C> <C> <C>
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
BASIC EARNINGS PER COMMON SHARE
Net income attributed to common shareholders ... $20,132 89,832 $0.22
Dilutive options ............................... -- 23,261 =====
------- -------
DILUTED EARNINGS PER COMMON SHARE
Net income attributed to common shareholders
Plus assumed conversions ..................... $20,132 113,093 $0.18
======= ======= =====
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
BASIC EARNINGS PER COMMON SHARE
Net income attributed to common shareholders ... $ 9,051 77,128 $0.12
Dilutive options ............................... -- 21,269 =====
------- -------
DILUTED EARNINGS PER COMMON SHARE
Net income attributed to common shareholders
Plus assumed conversions ..................... $ 9,051 98,397 $0.09
======= ======= =====
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
BASIC EARNINGS PER COMMON SHARE
Net income attributed to common shareholders ... $53,227 87,042 $0.61
Dilutive options ............................... -- 25,720 =====
------- -------
DILUTED EARNINGS PER COMMON SHARE
Net income attributed to common shareholders
Plus assumed conversions ..................... $53,227 112,762 $0.47
======= ======= =====
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
BASIC EARNINGS PER COMMON SHARE
Net income attributed to common shareholders ... $28,195 76,674 $0.37
Dilutive options ............................... -- 20,235 =====
------- ------
DILUTED EARNINGS PER COMMON SHARE
Net income attributed to common shareholders
Plus assumed conversions ..................... $28,195 96,909 $0.29
======= ======= =====
</TABLE>
Page 6
<PAGE> 9
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 7. TERMINATION OF MAJOR CONTRACT
The Company provided services for East Midlands Electricity (IT) Limited
(together with its parent company, East Midlands Electricity plc, "EME") under
an Information Technology Services Agreement initially entered into on April 8,
1992, as amended. Under the terms and conditions of this agreement, EME had the
right to terminate its relationship with the Company following a change in
control of EME. In July 1998, PowerGen plc acquired EME from Dominion Resources,
Inc. During the first quarter of 1999, PowerGen plc and EME exercised this
right. The Company completed an early termination of the EME contract effective
on September 1, 1999. Under the terms and conditions of this agreement, the
Company received a cash payment of $10,620 which was fully recognized as revenue
in the third quarter of 1999. Related expenses charged to direct cost of
services during the third quarter of 1999 were $2,591, of which $489 was accrued
as of September 30, 1999. The resulting gain of $8,029 was included in gross
margin for the three and nine months ended September 30, 1999.
NOTE 8. RELOCATION CHARGE
In March 1999, the Company formulated a plan for relocating certain general and
administrative support groups from Reston, Virginia to the corporate
headquarters in Dallas, Texas. This plan was announced to affected employees in
April 1999 and is expected to be substantially complete by the end of 1999. The
Company recorded a charge of $3,309 during the nine months ended September 30,
1999 and does not anticipate further significant expense related to the
relocation.
Page 7
<PAGE> 10
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Comparison of the three months ended September 30, 1999 and 1998
Total revenue increased in the three months ended September 30, 1999
by 12.3% to $304.8 million from $271.5 million in the three months ended
September 30, 1998 due to increases of $23.1 million from several new contracts
entered into after the third quarter of 1998, $6.7 million from UBS AG, $4.1
million from contract termination fees, and $12.3 million from other business.
Offsetting these increases was a $12.9 million decrease from contracts which
ended prior to the third quarter of 1999.
Domestic revenue grew by 11.3% in the third quarter of 1999 to $191.3
million from $171.9 million in the third quarter of 1998, and slightly decreased
as a percentage of total revenue to 62.8% from 63.3% over the same period.
Non-domestic revenue, consisting of European and Asian operations,
grew by 13.9% in the third quarter of 1999 to $113.5 million from $99.6 million
in the third quarter of 1998, and increased as a percentage of total revenue to
37.2% from 36.7%. The largest components of European operations were the United
Kingdom, where revenue (including contract termination fees) increased 1.4% to
$74.9 million in the third quarter of 1999 from $73.8 million in the third
quarter of 1998, and Switzerland, where revenue increased 36.0% to $16.2 million
in the third quarter of 1999 from $11.9 million in the third quarter of 1998.
