-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, E2+LfCCJkK0Hfaaum+UixS17X12TR9t6JHtLg5mwjzK9iq6oPRxIBJlwU2TUSpaE C0TG5bwGI2/oOR5I7ajQFA== 0000811716-99-000003.txt : 19990519 0000811716-99-000003.hdr.sgml : 19990519 ACCESSION NUMBER: 0000811716-99-000003 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990403 FILED AS OF DATE: 19990518 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SEQUENT COMPUTER SYSTEMS INC /OR/ CENTRAL INDEX KEY: 0000811716 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRONIC COMPUTERS [3571] IRS NUMBER: 930826369 STATE OF INCORPORATION: OR FISCAL YEAR END: 0102 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-15627 FILM NUMBER: 99628984 BUSINESS ADDRESS: STREET 1: 15450 SW KOLL PKWY STREET 2: ED02-803 CITY: BEAVERTON STATE: OR ZIP: 97006-6063 BUSINESS PHONE: 5036265700 MAIL ADDRESS: STREET 1: 15450 SW KOLL PKWY STREET 2: ED02 -803 CITY: BEAVERTON STATE: OR ZIP: 97006-6063 10-Q 1 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 April 3, 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: 0-15627 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. 41,974,989 common shares were issued and outstanding as of May 4, 1999. SEQUENT COMPUTER SYSTEMS, INC. PART I. FINANCIAL INFORMATION Page No. Item 1. Consolidated Financial Statements Consolidated Balance Sheets - April 3, 1999 and January 2, 1999 3 Consolidated Statements of Operations - Three months ended April 3, 1999 and April 4, 1998 4 Consolidated Statements of Shareholders' Equity - January 2, 1999 through April 3, 1999 5 Consolidated Statements of Cash Flows - Three months ended April 3, 1999 and April 4, 1998 6 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Conditions and Results of Operations 12 Item 3. Quantitative and Qualitative Disclosures About Market Risk Information with respect to quantitative and qualitative disclosures about market risk is included under "Derivative and Other Financial Instruments" under "Management's Discussion and Analysis of Financial Conditions and Results of Operations." PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 20 SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts) April 3, 1999 January 2, 1999 (unaudited) ASSETS Current assets: Cash and cash equivalents $ 153,455 $ 192,876 Restricted deposits 10,370 28,280 Receivables, net 214,969 221,611 Inventories 95,033 86,333 Prepaid royalties and other 37,071 23,282 Total current assets 510,898 552,382 Property and equipment, net 140,486 133,831 Capitalized software costs, net 74,098 72,469 Other assets, net 36,190 37,433 Total assets $ 761,672 $ 796,115 LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Notes payable $ 10,785 $ 29,908 Accounts payable and other 127,522 124,099 Accrued payroll 11,925 19,070 Unearned revenue 53,611 47,446 Income taxes payable 5,003 4,865 Current obligations under capital leases 4,754 2,320 Total current liabilities 213,600 227,708 Other accrued expenses 7,070 8,073 Long-term obligations under capital leases 7,427 7,480 Total liabilities 228,097 243,261 Shareholders' equity: Common stock, $.01 par value, 100,000 shares authorized, 42,093 and 43,471 shares outstanding 421 435 Paid-in capital 494,567 511,169 Retained earnings 48,103 46,883 Accumulated other comprehensive income: Foreign currency translation adjustment (9,516) (5,633) Total shareholders' equity 533,575 552,854 Total liabilities and shareholders' equity $ 761,672 $ 796,115 See notes to consolidated financial statements. SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS - Unaudited (in thousands, except per share amounts) Three Months Ended April 3, 1999 April 4, 1998 Revenue: Product $ 120,528 $ 118,445 Service 73,451 64,623 Total revenue 193,979 183,068 Costs and expenses: Cost of products sold 77,184 62,906 Cost of service revenue 53,486 47,336 Research and development 17,934 17,064 Selling, general and administrative 46,313 49,620 Restructuring credits (998) - Total costs and expenses 193,919 176,926 Operating income 60 6,142 Interest, net 1,456 621 Other, net 80 (934) Income before provision for income taxes 1,596 5,829 Provision for income taxes 376 1,807 Net income $ 1,220 $ 4,022 Net income per share - basic $ .03 $ .09 Net income per share - diluted $ .03 $ .09 Shares used in the calculation of net income per share - basic 42,961 43,184 Shares used in the calculation of net income per share - diluted 43,495 45,395 See notes to consolidated financial statements. SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (in thousands)
Foreign Currency Total Common Stock Paid-in Retained translation comprehensive Shares Amount capital Earnings adjustment Total income Balance, January 2, 1999 43,471 $ 435 $511,169 $46,883 $(5,633) $552,854 $(50,246) Common shares issued 677 7 4,362 - - 4,369 Common shares repurchased (2,055) (21) (21,117) - - (21,138) Tax benefit of option exercises - - 153 - - 153 Net income - - - 1,220 - 1,220 1,220 Foreign currency translation adjustment - - - - (3,883) (3,883) (3,883) Balance, April 3, 1999 (unaudited) 42,093 $ 421 $494,567 $48,103 $(9,516) $533,575 $(52,909)
