1
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 June 30, 1998
or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number 0-22495
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.)
12377 MERIT DRIVE, SUITE 1100
DALLAS, TEXAS 75251
(Address of principal executive offices) (Zip Code)
(972) 383-5600
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
As of July 31, 1998, the registrant had outstanding 38,416,170 shares of Class A
Common Stock.
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PEROT SYSTEMS CORPORATION
FORM 10-Q
For the Quarter Ended June 30, 1998
INDEX
Page
PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS (Unaudited)
Condensed Consolidated Balance Sheets as of June 30, 1998 and
December 31, 1997........................................................ 1
Condensed Consolidated Statements of Operations for the three months
and six months ended June 30, 1998 and 1997.............................. 2
Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 1998 and 1997............................................. 3
Notes to Condensed Consolidated Financial Statements..................... 4-9
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................ 10-16
PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS................................................................ 17
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................... 17
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K.................................................. 18
SIGNATURES................................................................................ 19
EXHIBIT INDEX............................................................................. 20
3
ITEM 1: FINANCIAL STATEMENTS
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
ASSETS
JUNE 30, 1998 DECEMBER 31, 1997
------------- -----------------
Current assets:
Cash and cash equivalents ............................................ $ 68,256 $ 35,298
Accounts receivable, net ............................................. 140,527 105,230
Prepaid expenses and other ........................................... 16,721 12,578
Deferred income taxes ................................................ 28,958 24,962
------------ ------------
Total current assets ............................................. 254,462 178,068
Property, equipment and purchased software, net ........................... 40,663 50,703
Other assets .............................................................. 36,497 38,332
------------ ------------
Total assets ..................................................... $ 331,622 $ 267,103
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities on capital lease obligations and long-term debt ... $ 1,241 $ 1,367
Accounts payable ..................................................... 56,313 35,760
Accrued liabilities .................................................. 82,800 76,040
Accrued compensation ................................................. 34,182 23,449
Other current liabilities ............................................ 38,473 33,545
------------ ------------
Total current liabilities ........................................ 213,009 170,161
Capital lease obligations and long-term debt, less current maturities ..... 1,150 1,532
Other long-term liabilities ............................................... 1,922 2,094
------------ ------------
Total liabilities ................................................ 216,081 173,787
------------ ------------
Stockholders' equity:
Common stock ......................................................... 406 406
Other stockholders' equity ........................................... 115,964 93,704
Accumulated other comprehensive income ............................... (829) (794)
------------ ------------
Total stockholders' equity ....................................... 115,541 93,316
------------ ------------
Total liabilities and stockholders' equity ....................... $ 331,622 $ 267,103
============ ============
The accompanying notes are an integral part of these financial statements.
Page 1
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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(SHARES AND DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
1998 1997 1998 1997
--------- --------- --------- ---------
Revenue ................................................ $ 238,625 $ 185,011 $ 452,712 $ 354,082
Costs and expenses:
Direct cost of services ......................... 189,973 148,936 359,891 278,650
Selling, general and administrative expenses .... 33,269 32,814 66,050 63,659
--------- --------- --------- ---------
Operating income ....................................... 15,383 3,261 26,771 11,773
Interest income ........................................ 793 300 1,579 923
Interest expense ....................................... (45) (273) (126) (500)
Equity in earnings/(losses) of affiliate ............... 1,529 253 2,511 226
Other income/(expense), net ............................ (100) (330) 2,554 1,660
--------- --------- --------- ---------
Income before taxes .................................... 17,560 3,211 33,289 14,082
Provision for income taxes ............................. 7,460 1,796 14,145 5,984
--------- --------- --------- ---------
Net income ...................................... $ 10,100 $ 1,415 $ 19,144 $ 8,098
========= ========= ========= =========
Basic and diluted earnings per common share:
Basic earnings per common share ................. $ 0.26 $ 0.04 $ 0.50 $ 0.20
Weighted average common shares outstanding ...... 38,302 39,875 38,224 39,754
Diluted earnings per common share ............... $ 0.21 $ 0.03 $ 0.40 $ 0.16
Weighted average diluted common shares
outstanding ..................................... 48,317 48,628 47,456 49,159
The accompanying notes are an integral part of these financial statements.