Asian operations represented $5.0 million, or 1.6% of total revenue, for the
three months ended September 30, 1999 compared to $5.5 million, or 2.0% of total
revenue, for the three months ended September 30, 1998.
Direct cost of services increased in the third quarter of 1999 by
7.4% to $231.2 million from $215.2 million in the same period of 1998 due to
continued growth in the Company's business. Gross margin as a percentage of
total revenue increased to 24.2% from 20.7% for the third quarter of 1999
compared to the third quarter of 1998 due to continued improvements in the
profitability on short-term projects. In addition, gross margin was impacted by
net contract termination gains of $8.0 million in the 1999 period compared to
$6.5 million in the 1998 period. During the third quarter of 1998, the Company
recorded a charge of $8.3 million to address Year 2000 exposures for certain
client contracts. During the third quarter of 1999, the Company reduced
previously recorded charges by $3.2 million due to revised estimates of costs to
complete work performed under these contracts.
Selling, general and administrative expenses ("SG&A") increased in
the third quarter of 1999 by 19.7% to $44.4 million from $37.1 million in the
same period of 1998, and increased as a percentage of total revenue to 14.6%
from 13.7%. While the Company continued to control its normal general and
administrative spending, there were $2.4 million in charges for specific
litigation related costs, employee benefits, and special payroll tax accruals
during the third quarter of 1999. In addition, the Company increased its
spending in the areas of recruitment, training, and sales. During the third
quarter of 1998, the Company wrote-down goodwill associated with acquired
businesses by $3.8 million.
Page 8
<PAGE> 11
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
As a result of the factors noted above, operating income increased in
the third quarter of 1999 to $29.2 million from $15.4 million in the third
quarter of 1998. Operating income as a percentage of total revenue increased to
9.6% from 5.7%.
Interest income increased to $2.8 million in the third quarter of
1999 compared to $1.4 million in the prior year period due primarily to a
significant increase in cash and cash equivalents, resulting from $108.1 million
of net proceeds received from the Company's initial public offering ("IPO") of
Class A Common Stock on February 5, 1999.
Equity in earnings of unconsolidated affiliates remained constant in
the third quarter of 1999 compared to the same period of 1998 at approximately
$1.7 million. The equity in earnings for HCL Perot Sytems N.V. ("HPS"), a
software development joint venture based in India, increased to $1.2 million
from $0.7 million for the quarters ended September 30, 1999 and 1998,
respectively. This increase was offset by a decrease in earnings at Systor AG
("Systor"), a subsidiary of UBS AG. The equity in earnings for Systor decreased
to $0.5 million from $1.0 million for the quarters ended September 30, 1999 and
1998, respectively. The decrease was due primarily to lower revenues from the
parent company. The decline in equity earnings for Systor is expected to
continue in the fourth quarter of 1999, and results for the full year 1999 are
anticipated to be less than full year 1998.
The decrease in the effective tax rate for the third quarter of 1999
to 40.0% from 51.3% for the third quarter of 1998 was due primarily to lower
overall foreign taxes in 1999 and lower 1999 goodwill amortization.
Net income increased 120.9% in the third quarter of 1999 to $20.1
million from $9.1 million in the third quarter of 1998, and net income as a
percentage of total revenue increased to 6.6% from 3.4%.
Comparison of the nine months ended September 30, 1999 and 1998
Total revenue increased in the nine months ended September 30, 1999
by 19.0% to $861.4 million from $724.2 million in the nine months ended
September 30, 1998 due to increases of $45.6 million from several new contracts
entered into after the third quarter of 1998, $70.7 million from UBS AG, and
$59.4 million from other business. These increases were partially offset by a
$38.5 million decrease from contracts which ended prior to the third quarter of
1999.