See notes to consolidated financial statements. SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - Unaudited (in thousands)
Three Months Ended April 3, 1999 April 4, 1998 Cash flow from operating activities: Net income $ 1,220 $ 4,022 Reconciliation of net income to net cash and cash equivalents provided by operating activities - Depreciation and amortization 22,731 22,294 Restructuring charges not affecting cash 477 - Deferred income taxes (336) (143) Changes in assets and liabilities - Receivables, net 6,642 101,276 Inventories (8,700) (6,138) Prepaid royalties and other (14,332) (13,206) Accounts payable and other 3,598 (36,338) Accrued payroll (7,150) (10,275) Unearned revenue 6,166 3,938 Income taxes payable 138 (15) Other, net 232 664 Net cash provided by operating activities 10,686 66,079 Cash flow from investing activities: Restricted deposits 17,910 1,067 Purchases of property and equipment, net (21,798) (15,985) Capitalized software costs (10,514) (9,700) Net cash used for investing activities (14,402) (24,618) Cash flow from financing activities: Notes payable, net (19,123) (1,096) Proceeds (payments) under capital lease obligations 2,381 (495) Stock issuance proceeds, net 4,522 8,888 Stock repurchases (21,138) - Net cash provided (used) by financing activities (33,358) 7,297 Effect of exchange rate changes on cash (2,347) 1,395 Net increase (decrease) in cash and cash equivalents (39,421) 50,153 Cash and cash equivalents at beginning of period 192,876 133,299 Cash and cash equivalents at end of period $ 153,455 $ 183,452
See notes to consolidated financial statements. SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS April 3, 1999 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 2, 1999. 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 inventory and recoverability of capitalized software, prepaid royalties and deferred tax assets. Reclassifications Reclassifications have been made to amounts in certain prior years. These changes had no impact on previously reported results of operations. Recently Issued Accounting Standards In 1998, the FASB issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133). This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. This statement is effective for fiscal years beginning after June 15, 1999 (January 1, 2000 for the Company). The Company is currently assessing the impact that the adoption of FAS 133 will have on its consolidated financial statements. Accounts Receivable At April 3, 1999, accounts receivable in the accompanying consolidated balance sheet is net of $23 million received by the Company under its agreement to sell its domestic accounts receivable. Inventories Inventories consist of the following: (in thousands) April 3, January 2, 1999 1999 Raw materials $ 9,828 $ 14,996 Work-in-progress 2,801 1,403 Finished goods 82,404 69,934 $ 95,033 $ 86,333 Property and Equipment Property and equipment consist of the following: (in thousands) April 3, January 2, 1999 1999 Land $ 6,307 $ 6,307 Operational equipment 238,502 230,449 Furniture and office equipment 83,663 86,069 Leasehold improvements 26,297 27,498 354,769 350,323 Less accumulated depreciation (214,283) (216,492) $ 140,486 $ 133,831 Research and Development Amortization of capitalized software costs, generally based on a three-year life, was $8.9 million and $7.8 million for the three month periods ended April 3, 1999 and April 4, 1998, 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. There was no outstanding balance at either April 3, 1999 or January 2, 1999. 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 with terms of fourteen days to three months. Proceeds from the borrowings are converted into U.S. dollars and placed in a term deposit account with the foreign bank. At April 3, 1999, maximum borrowings allowed under the agreement were approximately $80.5 million. The maximum borrowing limit is denominated in specified foreign currencies and fluctuates with the change in foreign exchange rates. Amounts outstanding were $10.4 million and $28.3 million at April 3, 1999 and January 2, 1999, respectively. In addition to the above borrowing agreements, the Company has entered into certain other miscellaneous borrowing arrangements with a foreign bank. At April 3, 1999 and January 2, 1999, $0.4 million and $1.6 million were outstanding, respectively. Common Stock During 1998, the Company announced a plan to repurchase up to 4,000,000 shares of its outstanding common stock. As of April 3, 1999, the Company has repurchased 3,788,500 shares at an average price of $10.72 per share. On April 27, 1999, the Board of Directors of the Company authorized the repurchase of up to 8,000,000 shares of its outstanding common stock in addition to the 4,000,000 shares previously authorized in 1998. From the inception of the repurchase program in 1998 through May 4, 1999, the Company has repurchased a total of 3,868,500 shares at an average price of $10.69 per share. Segment Reporting The Company has determined that its reportable segments are those that are based on the Company's primary basis of organization and method of internal reporting - (1) Product, (2) Customer Services (CS), (3) Professional Services (PS) and (4) Research and Development (R&D). The tables below present information about reported segments for the three months ended April 3, 1999 and April 4, 1998, respectively, and include a reconciliation of segment activity to consolidated net income before the provision for income taxes. Three months ended April 3, 1999:
Professional Customer Research & Product Service Service Development Consolidated Revenue $ 120,528 $ 26,421 $ 47,030 $ 193,979 Cost of products sold 77,184 77,184 Cost of service revenue 24,781 28,705 53,486 Gross margin 43,344 1,640 18,325 63,309 R&D expenses 17,934 17,934 Selling, general & administrative 46,313 Restructuring credits (998) Operating income 60 Interest, net 1,456 Other income, net 80 Income before provision for income taxes $ 1,596
Three months ended April 4, 1998:
Professional Customer Research & Product Service Service Development Consolidated Revenue $ 118,445 $ 21,999 $ 42,624 $ 183,068 Cost of products sold 62,906 62,906 Cost of service revenue 21,267 26,069 47,336 Gross margin 55,539 732 16,555 72,826 R&D expenses 17,064 17,064 Selling, general & administrative 49,620 Operating income 6,142 Interest, net 621 Other expense, net (934) Income before provision for income taxes $ 5,829
Information concerning principal geographic areas is as follows: Three Months Ended April 3, 1999 April 4, 1998 Revenue from external customers: United States $ 101,635 $ 82,697 United Kingdom 55,223 70,998 Other foreign 30,839 18,635 Export 6,282 10,739 Total $ 193,979 $ 183,068 April 3, 1999 January 2, 1999 Identifiable assets: United States $ 597,044 $ 594,715 United Kingdom 104,457 123,346 Other foreign 60,171 78,054 Total $ 761,672 $ 796,115 Revenues are attributed to geographic areas based on the location of the identifiable assets producing the revenues. Foreign revenue is that which is produced by identifiable assets located in foreign countries while export revenue is that which is generated by identifiable assets located in the United States. Intercompany sales between geographic areas, primarily from the United States to Europe, were $25.4 million and $41.6 million for the first quarters of 1999 and 1998, respectively. Restructuring Charges During 1998, the Company recorded restructuring charges net of estimate revisions totaling $61.4 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. In addition, a change in the restructuring estimate during the first quarter of 1999 resulted in a $1.0 million credit. Please refer to the discussion of restructuring costs and current period adjustments included in Management's Discussion and Analysis of Financial Condition and Results of Operations. 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 research tax credit and the Company's Foreign Sales Corporation. Earnings Per Share (in thousands, except per share amounts)
Income Shares Per-Share (Numerator) (Denominator) Amount Three Months Ended Three Months Ended Three Months Ended Apr. 3, Apr. 4, Apr. 3, Apr. 4, Apr. 3, Apr. 4, 1999 1998 1999 1998 1999 1998 Basic EPS Income available to common shareholders $ 1,220 $ 4,022 42,961 43,184 $ .03 $ .09 Effect of Dilutive Securities Stock options 347 2,104 Employee stock purchase plan 187 107 Diluted EPS Income available to common shareholders + assumed conversions $ 1,220 $ 4,022 43,495 45,395 $ .03 $ .09
Significant Customers The core business operations of the Company include the design, manufacture and marketing of high-performance computer systems and operating environment software. Project-oriented offerings include consulting and professional services to help customers solve complex information technology problems. The Company had no single customer that represented greater than 10% of total revenue in either of the first quarters of 1999 or 1998. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The Company reported total revenue and net income of $194.0 and $1.2 million, respectively in the first quarter of 1999 as compared to $183.1 million and $4.0 million, for the same period in 1998. Earnings for the quarter were down in relation to the prior year owing primarily to the Company's aggressive pricing of its mid-range NUMA-Q product lines. Consequently, product revenue growth was virtually flat over the two quarters. Professional and Service revenues, however, were up moderately, thus sustaining a composite 6% growth in total revenue. International revenue was approximately 48% of the Company's total revenue in the first quarter of 1999, down from 55% in the same period in 1998. Overall results reflect the Company's shift in strategic initiative to focus efforts on broadening product offerings and expanding its distribution