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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
1998 1997
------------ ------------
Cash flows from operating activities:
Net income ............................................................ $ 19,144 $ 8,098
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization ..................................... 16,826 15,162
Other non-cash items .............................................. (3,650) 3,195
Changes in current assets ......................................... (39,829) 5,804
Changes in current liabilities .................................... 39,938 (26,526)
------------ ------------
Net cash provided by operating activities ................ 32,429 5,733
------------ ------------
Cash flows from investing activities:
Purchase of property, equipment and software .......................... (12,613) (23,633)
Proceeds from sale of property, equipment and software ................ 7,530 525
Acquisition of businesses, net of cash acquired of $532 in 1997 ....... -- (13,452)
Proceeds from sale of nonmarketable equity securities ................. 5,162 --
Investments in and advances to minority interests ..................... (358) (3,082)
------------ ------------
Net cash used in investing activities .................... (279) (39,642)
------------ ------------
Cash flows from financing activities:
Principal payments on debt and capital lease obligations .............. (513) (1,571)
Proceeds from short-term borrowings ................................... -- 18,800
Proceeds from issuance of common stock ................................ -- 381
Proceeds from sale of stock options ................................... -- 8,139
Proceeds from issuance of treasury stock .............................. 2,247 560
Repayment of stockholder notes receivable ............................. 164 171
Purchase of treasury stock ............................................ (890) (1,388)
------------ ------------
Net cash provided by financing activities ................ 1,008 25,092
------------ ------------
Effect of exchange rate changes on cash and cash equivalents ................. (200) (1,716)
------------ ------------
Net increase/(decrease) in cash and cash equivalents ......................... 32,958 (10,533)
Cash and cash equivalents at beginning of period ............................. 35,298 27,516
------------ ------------
Cash and cash equivalents at end of period ................................... $ 68,256 $ 16,983
============ ============
The accompanying notes are an integral part of these financial statements.
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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(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 inter-company 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, 1997 as filed in the Company's
Registration Statement on Form 10-K filed with the SEC on March 31, 1998.
Operating results for the three-month and six-month periods ended June 30, 1998
are not necessarily indicative of the results for the year ending December 31,
1998. Dollar amounts presented are in thousands, except as otherwise noted.
Certain of the 1997 amounts in the accompanying financial statements have been
reclassified to conform to the current presentation.
NOTE 2. IMPLEMENTATION OF NEW ACCOUNTING STANDARD
The Company implemented Statement of Financial Accounting Standard No. 130,
"Reporting Comprehensive Income" during the first quarter of 1998. The Company's
total comprehensive income was as follows:
For the Three months For the Six months
Ended June 30 Ended June 30
------------- -------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
Net income .................................. $ 10,100 $ 1,415 $ 19,144 $ 8,098
Foreign currency translation adjustments .... 163 (314) (35) (1,476)
----------- ----------- ----------- -----------
Total comprehensive income .................. $ 10,263 $ 1,101 $ 19,109 $ 6,622
=========== =========== =========== ===========
NOTE 3. ACQUISITIONS
There were no acquisitions during the three or six months ended June 30, 1998.
During the first and second quarter of 1997, the Company completed five business
acquisitions accounted for under the purchase method of accounting.
Collectively, total consideration included $14,386 in cash, $2,701 in the form
of 370,000 shares of the Company's Class A Common Stock, and $1,500 in the form
of 550,000 options to purchase the Company's Class A Common Stock. On the basis
of a proforma consolidation of the results of operations as if the acquisitions
had taken place on January 1, 1997 and January 1, 1996, the impact on revenue,
net income and earnings per share would not have been material.
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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
During the six months ended June 30, 1997, the Company purchased an interest in
an unconsolidated entity for $1,000. During the three months and six months
ended June 30, 1997, the Company invested an additional $494 and $1,527 in an
existing unconsolidated limited partnership capital fund. In January, 1998, the
Company sold its entire investment in the fund for $5,162, recognized a gain of
$2,986, and has no future commitment to the fund.