Domestic revenue grew by 18.4% in the nine months ended September 30,
1999 to $554.2 million from $468.0 million in the nine months ended September
30, 1998, and decreased slightly as a percentage of total revenue to 64.3% from
64.6% in the same period of the prior year.
Non-domestic revenue, consisting of European and Asian operations,
grew by 19.9% in the nine months ended September 30, 1999 to $307.2 million from
$256.2 million in the same period of 1998, and slightly increased as a
percentage of total revenue to 35.7% from 35.4%. The largest components of
European operations were the United Kingdom, where revenue increased 6.0% to
$198.1 million in the nine month period of 1999 from $186.8 million in the same
period of 1998, and Switzerland, where revenue increased 54.1% to $46.8 million
in the nine month period of 1999 from $30.4 million in the nine month period of
1998. Asian operations represented $14.8 million, or 1.7% of total revenue, for
the nine months ended September 30, 1999 compared to $11.4 million, or 1.6% of
total revenue, for the nine months ended September 30, 1998.
Page 9
<PAGE> 12
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Direct cost of services increased in the first nine months of 1999 by
14.9% to $660.5 million from $575.1 million in the same period of 1998 due to
continued growth in the Company's business. Gross margin as a percentage of
total revenue increased to 23.3% from 20.6% for the nine months ended September
30, 1999 compared to the same period of 1998. During the nine month period ended
September 30, 1998, the Company recorded charges totaling $13.5 million to
address Year 2000 exposures for certain client contracts. During the nine months
ended September 30, 1999, the Company reduced previously recorded charges by
$0.7 million due to revised estimates of costs to complete work performed under
these contracts.
SG&A increased in the nine months ended September 30, 1999 by 21.6%
to $125.4 million from $103.1 million in the same period of 1998, and slightly
increased as a percentage of total revenue to 14.6% from 14.2%. While the
Company continued to control its normal general and administrative spending,
there were $8.5 million of charges for departmental relocations, special payroll
tax accruals, litigation related costs, and employee benefits during the nine
months ended September 30, 1999. In addition, the Company increased its spending
in the areas of recruitment, training, and sales.
As a result of the factors noted above, operating income increased in
the nine months ended September 30, 1999 to $75.5 million from $42.1 million in
the nine months ended September 30, 1998. As a percentage of total revenue,
operating income increased to 8.8% from 5.8%.
Interest income increased to $7.7 million in the nine months ended
September 30, 1999 compared to $3.0 million in the prior year period due
primarily to a significant increase in cash and cash equivalents, resulting from
$108.1 million of net proceeds received from the Company's IPO.
Equity in earnings of unconsolidated affiliates increased in the nine
months ended September 30, 1999 to $6.4 million from $4.2 million during the
nine months ended September 30, 1998 due to improved results both at HPS and at
Systor. The equity in earnings for HPS increased to $3.9 million from $2.0
million, and equity in earnings for Systor increased to $2.5 million from $2.2
million for the nine month periods ended September 30, 1999 and 1998,
respectively.
The decrease in the effective tax rate for the nine months ended
September 30, 1999 to 40.0% from 45.7% for the same period of 1998 was due
primarily to lower overall foreign taxes in 1999 and lower 1999 goodwill
amortization.
Net income increased 88.7% in the nine months ended September 30,
1999 to $53.2 million from $28.2 million in the nine months ended September 30,
1998, and net income as a percentage of total revenue increased to 6.2% from
3.9%.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 1999, cash and cash
equivalents increased 81.6% to $263.2 million from $144.9 million at December
31, 1998 primarily due to the proceeds from the Company's IPO.
Net cash provided by operating activities was $35.0 million for the
nine months ended September 30, 1999 compared to $65.1 million for the nine
months ended September 30, 1998. This change was due primarily to significant
growth in accrued compensation for annual bonuses earned in 1998, but not paid
until the first quarter of 1999, and was partially offset by an increase in net
income of $25.0 million.