channels. REVENUE/NET INCOME Three Months Ended (dollars in millions) April 3, % April 4, 1999 change 1998 Total Revenue $ 194.0 6% $ 183.1 Product $ 120.5 2% $ 118.4 Professional Service 26.5 20% 22.0 Customer Service 47.0 10% 42.7 US $ 101.6 23% $ 82.7 United Kingdom 55.2 (22%) 71.0 International 37.2 27% 29.4 Net Income $ 1.2 (70%) $ 4.0 PRODUCT Competition in the hardware vendor market continues to challenge the product segment of the business and place pressures on pricing and sales margins. NUMA-Q product lines introduced during the quarter were priced aggressively to compete with these downward price pressures in the market. As a result, product revenue growth for the first quarter of 1999 increased narrowly at a rate of 2% over the same period in 1998. Normal seasonal softness also contributed to the difficulties in achieving sustained revenue growth along with significant decreases in international revenues, particularly from the Company's United Kingdom operations. SERVICE Revenues from customer and professional service segments increased approximately 10% and 20%, respectively, in the first quarter of 1999 over the same period in 1998. Steady increases in the number of installed customer systems under service contracts as well as continued growth in professional service opportunities, were both factors in the overall solid revenue growth for these segments during the quarter. The following table sets forth certain operating data as a percentage of total revenue: Three Months Ended April 3, April 4, 1999 1998 Revenue: End-user products 62% 62% OEM products - 3 Service 38 35 Total revenue 100 100 Cost of product and service 67 60 Gross profit 33 40 Operating expenses: Research and development 9 9 Selling, general and administrative 24 27 Rounding - 1 Restructuring charges (credits) - - Total operating expenses 33 37 Operating income - 3 Interest and other, net 1 - Income before provision for income taxes 1 3 Provision for income taxes - 1 Net income 1% 2% GROSS MARGINS Three Months Ended April 3, April 4, 1999 1998 Product 36% 47% Service 27% 27% The factors influencing gross margins in a given period include unit volumes (which affect economies of scale), product configuration mix (including the amount of third party products), changes in component and manufacturing costs, product pricing and the mix between product and service revenue. Total cost of sales as a percentage of total revenue increased in the first quarter of 1999 over the same period in 1998. Product cost of sales as a percentage of revenue continues to be negatively impacted by competitive pricing pressures and the impact of product transitioning. Specifically, the Company's margins were impacted by sales of Pentium Pro-based NUMA-Q products subjected to greater discounting in order to transition to the new Pentium II Xeon-based NUMA-Q product lines. Also impacting the Company's declining margins were competitive pricing on new products as well as volume of sales of third-party products, which generally yield lower margins than the Company's products. Service segment gross margins maintained a flat rate for the first quarter of 1999 when compared to the same period in 1998. Margin rates for services were primarily the result of the impact of cost control initiatives and other efficiencies achieved by experienced professionals in the service segments. RESEARCH AND DEVELOPMENT Three Months Ended (dollars in millions) April 3, % April 4, 1999 change 1998 Research and development expense $17.9 5% $17.1 As a percentage of total revenue 9% 9% Software costs capitalized $10.4 7% $ 9.7 Research and development expense dollars increased slightly in the first quarter of 1999 in comparison with the same period in 1998. Expense as a percentage of total revenue, however, was maintained at a rate of 9%. During the first quarter of 1999, the Company continued to make investments in new software development for its next-generation of NUMA-Q products, including further development of software for the Company's NUMA-Q 1000 mid-range product line as well as enhancements to NUMACenter architecture which runs both Unix and Windows NT applications. In addition, development work began towards next-generation products to be based on 64-bit architecture. SELLING, GENERAL AND ADMINISTRATIVE Three Months Ended (dollars in millions) April 3, % April 4, 1999 change 1998 Selling, general and administrative $46.3 (7%) $49.6 As a percentage of revenue 24% 27% First quarter 1999 selling, general and administrative (SG&A) expenses decreased $3.3 million over the same period in 1998. Factors contributing to the decrease include the restructure during the second quarter of 1998 with its resulting impact to worldwide headcount, as well as continued cost control measures. RESTRUCTURING CHARGES During 1998, the Company recorded net restructuring charges totaling $61.4 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. In addition, a change in the restructuring estimate during the first