NOTE 4. BORROWINGS
There were no borrowings outstanding under the Company's $40,000 line of credit
at June 30, 1998 and December 31, 1997. This facility expired July 31, 1998, and
was renewed pursuant to the same terms until January 31, 1999.
NOTE 5. STOCKHOLDERS' EQUITY
The components of other stockholders' equity were as follows:
June 30, 1998 December 31, 1997
-------------- -----------------
Additional paid-in-capital ................................. $ 67,562 $ 61,546
Retained earnings .......................................... 58,191 39,047
Treasury stock ............................................. (4,687) (3,950)
Notes receivable from stockholders ......................... (1,676) (2,939)
Deferred compensation ...................................... (3,426) --
------------ ------------
Total other stockholders' equity ........................... $ 115,964 $ 93,704
============ ============
The primary factors causing an increase in paid-in capital were a $3,582
increase in deferred compensation expense and a $1,854 tax benefit relating to
employee stock options exercised during the period. The deferred compensation
expense was related to options granted during the six months ended June 30,
1998, and represented the difference between the option exercise price and the
fair value of the underlying common stock. The Company recognized $156 of
compensation expense during the six months ended June 30, 1998 and will amortize
the remaining deferred compensation ratably over the respective vesting periods
of the option grants. Prior to any option forfeitures resulting from employee
attrition, the estimated amount of deferred compensation expense to be
recognized during 1998 is $273 and approximately $362 for each year through
2008. The increase in retained earnings of $19,144 represented net income for
the period.
At June 30, 1998, there were 38,308,790 shares of the Company's Class A Common
Stock outstanding, 50,000 shares of the Company's Class B Convertible Common
Stock and 2,222,154 Class A shares held in treasury. At December 31, 1997, there
were 38,227,707 shares of the Company's Class A Common Stock outstanding, 50,000
shares of the Company's Class B Convertible Common Stock and 2,297,112 Class A
shares held in treasury.
NOTE 6. OTHER
In April 1998, the Company paid a fee of $536 to terminate a contract-related
interest rate swap agreement. In the second quarter of 1998, the Company
recorded a loss accrual of $2,750 to direct cost of services in connection with
the planned abandonment of certain leased properties.
Page 5
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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
NOTE 7. EARNINGS PER SHARE
In 1997, the Company adopted Statement of Financial Accounting Standards No. 128
(SFAS 128), "Earnings Per Share", effective for fiscal years ending after
December 15, 1997. SFAS 128 replaces the presentation of primary earnings per
common share with basic earnings per share, with the principal difference being
that common stock equivalents are not considered in computing basic earnings per
share. The Earnings Per Share amounts for the three months and six months ended
June 30, 1997, are restated for the effect of SFAS 128. The following chart is a
reconciliation of the numerators and the denominators of the basic and diluted
per-share computations.
SHARES PER-SHARE
INCOME (IN THOUSANDS) AMOUNT
------------ -------------- ------------
FOR THE QUARTER ENDED JUNE 30, 1998
- -----------------------------------
BASIC EARNINGS PER COMMON SHARE
Net income attributed to common shareholders ..... $ 10,100 38,302 $ 0.26
============
Dilutive options ................................. -- 10,015
------------ --------------
DILUTED EARNINGS PER COMMON SHARE
Net income attributed to common shareholders
Plus assumed conversions ....................... $ 10,100 48,317 $ 0.21
============ ============== ============
FOR THE QUARTER ENDED JUNE 30, 1997
BASIC EARNINGS PER COMMON SHARE
Net income attributed to common shareholders ..... $ 1,415 39,875 $ 0.04
============
Dilutive options ................................. -- 8,753
------------ --------------
DILUTED EARNINGS PER COMMON SHARE
Net income attributed to common shareholders
Plus assumed conversions ....................... $ 1,415 48,628 $ 0.03
============ ============== ============
FOR THE SIX MONTHS ENDED JUNE 30, 1998
BASIC EARNINGS PER COMMON SHARE
Net income attributed to common shareholders ..... $ 19,144 38,224 $ 0.50
============
Dilutive options ................................. -- 9,232
------------ --------------
DILUTED EARNINGS PER COMMON SHARE
Net income attributed to common shareholders
Plus assumed conversions ....................... $ 19,144 47,456 $ 0.40
============ ============== ============
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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 1997