Page 10
<PAGE> 13
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Net cash used in investing activities was $30.8 million for the nine
months ended September 30, 1999 and $4.8 million for the same period in 1998.
The significant increase in cash used in investing was due to the Company's
purchase of 1,000,000 shares in the initial public offering of TenFold
Corporation for $17.0 million during the second quarter of 1999. In addition,
cash paid for property, equipment and software purchased was $14.7 million and
$18.9 million for the nine months ended September 30, 1999 and 1998,
respectively. The expenditures in 1998 were offset by $5.2 million in proceeds
from the sale of the Company's limited partnership interest in a venture capital
fund and $7.6 million in proceeds from the sale of property, equipment, and
software purchased.
For the nine months ended September 30, 1999, net cash provided by
financing activities was $117.6 million compared to $4.5 million for the nine
months ended September 30, 1998. This increase was due to proceeds of $108.1
million from the Company's IPO, $3.1 million from the exercise of options to
purchase 850,000 shares of the Company's Class B Common Stock by UBS AG, and
$6.2 million due to the exercise of stock options by employees (including those
issued from treasury stock).
The Company routinely maintains cash balances in certain European and
Asian currencies to fund operations in those regions. During the nine months
ended September 30, 1999, foreign exchange rate fluctuations adversely impacted
the Company's non-domestic cash balances by $3.4 million, as British pounds,
Irish pounds, Swiss francs, and Netherlands guilders all strengthened against
the U.S. dollar. The Company's foreign exchange policy does not call for hedging
foreign exchange exposures that are not likely to impact net income or working
capital.
The Company has no committed line of credit or other borrowings and
anticipates that existing cash and cash equivalents and expected net cash flows
from operating activities will provide sufficient funds to meet its needs for
the foreseeable future. From time to time, the Company may consider repurchasing
its Class A Common Stock depending on price and availability and alternative
uses for its financial resources.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements. These statements
relate to future events or our future financial performance. In some cases, you
can identify forward-looking statements by terminology such as "may," "will,"
"should," "forecasts," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential," or "continue" or the negative of such
terms and other comparable terminology. These statements are only predictions.
Actual events or results may differ materially. In evaluating these statements,
you should specifically consider various factors, such as: the loss of major
clients; the Company's ability to achieve future sales; changes in our
relationship and variability of revenue and expense associated with our largest
customer; the loss of key personnel; the highly competitive market in which we
operate; the variability of quarterly operating results; changes in technology;
risks related to international operations; risks related to potential Year 2000
problems; and general economic conditions. These and other risks are outlined in
our annual report on Form 10-K, which is on file with the Securities and
Exchange Commission and available at www.sec.gov. These factors may cause our
actual results to differ materially from any forward-looking statement.
YEAR 2000 ISSUES
The following statements and all other statements made in this
quarterly report or the accompanying financial statements with respect to the
Company's Year 2000 processing capabilities or readiness are "Year 2000
Readiness Disclosures" in conformance with the Year 2000 Information and
Readiness Disclosure Act of 1998 (Public Law 105-271, 112 Stat. 2386).
Page 11
<PAGE> 14
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Some computers, software, and other equipment include computer code
in which calendar year data is abbreviated to only two digits. As a result of
this design decision, some of these systems could fail to operate or fail to
produce correct results if "00" is interpreted to mean 1900, rather than 2000.
These problems are widely expected to increase in frequency and severity as the
year 2000 approaches, and are commonly referred to as the "Year 2000 Problem".
Assessment. The Year 2000 Problem affects computers, software, and
other equipment used, operated, or maintained by the Company for itself and its
customers. Accordingly, the Company has assessed and will continue to assess the
potential impact of, and costs of remediating the Year 2000 Problem for its
internal systems and, where the Company is contractually obligated to remediate
the Year 2000 Problem, on systems operated or maintained on behalf of its
customers.
For each of these areas, the Company is using a methodology involving
the following six phases: Discovery, Assessment, Planning, Remediation, Testing,
and Implementation. At September 30, 1999, most program areas were substantially
complete.