quarter of 1999 resulted in a $1.0 million credit. It is anticipated that the restructuring actions taken in 1998 will yield operating cost reductions of approximately $25 million during 1999. Remaining cash outlays expected from the restructuring consist of $14.6 million for facilities and $0.2 million relating to employee termination costs. Expenditures and adjustments totaling ($1.4) million for facilities were made for the costs of excess space incurred during the period. The following table presents a summary of the activity in the restructuring accrual during the first quarter of 1999 and the resulting net balance sheet amounts as of April 3, 1999. The balance of accrued restructuring costs of $14.8 million at April 3, 1999 is included in Accounts Payable and Other in the accompanying balance sheet. (dollars in millions)
First Balance at Quarter Write-offs/ Balance at January 2, 1999 Expenditures Adjustments April 3, 1999 Employee termination and related costs $ 0.2 $ - $ - $ 0.2 Prepaid software licenses 0.3 - (0.3) - Facilities 16.0 (1.3) (0.1) 14.6 Capital assets - - - - Capitalized software - - - - Goodwill - - - - Other assets - - - - $ 16.5 $ (1.3) $ (0.4) $ 14.8
INTEREST AND OTHER, NET (dollars in millions) Three Months Ended April 3, % April 4, 1999 change 1998 Interest income $ 2.1 11% $ 1.9 Interest expense (0.6) (54%) (1.3) Other, net 0.1 (111%) (0.9) Interest income is primarily generated from invested cash and cash equivalents and restricted deposits held at foreign and domestic banks. Interest expense includes costs related to foreign currency hedging loans, interim short-term borrowings and capital lease obligations. The decrease in interest expense in the first quarter of 1999 over the same period in 1998 is attributed to the decrease in the use of the Company's short-term borrowing agreement in 1999 to manage foreign currency exposures. Other income (expense) consists primarily of net realized and unrealized foreign exchange gains and losses. Other net income of $0.1 million in the first quarter of 1999 is a result of effective hedge activity during the quarter. INCOME TAXES The Company provided $375,000 for income taxes in the first quarter of 1999 based on a net profit before tax of $1.6 million. The difference between the statutory rate and the effective tax rate of 23.5% for the first quarter of 1999 is principally due to the benefit from the research tax credit and the Company's Foreign Sales Corporation. The effective rate of 23.5% for the first quarter of 1999 compares to an effective tax rate benefit of 31.0% for 1998. The change in the tax rate is due primarily to permanent tax benefits such as the Foreign Sales Corporation and research and experimentation credits which do not fluctuate based on differences in pre-tax earnings (losses) year over year. LIQUIDITY AND CAPITAL RESOURCES Working capital was $297.3 million at April 3, 1999 compared to $324.7 million at January 2, 1999. The Company's current ratio was 2.4:1 at both April 3, 1999 and January 2, 1999. Cash and cash equivalents decreased $39.4 million during the first quarter of 1999. The decrease resulted primarily from cash used in financing activities, specifically, payments of $19.1 million for notes payable and $21.1 million for stock repurchases. Investments during the quarter in property and equipment and capitalized software approximated $21.8 million and $10.5 million, respectively. The Company has a $40 million receivable sales facility with a group of banks. At April 3, 1999, accounts receivable in the accompanying consolidated balance sheet is net of $23 million received by the Company under this agreement to sell its domestic accounts receivable. 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 April 3, 1999, 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 $80.5 million, of which $10.4 million was outstanding at April 3, 1999 (based on currency exchange rates on such date). The Company also maintains a miscellaneous borrowing arrangement with a foreign bank. At April 3, 1999, $0.4 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. Sequent is executing a company-wide Year 2000 Readiness Program (Program) for the Company's products, on-going operations (operations), mission-critical information systems (IS) and key suppliers (suppliers). While the majority of business critical century date change issues were identified and remediated before the end of 1998, ongoing remediation, testing and contingency planning is expected to continue throughout 1999. The Year 2000 Readiness Program is organized into six major phases: 1) exposure inventory, 2) risk assessment, 3) prioritization, 4) remediation (either by repair or replacement), 5) contingency planning and 6)testing/verification. These stages have been largeley completed for the Company's standard products and are in progress for ongoing operational issues as well as critical suppliers. The Program organization consists of a Steering Committee made up of