- --------------------------------------
Net income............................................... $ 8,098
Less preferred stock dividend............................ --
-------
BASIC EARNINGS PER COMMON SHARE
Net income attributed to common shareholders............. 8,098 39,754 $ 0.20
======
Dilutive options......................................... 9,405
------- ------
DILUTED EARNINGS PER COMMON SHARE
Net income attributed to common shareholders
Plus assumed conversions............................... $ 8,098 49,159 $ 0.16
======= ====== ======
NOTE 8. YEAR 2000 COMPLIANCE
The inability of computers, software and other equipment utilizing
microprocessors to recognize and properly process date fields containing a 2
digit year is commonly referred to as the Year 2000 Compliance issue. As the
year 2000 approaches, such systems could be unable to accurately process certain
date-based information. The Company believes it has identified all significant
applications that will require modification to ensure Year 2000 Compliance and
does not believe compliance with the Year 2000 requirements will have a material
adverse effect on the Company's business or results of operations. The Company
is performing an assessment of its obligations to make any of its client's
systems Year 2000 compliant, including an estimate of the cost and revenues to
be incurred in fulfilling such obligations, and monitors this assessment on an
ongoing basis.
The Company estimates the total cost of completing any required modifications,
upgrades, or replacements of its internal systems to be approximately $1,000,
almost all of which the Company believes will be incurred during the remainder
of 1998 and 1999. This estimate is being monitored and will be revised as
additional information becomes available. In addition, the Company recorded a
$5,196 charge in direct cost of services during the second quarter of 1998 to
address Year 2000 exposures for certain client contracts.
NOTE 9: NEW ACCOUNTING DEVELOPMENTS
In June 1997, the Financial Accounting Standard Board ("FASB") issued SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information"
("Statement 131") effective for years beginning after December 15, 1997.
Statement 131 requires that a public company report financial and descriptive
information about its reportable operating segments pursuant to criteria that
differ from current accounting practice. Operating segments, as defined, are
components of an enterprise about which separate financial information is
available that is evaluated regularly by management in deciding how to allocate
resources and in assessing performance. The financial information to be reported
includes segment profit or loss, certain revenue and expense items and segment
assets and reconciliations to corresponding amounts in the financial statements.
Statement 131 also requires information about revenues from products or
services, countries where the company has operations or assets and major
customers. Management does not believe the implementation of Statement 131 will
have a material impact on its consolidated financial statements.
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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
In June 1998, the FASB issued SFAS No. 133 which establishes accounting and
reporting standards for derivative instruments and for hedging activities. The
Statement requires that an entity recognize all derivatives as either assets or
liabilities in the balance sheet at fair value. If certain conditions are met, a
derivative may be specifically designated as a fair value hedge, a cash flow
hedge, or a foreign currency hedge. A specific accounting treatment applies to
each type of hedge. SFAS No. 133 is effective for all fiscal quarters of fiscal
years beginning after June 15, 1999. SFAS No. 133 is not expected to have a
material impact on the Company's financial statements.
The American Institute of Certified Public Accountants (the "AICPA") issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," in March 1998. SOP 98-1
provides guidance on accounting for the costs of computer software developed or
obtained for internal use and requires costs incurred in the application
development stage (whether internal or external) to be capitalized. This SOP is
applicable to all financial statements for fiscal years beginning after December
15, 1998, and should be applied to internal-use computer software costs incurred
in those fiscal years for all projects, including those projects in progress
upon initial application of this SOP. Costs incurred prior to initial
application of this SOP, whether or not capitalized, should not be adjusted to
the amounts that would have been capitalized had this SOP been in effect when
those costs were incurred. The adoption of this SOP is not expected to have a
material impact on the annual financial position or operating results of the
Company.