Because the Company's business involves the assessment,
implementation, and operation of computer systems, the Company has not generally
obtained verification or validation by independent third parties of its
processes to assess Year 2000 Problems, its corrections of Year 2000 Problems,
or the costs associated with these activities. However, the Company's Year 2000
project team has reviewed the project plans prepared by each of the Company's
business units and continues to monitor their methods and progress against those
plans.
Internal Infrastructure. The Company believes that it has identified
most of the major computers, software applications, and related equipment used
in connection with its internal operations that must be modified, upgraded, or
replaced to minimize the possibility of a material disruption to its business.
The Company has substantially completed all modification, upgrades, and
replacements of major systems that have been assessed as adversely affected, and
expects to complete this process before the occurrence of any material
disruption of its business. In addition, the Company has scheduled a suspension
of non-critical changes to its internal production systems to minimize the
possibility of introducing new Year 2000 Problems into its environment.
Systems Other than Information Technology Systems. In addition to
computers and related systems, the operation of office and facilities equipment,
such as fax machines, photocopiers, telephone switches, security systems,
elevators, and other common devices may be affected by the Year 2000 Problem.
The Company has assessed and will continue to assess the potential effect of,
and costs of remediating, the Year 2000 Problem on its office and facilities
equipment. The Company does not anticipate any material disruptions of its
business as a result of Year 2000 Problems affecting any of these systems.
The Company estimates the total cost to the Company of completing any
required modifications, upgrades, or replacements of these internal systems to
be approximately $2.0 million, $1.8 million of which has already been incurred.
This estimate is being monitored and will be revised as additional information
becomes available.
Based on the activities described above, the Company does not believe
that the Year 2000 Problem will have a material adverse effect on the Company's
business or results of operations. In addition, the Company has not deferred any
material information technology projects as a result of its Year 2000 Problem
activities.
Page 12
<PAGE> 15
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Client Systems. During 1997, the Company initiated assessments of the
effect of the Year 2000 Problem on computers, software, and other equipment it
operates or maintains for its customers, and its obligations to modify, upgrade,
or replace these systems. As part of this process, the Company has been
estimating the costs and revenues to the Company for performing any necessary
services. The Company is monitoring and updating this assessment on an ongoing
basis. The estimated cost associated with making clients' systems Year 2000
compliant for contracts where the Company is obligated to perform these services
at its expense has been and will be treated as a contract cost and is included
in the estimate of total contract costs for the respective contract under the
Company's revenue recognition policy. The Company believes that its clients have
been deferring other projects pending resolution of their Year 2000 Problems.
Suppliers. The Company has initiated communications with third party
suppliers of the major computers, software, and other equipment used, operated,
or maintained by the Company for itself or its customers to identify and, to the
extent possible, to resolve issues involving the Year 2000 Problem. However, the
Company has limited or no control over the actions of these third party
suppliers. Thus, while the Company expects that it will be able to resolve any
significant Year 2000 Problems with these systems, there can be no assurance
that these suppliers will resolve any or all Year 2000 Problems with these
systems before the occurrence of a material disruption to the business of the
Company or any of its customers. Any failure of these third parties to timely
resolve Year 2000 Problems with their systems could have a material adverse
effect on the Company's business, financial condition, and results of operation.
Most Likely Consequences of Year 2000 Problems. The Company believes
that it has identified and expects to resolve all Year 2000 Problems that could
materially adversely affect its business operations. However, management
believes that it is not possible to determine with complete certainty that all
Year 2000 Problems affecting the Company or its clients have been identified or
corrected. The number of devices that could be affected and the interactions
among these devices are simply too numerous. In addition, no one can accurately
predict how many Year 2000 Problem-related failures will occur or the severity,
duration, or financial consequences of these perhaps inevitable failures. As a
result, management expects that the Company will likely suffer the following
consequences:
o a significant number of operational inconveniences and inefficiencies
for the Company and its clients that will divert management's time
and attention and financial and human resources from its ordinary
business activities;
o a lesser number of serious system failures that will require
significant efforts by the Company or its clients to prevent or
alleviate material business disruptions;
o several routine business disputes and claims for pricing adjustments
or penalties due to Year 2000 Problems by clients, which will be
resolved in the ordinary course of business; and
o a few serious business disputes alleging that the Company failed to
comply with the terms of its contracts or industry standards of
performance, some of which could result in litigation or contract
termination.
