<PAGE>
 
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                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                               ----------------
 
                                   FORM 10-K
 
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE 
    ACT OF 1934
 
    FOR THE FISCAL YEAR ENDED SEPTEMBER 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 NO. 1-14196
 
                               ----------------
 
                            STERLING COMMERCE, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                            <C>
                  DELAWARE                                       75-2623341
        (STATE OR OTHER JURISDICTION                          (I.R.S. EMPLOYER
      OF INCORPORATION OR ORGANIZATION)                     IDENTIFICATION NO.)
</TABLE>
 
              300 CRESCENT COURT, SUITE 1200 DALLAS, TEXAS 75201
         (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
 
                                (214) 981-1100
             (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
                               ----------------
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
 
<TABLE>
<S>                                            <C>
             TITLE OF EACH CLASS                 NAME OF EACH EXCHANGE ON WHICH REGISTERED
             -------------------                 -----------------------------------------
        Common Stock, $0.01 Par Value                     New York Stock Exchange
 Rights to Purchase Series A Junior                     New York Stock Exchange
               Participating
       Preferred Stock, $0.01 Par Value
</TABLE>
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
 
                                     NONE
 
                               ----------------
 
  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. Yes [X] No [_]
 
  Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
 
  As of November 13, 1998, the aggregate market value of the Registrant's
Common Stock held by non-affiliates of the Registrant was $3,123,158,402,
based on the closing sales price of $33 1/2 of the Registrant's Common Stock
on the New York Stock Exchange. All executive officers and directors of the
Registrant have been deemed, solely for the purpose of the foregoing
calculation, to be "affiliates" of the Registrant.
 
  As of November 13, 1998, 94,564,538 shares of the Registrant's Common Stock
were outstanding.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
  Portions of the proxy statement for the annual meeting of the Registrant to
be held during 1999 are incorporated by reference in Part III.
 
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<PAGE>
 
                            STERLING COMMERCE, INC.
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
 FORM 10-K ITEM                                                           PAGE
 --------------                                                           ----
 <C>            <S>                                                       <C>
                                         PART I
 ITEM 1.        BUSINESS................................................    2
 ITEM 2.        PROPERTIES..............................................   12
 ITEM 3.        LEGAL PROCEEDINGS.......................................   12
 ITEM 4.        SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.....   12
                                         PART II
 ITEM 5.        MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
                 STOCKHOLDER MATTERS....................................   13
 ITEM 6.        SELECTED FINANCIAL DATA.................................   13
 ITEM 7.        MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                 CONDITION AND RESULTS OF OPERATIONS....................   14
                   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
 ITEM 7A.       RISK....................................................   28
 ITEM 8.        FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.............   28
 ITEM 9.        CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                 ACCOUNTING AND FINANCIAL DISCLOSURE....................   53
                                        PART III
 ITEM 10.       DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......   53
 ITEM 11.       EXECUTIVE COMPENSATION..................................   53
 ITEM 12.       SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                 MANAGEMENT.............................................   53
 ITEM 13.       CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..........   53
                                         PART IV
 ITEM 14.       EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
                 FORM 8-K...............................................   54
</TABLE>
<PAGE>
 
                                    PART I
 
ITEM 1. BUSINESS.
 
INTRODUCTION
 
  Sterling Commerce, Inc. (together with its predecessors and subsidiaries,
the "Company") is a leading provider of electronic commerce ("EC") products,
services and solutions worldwide. The Company develops, markets and supports
electronic commerce software products, and provides electronic commerce
services that enable businesses to engage in business-to-business electronic
communications and transactions. The Company has been providing electronic
commerce solutions for over 25 years and has numerous customers in many
industries, including banking, healthcare, manufacturing, pharmaceuticals,
retailing, telecommunications and transportation. The Company has operations
throughout the world, including 16 direct sales offices outside of North
America, a Pan-European support center in Amsterdam, an Asian support and
development center in Singapore and more than 40 distributors worldwide.
 
  The Company was incorporated in December 1995 as a wholly owned subsidiary
of Sterling Software, Inc. ("Sterling Software"). The Company completed its
initial public offering (the "Offering") on March 13, 1996. Pursuant to the
Offering, the Company sold to the public 1,800,000 previously unissued shares
of common stock, $0.01 par value, of the Company ("Common Stock"), and
Sterling Software sold to the public 12,000,000 of the 73,200,000 shares of
Common Stock then owned by it.
 