Note 10. SUBSEQUENT EVENTS
On August 5, 1998, the Company filed a registration statement with the
Securities and Exchange Commission for an initial public offering of the
Company's Class A Common Stock. The proposed maximum aggregate offering price is
$115,000 and the number of shares to be issued has not yet been determined.
In July, 1998, the Board of Directors adopted an employee stock purchase plan
("the ESPP"), which provides for the issuance of a maximum of 10,000,000 shares
of Common Stock. The ESPP will become effective immediately following the
proposed initial public offering of the Company's Class A Common Stock. Eligible
employees may have up to 10% of their earnings withheld, to be used to purchase
shares of the Company's Common Stock on specified dates determined by the Board
of Directors. The price of the Common Stock purchased under the ESPP will be
equal to 85% of the fair value of the stock on the exercise date for the
offering period.
In July, 1998, the Board of Directors approved an amendment to the Company's
Certificate of Incorporation which includes an increase in the authorized number
of shares of Class A Common Stock to 200,000,000 from 100,000,000 shares. The
Company intends to submit the proposed amendment to its stockholders for
approval on or about August 19, 1998.
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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
The Board of Directors of Perot Systems anticipates authorizing the Company to
enter into a Stockholder Rights Plan (the "Rights Plan"), providing that one
Class A right (a "Class A Right") will be attached to each share of Class A
Common Stock and one Class B right (a "Class B Right", and together with the
Class A Rights, the "Rights") will be attached to each share of Class B Common
Stock as of the record Date to be determined by the Executive Committee of the
Board of Directors. Each Right will entitle the registered holder to purchase
from the Company a unit (a "Unit") consisting of one one-hundredth of a share of
Series A Junior Participating Preferred Stock, par value $0.01 per share (the
"Preferred Stock"), at a purchase price to be determined by the Executive
Committee of the Board of Directors, which price will be subject to adjustment.
The Rights will not be exercisable until the Distribution Date and will expire
ten years following the adoption of the Rights Plan, unless earlier redeemed by
the Company as described below. At any time until 10 days following the Stock
Acquisition Date, the Company may redeem the Rights in whole, but not in part,
at a price of $.01 per Right. The ten day redemption period may be extended by
the Board of Directors so long as the Rights are still redeemable. Immediately
upon the action of the Board of Directors ordering redemption of the Rights, the
Rights will terminate and the only right of the holders of Rights will be to
receive the $.01 redemption price.
The Rights have certain anti-takeover effects. The Rights will cause substantial
dilution to a person or group that attempts to acquire the Company in certain
circumstances. Accordingly, the existence of the Rights may deter certain
acquirors from making takeover proposals or tender offers. The Rights are
designed to enhance the ability of the Board of Directors to negotiate with an
acquiror on behalf of all of the shareholders.
Page 9
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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 June 30, 1998 and 1997
Revenue increased in the second quarter of 1998 by 29.0% to $238.6
million from $185.0 million in 1997, due to the entry of two significant
contracts in the third quarter of 1997 that generated $24.7 million in the three
months ended June 30, 1998, $1.8 million in additional revenue resulting from
the inclusion of businesses acquired in the second quarter of 1997 for the
entire three month period in 1998, and a $27.1 million increase in revenue from
other new and existing business, including $3.9 million from UBS AG ("UBS"),
formerly Swiss Bank Corporation.
Domestic revenue grew by 23.9% in the second quarter of 1998 to
$156.6 million from $126.4 million in the second quarter of 1997, and decreased
slightly as a percentage of total contract revenue to 65.6% from 68.3% over the
same period.
Non-domestic revenue, comprising European and Asian operations, grew
by 39.9% in the second quarter of 1998 to $82.0 million from $58.6 million in
the second quarter of 1997, and increased as a percentage of total contract
revenue to 34.4% from 31.7%. Asian operations represented $3.5 million, or 1.5%,
and $2.1 million, or 1.1%, of total revenue for the three months ended June 30,
1998 and 1997, respectively.