Contingency Plans. The Company has completed developing contingency
plans to be implemented if its efforts to identify and correct Year 2000
Problems affecting its internal systems are not effective. The Company's
contingency plans were complete at September 30, 1999. Depending on the systems
affected, these plans include accelerated replacement of affected equipment or
software, short-to medium-term use of backup sites, equipment and software,
increased work hours for Company personnel or use of contract personnel to
correct on an accelerated schedule any Year 2000 Problems that arise or to
provide manual
Page 13
<PAGE> 16
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
workarounds for information systems, and similar approaches. Additionally, each
plan contains an emergency call list with Company personnel contact information
to implement each plan. If the Company is required to implement any of these
contingency plans, it could have a material adverse effect on the Company's
financial condition and results of operations.
The Company has and is continuing to develop contingency plans for
certain clients where such plans are contractually required or are otherwise
appropriate to be developed. In most cases, these contingency plans are being
developed jointly by the Company and its clients. Depending on the systems
affected, these plans include accelerated replacement of affected equipment or
software, short-to medium-term use of backup sites, equipment and software,
increased work hours for company personnel or use of contract personnel to
correct on an accelerated schedule any Year 2000 Problems that arise or to
provide manual workarounds for information systems, and similar approaches. If
the Company is required to implement any of these contingency plans, it could
have a material adverse effect on the Company's financial condition and results
of operations.
The Company will have support staff available to provide customers
with around the clock support and a centralized environment to globally monitor
and periodically report the operating status of systems, applications, and
account support activities during the 99/00 rollover beginning December 31, 1999
and continuing through Wednesday January 5, 2000. During that period should
calls exceed our expectations, additional technical resources are also on call
to expand our support capability.
Disclaimer. The discussion of the Company's efforts, and management's
expectations, relating to Year 2000 compliance are forward-looking statements.
The Company's ability to achieve Year 2000 compliance and the level of
incremental costs associated therewith, could be adversely impacted by, among
other things, the availability and cost of programming and testing resources,
vendors' ability to modify proprietary software, and unanticipated problems
identified in the ongoing compliance review.
IMPACT OF EUROPEAN MONETARY UNION
Effective January 1, 1999, the majority of the members of the
European Union adopted economic and monetary union, resulting in the
introduction of a single currency called the EURO in those countries. The
Company is currently assessing the potential effects of, and costs of adopting,
the EURO conversion for its internal systems and, where the Company is
contractually obligated to take these steps, on systems operated or maintained
on behalf of its clients. For each of these areas, the Company is using the six
phase methodology described above for the Year 2000 Problem. The Company has
substantially completed the discovery and assessment phases, and the EURO
conversion is not expected to have a material effect on the Company's
operations, financial condition or results of operations.
The discussion of the Company's efforts, and management's
expectations, relating to the EURO conversion are forward-looking statements.
The Company's ability to adapt for the EURO conversion and the level of
incremental costs associated therewith could be adversely affected by, among
other things, the availability and cost of programming and testing resources and
unanticipated problems identified in the ongoing conversion review.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
Page 14
<PAGE> 17
PEROT SYSTEMS CORPORATION
FORM 10-Q
For the Quarter Ended September 30, 1999
PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
The Company is, from time to time, involved in various litigation
matters arising in the ordinary course of its business. The Company believes
that the resolution of currently pending legal proceedings, either individually
or taken as a whole, will not have a material adverse effect on the Company's
consolidated financial position or results of operations.