Company executives, a Year 2000 taskforce representing each of the Company's major departments and a Year 2000 Project Management Office. In addition, several Focus Teams have been set up to deal with cross-functional issues related to customers, partners, suppliers and major business process contingency plans. Operational program work is being done by each of the Company's departments with oversight by the Year 2000 Program Office. Operational program work includes the Company's critical business computer applications, data and infrastructure. Mission- critical third party service and equipment suppliers are being contacted via written inquiry, as well as direct discussion, to understand and mitigate potential risks. The current status of the Company's Year 2000 Readiness Program is as follows: The Company's current line of hardware products, which are designed and manufactured to the Company's specifications, are Year 2000 ready if utilized with the appropriate version of the operating system software. The Company cannot ensure that its software products do not contain undetected problems associated with Year 2000 compliance. Such problems, should they occur, may result in material adverse effects on future operating results. Of the Company's eight Operations remediations programs, five have completed the remediation phase and three are still in process. Among the latter, remediation status ranges from 40% to 90% complete. Identified business critical exposures are expected to be resolved by the second quarter of 1999. The Company's Supplier readiness program is managed through its Global Sourcing and Procurement group. Of those suppliers identified as business critical, all have informed the Company that they have remediation plans in place and completion is planned on or before the end of the second quarter of 1999. The Company's Information Systems group is remediating both critical IS applications and IT infrastructure. Of the identified enterprise level business critical appliations, 100% have now been remediated. All IS-manged applications, regardless of business criticality, will be remediated, replaced or retired, worldwide. Remediation of the Company's worldwide IT infrastructure (networks, servers and PCs) is 90% complete. Any other IT exposures, such as workgroup level software applications, are being identified and dealt with as part of individual department Y2K programs. The total cost of the Program is currently estimated to be approximately $10 million and is being funded through operating cash flows. The Company is expensing costs associated with identification and resulting changes to these systems, but does not expect the amounts to have a material effect on its financial position or results of operations. These costs are not incremental as the Company's internal IS development resources were re-directed solely to the Year 2000 remediation effort during 1998. In 1999, resources required for the remediation effort have not materially affected new development projects scheduled and budgeted. As of April 3, 1999, the total amount expended on the Program was approximately $6 million, with the majority of the costs representing hardware and labor expenditures. The Company has classified potential worst case scenarios as either 1) Year 2000 related failures in internal business critical information system applications or 2) the development of service or product supply difficulties by business critical suppliers. These circumstances are not considered probable, but have been reviewed as part of the Company's due diligence efforts. For Year 2000 type failures in internal applications (scenario 1), business critical applications have been identified, assessed as to possible business impact of their failure and are being repaired, upgraded or replaced based on the severity of potential impact. For each of these applications, a business continuity contingency plan is expected to be in place by the end of the first half of 1999. For service and product supplier type failures, an inventory has been completed and the business critical suppliers have been identified. A variety of risk reduction strategies have commenced, including but not limited to, developing possible alternative suppliers, acquiring safety stock and establishing enhanced testing programs and process audits. For the identified business critical suppliers, the Company expects to establish a contingency plan by mid 1999. There can be no assurance, however, that the systems or products of other companies on which the Company's systems also rely will be converted timely or that any such failure to convert by a vendor, customer or another company would not have an adverse effect on the Company's systems or results of operations. EURO CONVERSION The European Economic and Monetary Union (EMU) and a new currency, the "Euro", went into effect in Europe on January 1, 1999. This is a significant and critical element in the European Union's (EU) plan to blend the