Direct cost of services increased in the second quarter of 1998 by
27.6% to $190.0 from $148.9 million in the second quarter of 1997, due primarily
to continued growth in the Company's business. Gross margins (contract revenue
less direct costs of services) increased slightly to 20.4% from 19.5% for the
quarter ended June 30, 1998 compared to the quarter ended June 30, 1997, due to
overall improvement in contribution margins on contracts offset by the
recognition of a $5.2 million charge in the second quarter of 1998 to address
Year 2000 exposures for certain client contracts, and an additional expense of
$2.8 million recognized in the second quarter of 1998 related to the abandonment
and sublease of unused office space.
Selling, general, and administrative expenses increased slightly in
the second quarter of 1998 by 1.5% to $33.3 million from $32.8 million in the
second quarter of 1997, but decreased as a percentage of total contract revenue
to 14.0% from 17.7% due to the Company's increased focus on expense reduction
and cost control over the last year. The most significant savings in
administrative expenses included reductions in executive compensation, the
cancellation of discretionary projects, and reductions in marketing and
promotional expenses, and non-essential travel. As a result of the factors noted
above, operating income increased in the second quarter of 1998 to $15.3 million
from $3.3 million in the second quarter of 1997, and operating margin (operating
income as a percentage of contract revenue) increased to 6.4% from 1.8%.
Page 10
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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Equity in earnings of unconsolidated affiliates, net, increased in the
second quarter ended June 30, 1998 to $1.5 million from $0.2 million during the
quarter ended June 30, 1997 due to improved results at Systor AG ("Systor"), a
subsidiary of UBS, and at HCL Perot Systems N.V. ("HPS"), a software joint
venture based in India. The equity in earnings for Systor increased to $0.8
million from $0.2 million and equity in earnings for HPS increased to $0.7
million from zero during the quarter ended June 30, 1998 and 1997, respectively.
Net income increased 621.4% in the second quarter of 1998 to $10.1
million from $1.4 million in the second quarter of 1997 and net income margin
increased to 4.2% from .8%.
Comparison of the six months ended June 30, 1998 and 1997
Revenue increased in the six months ended June 30, 1998 by 27.9% to
$452.7 million from $354.1 million in the six months ended June 30, 1997, due to
the entry into two significant contracts in the third quarter of 1997 that
generated $43.9 million in the six months ended June 30, 1998, $13.3 million in
additional revenue resulting from the inclusion of businesses acquired in the
first six months of 1997 for the entire six month period in 1998, and a $41.4
million increase in revenue from other new and existing business, including $3.9
million from UBS.
Domestic revenue grew by 24.7% in the six months ended June 30, 1998
to $296.1 million from $237.4 million in the six months ended June 30, 1997, and
decreased slightly as a percentage of total revenue to 65.4% from 67.0% over the
same period.
Non-domestic revenue, comprising European and Asian operations, grew
by 34.2% in the six months ended June 30, 1998 to $156.6 million from $116.7
million in the six months ended June 30, 1997, and increased as a percentage of
total revenue to 34.6% from 33.0%. Asian operations represented $6.0 million, or
1.3%, and $4.5 million, or 1.3%, of total revenue for the six months ended June
30, 1998 and 1997, respectively.
Direct cost of services increased in the six months ended June 30,
1998 by 29.2% to $359.9 from $278.6 million in the six months ended June 30,
1997, due primarily to continued growth in the Company's business. Gross margin
decreased slightly to 20.5% from 21.3% for the six months ended June 30, 1998
compared to the six months ended June 30, 1997, due in part to the recognition
of a $5.2 million charge in the second quarter of 1998 to address Year 2000
Problem-related exposures for certain client contracts, and an additional
expense of $2.8 million recognized in the first half of 1998 related to the
abandonment and sublease of unused office space.
Selling, general, and administrative expenses increased in the six
months ended June 30, 1998 by 3.8% to $66.1 million from $63.7 million in the
six months ended June 30, 1997, but decreased as a percentage of total contract
revenue to 14.6% from 18.0%, respectively, due primarily to the Company's cost
control measures. As a result, operating income increased in the six months
ended June 30, 1998 to $26.7 million from $11.8 million in the six months ended
June 30, 1997, and operating margin (operating income as a percentage of
contract revenue) increased to 5.9% from 3.3%.