On October 19, 1998, the Robert Plan Corporation ("Robert Plan")
filed a complaint, which was subsequently amended, in New York state court
against the Company and Ross Perot in connection with a September 1, 1990
contract under which the Company provides data processing and software
development needs for some of Robert Plan's operations. The complaint, as
amended, alleges breach of the 1990 contract, misappropriation of Robert Plan's
proprietary information and business methods in connection with an imaging
system, breach of warranty and similar claims relating to the contract. Although
the complaint seeks substantial monetary awards and injunctive relief, the 1990
contract substantially limits each party's liability except in limited
circumstances, including for "wanton or willful misconduct." Accordingly, Robert
Plan has alleged that the Company has acted in a "wanton" and "willful" fashion,
even though Robert Plan has used and continues to use the services of the
Company under the 1990 contract. The Company believes that it has meritorious
defenses to Robert Plan's claims. The Company has filed a motion to dismiss
Robert Plan's claims. The court has heard arguments on the motion, but has not
yet ruled. The Company intends to continue vigorously defending the lawsuit. The
Company does not believe that the outcome of this litigation will have a
material adverse effect on the Company.
ITEM 2: CHANGES IN SECURITIES
On February 1, 1999, the Securities and Exchange Commission declared
the Company's Registration Statement on Form S-1, Registration No. 333-60755
relating to the Company's IPO, effective.
The Company incurred the following offering expenses in connection
with the IPO:
<TABLE>
<S> <C>
Underwriting discounts and commissions...... $ 8,372,000
Other expenses ............................. 3,101,680
-----------
Total expenses ............................. $11,473,680
===========
</TABLE>
None of the above expenses were paid either directly or indirectly to
directors, officers, general partners of the Company or its associates, or to
persons owning more than 10% of any class of equity security of the Company or
to affiliates of the Company.
As of the date of filing of this Form 10-Q, the Company has used
$17,000,000 in proceeds from the IPO to purchase 1,000,000 shares of common
stock in a publicly traded company as a temporary investment.
Page 15
<PAGE> 18
PEROT SYSTEMS CORPORATION
FORM 10-Q
For the Quarter Ended September 30, 1999
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters to a vote of its security
holders during the period covered by this report.
ITEM 5: OTHER INFORMATION
None.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required by Item 601 of Regulation S-K
<TABLE>
<CAPTION>
Exhibit No. Document
----------- --------
<S> <C>
27 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
No reports were filed on Form 8-K during the three months ended
September 30, 1999.
Page 16
<PAGE> 19
PEROT SYSTEMS CORPORATION
FORM 10-Q
For the Quarter Ended September 30, 1999
SIGNATURES
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.
PEROT SYSTEMS CORPORATION
(Registrant)
Date: November 5, 1999 By /s/ TERRY ASHWILL
----------------------
Terry Ashwill
Vice President and Chief Financial Officer
(principal financial officer and
chief accounting officer)
page 17
<PAGE> 20
PEROT SYSTEMS CORPORATION
FORM 10-Q
For the Quarter Ended September 30, 1999
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description
- -------------- --------------
<S> <C>
27 Financial Data Schedule as of September 30, 1999.
</TABLE>
Page 18
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 263,215
<SECURITIES> 0
<RECEIVABLES> 176,806
<ALLOWANCES> 3,828
<INVENTORY> 0
<CURRENT-ASSETS> 495,767
<PP&E> 122,759
<DEPRECIATION> 87,437
<TOTAL-ASSETS> 591,959
<CURRENT-LIABILITIES> 229,008
<BONDS> 0
0
0
<COMMON> 917
<OTHER-SE> 355,673
<TOTAL-LIABILITY-AND-EQUITY> 591,959
<SALES> 861,412
<TOTAL-REVENUES> 861,412
<CGS> 660,516
<TOTAL-COSTS> 785,877
<OTHER-EXPENSES> 541
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 439
<INCOME-PRETAX> 88,711
<INCOME-TAX> 35,484
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 53,227
<EPS-BASIC> .61
<EPS-DILUTED> .47
</TABLE>