economies of the EU's member states into one integrated market, with unrestricted and unencumbered trade and commerce across borders. Eleven European countries (the "participating countries") of the fifteen member EU countries will initially participate (Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain). Other member states (Denmark, Greece, the United Kingdom and Sweden) may join in the years to come. The Euro will trade on currency exchanges and the legacy currencies will remain legal tender for a transition period between January 1, 1999 and January 1, 2002. During the transition period, public and private companies may pay for goods and services using either the Euro or the participating country's legacy currency. The Company is currently determining the necessary modifications to its internal systems to accommodate Euro-denominated transactions and is assessing the business implications of the conversion to the Euro, including long-term competitive implications and the effect of market risk with respect to financial instruments. The Company does not believe the financial impact of these matters, if any, will be material to its results of operations, financial condition or cash flows. However, the Company will continue to assess the impact of Euro conversion issues as the applicable accounting, tax, legal and regulatory guidance evolves. DERIVATIVE AND OTHER FINANCIAL INSTRUMENTS Risk Management Strategy In the normal course of business, Sequent enters into various financial instruments, including derivative financial instruments, for purposes other than trading. Derivative financial instruments are not entered into for speculative purposes. These instruments primarily consist of accounts receivable, short-term investments, short-term debt, forward exchange contracts and option contracts which are used to reduce Sequent's exposure to currency exchange rates. At inception, foreign exchange contracts are designated as hedges of firmly committed or forecasted transactions. These transactions are generally expected to be completed in less than one year. The forward contracts and options generally mature within twelve months. The majority of Sequent's foreign exchange forward contracts are to exchange Japanese Yen, Australian Dollars and New Zealand Dollars. The option contracts are no-cost collars and exchange British Pounds and Korean Won. Exposure to credit risk is managed through credit approvals and monitoring procedures, and management believes that the reserves for losses are adequate. The counterparties to these financial instruments are substantial and creditworthy corporations, state agencies and multinational commercial banks. In management's opinion the risk of counterparty nonperformance associated with these instruments is not considered to be significant. Interest Rate Risk The Company routinely invests in short-term financial instruments within the parameters of its investment policy with maturities of less than three months. The instruments pay a fixed rate of return. These instruments are subject to overall market interest rate sensitivity upon maturity. As part of the Company's foreign currency hedging activities, the Company maintains short-term loans with a multinational commercial bank. These loans are for durations ranging from fifteen days to three months and carry a fixed interest rate. Upon maturity, these instruments are subject to overall market interest rate sensitivity. The Company also maintains two long-term leases with variable interest rates based on LIBOR (London Inter Bank Offer Rate). The table below illustrates the effect on lease payments of a +/-10% change in the underlying base rate: 1999 Forecast Rental Payments Base Rate $1,957K Base Rate plus 10% $2,072K Base Rate less 10% $1,748K Foreign Exchange Risk The table below presents foreign exchange contracts, options and debt at April 3, 1999 and January 2, 1999 (in thousands). The notional amounts represent agreed upon amounts on which calculations of dollars to be exchanged are based, and are an indication of the extent of Sequent's involvement in such instruments. They do not represent amounts exchanged by the parties and, therefore, are not a measure of the instruments. (in thousands) Contract Carrying Amount Fair Value Amount Asset Liability Asset Liability April 3, 1999 FX Forward Contracts $ 8,975 $ - $ - $ 8,975 $ 8,975 FX Options (net) 97,570 - - 1,439 71 Debt 10,370 - 10,370 - 10,370 January 2, 1999 FX Forward Contracts $ 8,086 $ - $ - $ 8,086 $ 8,086 FX Options (net) 129,100 - - 135 123 Debt 28,244 - 28,244 - 28,244 Fair values of financial instruments represent estimates of possible value that may not be realized in the future. EUROPEAN SALES OPERATIONS In January 1999, the Company signed a strategic partnership agreement with Comparex, one of Europe's leading suppliers of complete solutions for IT infrastructures. The partnership, which was effective March 1, 1999, allows Comparex to take responsibility for