  In contemplation of the Offering, among other things: (1) Sterling Software
caused to be transferred to the Company certain assets relating to the
electronic commerce business previously conducted by Sterling Software and (2)
the Company entered into contractual arrangements with Sterling Software
related to, among other things, tax allocation, indemnification and
international marketing. See "Shared Management and Contractual Arrangements
with Sterling Software" below.
 
  On September 23, 1996, the Board of Directors of Sterling Software declared
a special dividend consisting of the distribution (the "Distribution") of all
shares of Common Stock held by Sterling Software on September 30, 1996,
payable pro rata to the holders of record of Sterling Software's common stock,
$0.10 par value ("Software Stock"), as of the close of business on such date.
As a result, effective September 30, 1996, the Company ceased to be a
subsidiary of Sterling Software.
 
  On February 28, 1997, the Company completed a public offering (the "Follow-
On Offering") of 14,375,000 previously unissued shares of Common Stock. The
net proceeds of $400,145,000 were added to the Company's working capital and
are being used for general corporate purposes, including acquisitions. Pending
such use, the funds are invested in investment grade debt securities and other
marketable securities.
 
  In June 1997, pursuant to an agreement (the "Termination Agreement") with
Sterling Software that terminated, effective as of June 30, 1997, the
International Distributor Agreement dated March 4, 1996, as amended (the
"International Marketing Agreement"), between the Company and Sterling
Software, the Company acquired certain assets and assumed certain liabilities
associated with the distribution of certain of the Company's products by
Sterling Software outside the United States and Canada. The Company also hired
certain Sterling Software employees, most of whom had been dedicated to the
sales and marketing of the Company's products.
 
ACQUISITIONS
 
  Throughout the Company's history, and particularly since the Distribution,
the Company has complemented its internal growth by actively pursuing
strategic acquisitions to expand its technologies, product offerings and
distribution capabilities. In fiscal 1997, the Company made several
acquisitions, including the acquisition of Comfirst S.A. ("Comfirst"), a
Paris, France based provider of communications and file transfer software and,
as described above, the Company's international distribution channel from
Sterling Software.
 
                                       2
<PAGE>
 
  In fiscal 1998, the Company made five additional acquisitions, including the
acquisition of XcelleNet, Inc. ("XcelleNet"), a provider of remote systems
management software and services; the electronic data interchange ("EDI")
software and services unit of o.tel.o Communications Gmbh & Co. ("o.tel.o"), a
Dusseldorf, Germany based telecommunications company; The Electronic Data
Exchange Service Limited ("EDES"), a London, England based provider of value-
added electronic data interchange network services and related PC-based
enabling software; and Network Integration Systems Pte Ltd. ("NIS") and
iCommerce Pte Ltd. ("iCommerce"), Singapore based providers of electronic
commerce software and services, including Web-based EC community management
software and services.
 
  For more information with respect to these acquisitions, see "1998 Business
Combinations and Reorganizations" in Item 7, Part II of this report and Note 4
of the Notes to Consolidated Financial Statements included in Item 8, Part II
of this report. Such information is incorporated herein by reference.
 
TARGETED MARKET
 
  The Company offers a comprehensive range of electronic commerce business
solutions for the business-to-business electronic commerce market. The Company
continually strives to understand the business requirements of the global
electronic commerce market, to address these requirements with flexible,
reliable and secure electronic commerce solutions and to deliver these
solutions in a cost efficient manner.
 
  The Company believes that many of today's business organizations operate as
extended enterprises that include an entity's divisions, plant sites and sales
offices, and also involve close partnering relationships with customers,
suppliers, banks and other trading partners. This extension of the enterprise
is often referred to as a supply chain. The Company's electronic commerce
solutions help to automate this supply chain by:
 
  .  Linking business processes within and between enterprises;
 
  .  Integrating different systems, such as various computing platforms,
     protocols and business document formats;
 
  .  Assisting in building and managing commerce community relationships; and
 
  .  Effecting electronic payments among companies and banks.
 