Page 11
14
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Equity in earnings of unconsolidated affiliates, net, increased in the
six months ended June 30, 1998 to $2.5 million from $0.2 million during the six
months ended June 30, 1997 due to improved results at Systor and at HPS. The
equity in earnings for Systor increased to $1.2 million from $0.4 million and
for HPS increased to equity in earnings of $1.3 million from equity in losses of
$0.2 million during the six months ended June 30, 1998 and 1997, respectively.
Other income/(expense) increased in the six months ended June 30, 1998 to $2.6
million from $1.7 million in the six months ended June 30, 1997 primarily due to
the $3.0 million gain on the sale of the Company's limited partnership interests
in a venture capital fund, which was offset in part by a $1.3 million decrease
in foreign exchange gains and a $0.8 million decrease in gains on asset sales.
Net income increased 135.8% in the six months ended June 30, 1998 to
$19.1 million from $8.1 million in the six months ended June 30, 1997 and net
income margin increased to 4.2% from 2.3%.
LIQUIDITY AND CAPITAL RESOURCES
During the six months ended June 30, 1998, cash and cash equivalents
increased 93.5% to $68.3 million from $35.3 million at December 31, 1997
primarily due to increased cash flow from operating activities.
Cash flow provided by operating activities increased to $32.4 million
from $5.7 million for the periods ended June 30, 1998 and 1997, respectively.
The increase in cash flow from operating activities was due primarily to general
business growth and increased focus on the timely collection of accounts
receivable. There was a $65.0 million increase in current liabilities such as
accounts payable, deferred revenue, and accrued compensation, offset in part by
a $46.1 million increase in current assets consisting primarily of increased
accounts receivable.
Net cash used in investing activities was $0.3 million for the six
months ended June 30, 1998. Cash expenditures for property, equipment and
software during the six months ended June 30, 1998 was $12.6 million and was
substantially offset by proceeds from the sale of property and equipment and the
sale of the Company's limited partnership interest in a venture capital fund.
Cash used for business acquisitions was $13.5 million for the six months ended
June 30, 1997 compared to zero in the six months ended June 30, 1998.
For the six months ended June 30, 1998, net cash provided by financing
activities was approximately $1.0 million, compared to $25.1 million for the six
months ended June 30, 1997. This decrease was due primarily to a $18.8 million
borrowing on the Company's line of credit at June 30, 1997, which was paid off
in full by December 31, 1997 and there were no borrowings at June 30, 1998. In
addition, during the six months ended June 30, 1997, the Company received
proceeds of $8.1 million from the sale of stock options to UBS, whereas no
proceeds were received for the six months ended June 30, 1998.
Page 12
15
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
As of July 31, 1998, the Company had a $40.0 million undrawn line of
credit with a financial institution that expires in January 1999. The Company
anticipates that 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.
NEW ACCOUNTING DEVELOPMENTS
In June 1997, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("Statement 131") effective for years beginning after December 15,
1997. Statement 131 requires that a public company report financial and
descriptive information about its reportable operating segments pursuant to
criteria that differ from current accounting practice. Operating segments, as
defined, are components of an enterprise about which separate financial
information is available that is evaluated regularly by management in deciding
how to allocate resources and in assessing performance. The financial
information to be reported includes segment profit or loss, certain revenue and
expense items and segment assets and reconciliations to corresponding amounts in
the financial statements. Statement 131 also requires information about revenues
from products or services, countries where the company has operations or assets
and major customers. Management does not believe the implementation of Statement
131 will have a material impact on its consolidated financial statements.
In June 1998, the FASB issued SFAS No. 133 which establishes
accounting and reporting standards for derivative instruments and for hedging
activities. The Statement requires that an entity recognize all derivatives as
either assets or liabilities in the balance sheet at fair value. If certain
conditions are met, a derivative may be specifically designated as a fair value
hedge, a cash flow hedge, or a foreign currency hedge. A specific accounting
treatment applies to each type of hedge. SFAS No. 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. SFAS No. 133 is
not expected to have a material impact on the Company's financial statements.