Sequent's sales activities in Austria, Belgium, Germany, the Netherlands, Portugal, Spain and Switzerland. The Company's operations in the United Kingdom and France geographies, which represent the majority of the Company's European business, were not included in the partnership agreement. The majority of the Company's personnel in the countries included under the agreement became employees of Comparex with the exception of certain individuals retained to manage and support the relationship with Comparex and to provide specialist skills and expertise. The agreement provided for the sale of certain assets to Comparex at recorded net book value. Total book value of the assets sold during the first quarter of 1999 was approximately $9 million. Management anticipates that the relationship with Comparex will positively impact both revenues and operating income in 1999 and 2000 in these geographies. FORWARD-LOOKING STATEMENTS Information in this report that is not historical information, including information regarding development and release of new products, anticipated savings resulting from the restructure, year 2000 issues and the Company's relationship with Comparex, 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 under the section titled "Impact of the Year 2000 Issue". Anticipated benefits from the arrangement with Comparex could be adversely affected if Comparex does not sell Sequent products at the expected levels. 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 2, 1999. The Company's forward-looking statements apply only as of the date made. The Company undertakes no obligation to publicly release the results of any revisions to forward-looking statements which may be made to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events. Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibit 11 - Statement regarding computation of earnings per share (b) Exhibit 27 - Financial Data Schedule (c) The Company filed a report on Form 8-K, dated March 26, 1999, reporting under Item 4 the approval of the Audit Committee of the Board of Directors to dismiss PricewaterhouseCoopers LLP as its independent auditors. The Company is in the process of selecting new independent auditors for its current fiscal year. 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 Robert S. Gregg Sr. Vice President of Finance and Legal and Chief Financial Officer Date: May 17, 1999 Exhibit 11 SEQUENT COMPUTER SYSTEMS, INC. AND SUBSIDIARIES STATEMENT SHOWING CALCULATION OF THE BASIC AND DILUTED EARNINGS PER SHARE (In thousands, except per share amounts)
Income Shares Per-Share (Numerator) (Denominator) Amount Three Months Ended Three Months Ended Three Months Ended Apr. 3, Apr. 4, Apr. 3, Apr. 4, Apr. 3, Apr. 4, 1999 1998 1999 1998 1999 1998 Basic EPS Income available to common shareholders $ 1,220 $ 4,022 42,961 43,184 $ .03 $ .09 Effect of Dilutive Securities Stock options 347 2,104 Employee stock purchase plan 187 107 Diluted EPS Income available to common shareholders + assumed conversions $ 1,220 $ 4,022 43,495 45,395 $ .03 $ .09
Exhibit 27 SEQUENT COMPUTER SYSTEMS, INC. FINANCIAL DATA SCHEDULE APRIL 3, 1999 Amount Item Number Item Description 153,455,000 5-02 (1) Cash and Cash Items - 5-02 (2) Marketable Securities 218,555,000 5-02 (3) (a) (1) Notes and Accounts Receivable-Trade 3,586,000 5-02 (4) Allowances for Doubtful Accounts 95,033,000 5-02 (6) Inventory 510,898,000 5-02 (9) Total Current Assets 354,769,000 5-02 (13) Property, Plant and Equipment 214,283,000 5-02 (14) Accumulated Depreciation 761,672,000 5-02 (18) Total Assets 213,600,000 5-02 (21) Total Current Liabilities - 5-02 (22) Bonds, Mortgages and Similar Debt - 5-02 (28) Preferred Stock - Mandatory Redemption - 5-02 (29) Preferred Stock - No Mandatory Redemption 421,000 5-02 (30) Common Stock 494,567,000 5-02 (31) Other Shareholders Equity 761,672,000 5-02 (32) Total Liabilities and Stockholders' Equity 120,528,000 5-03 (b) 1(a) Net Sales of Tangible Products 193,979,000 5-03 (b) 1 Total Revenue 77,184,000 5-03 (b) 2(a) Cost of Tangible Goods Sold 193,919,000 5-03 (b) 2 Total Costs and Expenses Applicable to Sales and Revenues 80,000 5-03 (b) 3 Other Costs and Expenses - 5-03 (b) 5 Provision for Doubtful Accounts and Notes 418,000 5-03 (b) 8 Interest and Amortization of Debt Discount 1,596,000 5-03 (b) (10) Income Before Taxes and Other Items 376,000 5-03 (b) (11) Income Tax Expenses 1,220,000 5-03 (b) (14) Income/Loss Continuing Operations - 5-03 (b) (15) Discontinued Operations - 5-03 (b) (17) Extraordinary Items - 5-03 (b) (18) Change in Accounting Principle 1,220,000 5-03 (b) (19) Net Income or Loss 0.03 5-03 (b) (20) Earnings Per Share - Basic 0.03 5-03 (b) (20) Earnings Per Share - Diluted EX-27 2
5 3-MOS DEC-27-1997 JUN-28-1997 54,688 0 240,526 3,287 82,262 454,279 322,162 183,000 676,862 261,978 13,711 0 0 351 326,309 676,862 154,422 210,653 78,590 120,788 76,059 300 1,541 0 3,991 8,597 0 0 0 8,597 0.23 0.23
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