The American Institute of Certified Public Accountants (the "AICPA")
issued Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," in March 1998. SOP 98-1
provides guidance on accounting for the costs of computer software developed or
obtained for internal use and requires costs incurred in the application
development stage (whether internal or external) to be capitalized. This SOP is
applicable to all financial statements for fiscal years beginning after December
15, 1998, and should be applied to internal-use computer software costs incurred
in those fiscal years for all projects, including those projects in progress
upon initial application of this SOP. Costs incurred prior to initial
application of this SOP, whether or not capitalized, should not be adjusted to
the amounts that would have been capitalized had this SOP been in effect when
those costs were incurred. The adoption of this SOP is not expected to have a
material impact on the annual financial position or operating results of the
Company.
YEAR 2000 ISSUES
Some computers, software, and other equipment includes 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 or "Year 2000
Problem".
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16
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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 is currently assessing 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. In
addition, the Company is performing assessments for some other customers.
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 or its corrections of Year 2000 Problems.
However, the Company's Year 2000 project team is reviewing the project plans
prepared by each of the Company's business units and monitoring 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 commenced the process of modifying, upgrading, and replacing
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.
The Company has commenced the process of identifying other
computers, software, and other equipment that may be affected by the Year 2000
Problem, and determining whether remedial action is needed. The Company expects
to complete this process before the end of 1998.
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 is currently assessing the potential effect of, and costs of
remediating, the Year 2000 Problem on its office and facilities equipment.
The Company estimates the total cost to the Company of completing
any required modifications, upgrades, or replacements of these internal systems
to be approximately $1.0 million, almost all of which the Company believes will
be incurred during the remainder of 1998 and 1999. 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.
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. Management believes that 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. The Company recorded a $5.2 million
charge in direct cost of services during the second quarter of 1998 to address
Year 2000 Problem exposures for certain client contracts.
Page 14
17
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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 expects to
identify and 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 is currently 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 expects
to complete its contingency plans by the end of 1998. Depending on the systems
affected, these plans could 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.
Page 15
18
PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Company is also developing 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
could 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.
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
The European Union is moving towards economic and monetary union in
Europe, with the goal of introducing a single currency called the EURO. The
Company is currently assessing the effect of the EURO conversion.
Page 16
19
PEROT SYSTEMS CORPORATION
FORM 10-Q
For the Quarter Ended June 30, 1998
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company held its annual meeting of shareholders of the Company
on May 5, 1998. The purpose of the meeting was to elect nine nominees to serve
as directors of the Company and ratify the selection of PricewaterhouseCoopers
LLP as the Company's independent accountants for the fiscal year ending December
31, 1998. The number of shares voted with respect to each nominee was as
follows:
Nominee For Withheld
- ------- --- --------
Ross Perot................................... 28,154,892 5,808
James Champy................................. 27,784,410 380,283
Steve Blasnik................................ 27,265,886 898,807
Carl Hahn ................................... 28,089,290 75,403
George Heilmeier............................. 28,135,340 29,353
Ross Perot, Jr............................... 27,310,332 854,361
There were no broker non-votes. All of the nominees were elected to the Board of
Directors. These directors constituted the entire Board of Directors of the
Company. The selection of PricewaterhouseCoopers LLP as the Company's
independent accountants for the fiscal year ended December 31, 1998 was ratified
by the shareholders. The vote was 28,100,990 for and 5,400 against with the
holders of 53,333 shares abstaining.
Page 17
20
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required by Item 601 of Regulation S-K
Exhibit No. Document
----------- --------
27 Financial Data Schedule
(b) Reports of Form 8-K
No reports were filed on Form 8-K during the three months ended
June 30, 1998.
Page 18
21
PEROT SYSTEMS CORPORATION
FORM 10-Q
For the Quarter Ended June 30, 1998
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: August 13, 1998 By /s/ TERRY ASHWILL
----------------------------------
Terry Ashwill
Vice President and Chief Financial Officer
Page 19
22
PEROT SYSTEMS CORPORATION
FORM 10-Q
For the Quarter Ended June 30, 1998
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
27 Financial Data Schedule as of June 30, 1998.
Page 20