  These solutions focus on the business-to-business market and take advantage
of multiple technologies, including Internet-related technologies, to address
the needs of customers.
 
ORGANIZATIONAL STRUCTURE
 
  The Company operates primarily through the following three groups, each of
which offers a distinct family of products and services to the worldwide
business-to-business electronic commerce market: the Commerce Services Group,
the Interchange Software Group and the Communications Software Group. The
Company also provides EC education, consulting and outsourcing services for
three of its primary product families through the Company's newly formed
Managed Services Division and provides bank automation software through its
Banking Systems Division. The Company believes that its decentralized
organizational structure promotes operating flexibility, improves
responsiveness to customer requirements and focuses management on achieving
revenue and profit objectives.
 
REVENUE SOURCES
 
  The Company generates revenue from three sources--products, product support
and services--as follows:
 
  .  Products revenue is primarily derived from license fees from the
     Company's GENTRAN, CONNECT and VECTOR software product families.
     Products revenue is recognized at the time of product delivery, provided
     no significant vendor obligations exist and collection is probable.
 
                                       3
<PAGE>
 
  .  Product support revenue consists primarily of fees from product support
     agreements that generally provide customers with updated or enhanced
     versions of the Company's software products and telephone and Internet
     access to the Company's technical personnel. Product support revenue is
     deferred and recognized ratably over the term of the applicable product
     support agreement, which is generally from one to three years.
 
  .  Services revenue consists primarily of transaction fees for services
     offered as part of the COMMERCE family of products and is recognized at
     the time the service is performed. Services revenue also includes fees
     generated through the Company's Managed Services Division, which revenue
     is recognized at the time the service is performed.
 
  A majority of the Company's software customers enter into product support
agreements and renew such agreements prior to expiration of the support
agreement. Moreover, although most COMMERCE services agreements are cancelable
upon 30 days' notice, the Company's experience is that once customers initiate
use of the Company's COMMERCE services, they generally continue to use such
services. Accordingly, the Company considers revenue from product support and
COMMERCE services as recurring revenue. Recurring revenue increased
$51,835,000, or 26%, in 1998 as compared to 1997 and represented 51% of total
revenue in 1998 and 57% in 1997. The decrease in the relative percentage is
due to the Company receiving 100% of the revenues from the licensing of
products outside the United States and Canada in 1998 as opposed to a 50%
royalty on such revenues from Sterling Software in the first three quarters of
1997 pursuant to the International Marketing Agreement and also in part to the
significant growth in products revenue in 1998.
 
PRODUCTS AND SERVICES
 
 General
 
  The Company's approach to automating the supply chain incorporates five
interrelated software and services solutions layers:
 
  .  Software infrastructure for electronic commerce, including software for
     the secure movement of information and for remote systems management;
 
  .  Application integration software to integrate disparate systems within
     and between enterprises;
 
  .  Software to automate business processes, such as buying and selling over
     the World Wide Web ("Web");
 
  .  Community management services to build, manage and service business
     communities; and
 
  .  Managed services to provide education, training, consulting and
     outsourcing.
 
  The Company's four families of software products and services address these
solutions layers. Most of the Company's supported software products and
services accommodate four character year dating required to address Year 2000
issues. For those supported software products or services that do not, the
Company has established plans to upgrade such products or to offer alternative
software products, services or solutions. These plans have been integrated
into the Company's normal development cycles. See "Year 2000" in Item 7, Part
II of this report. Such information is incorporated herein by reference. A
brief description of each family of products is included in the following
table:
 
<TABLE>
<CAPTION>
       COMMERCE                 GENTRAN                 CONNECT                 VECTOR
       --------                 -------                 -------                 ------
<S>                     <C>                     <C>                     <C>
A family of EC          A family of EC message  A family of advanced   A family of bank
community management    management and data     file transfer and       automation software                  
and value-added         transformation          remote and mobile          products               
services                software products       management software                
                                                products
</TABLE>
 
                                       4
<PAGE>
 
 COMMERCE Family
 
  COMMERCE services and products, offered by the Company's Commerce Services
Group, are EC value-added services and software that allow companies to build,
manage and service their global commerce communities over the Internet and
private networks. These include vertical business application solutions that
take advantage of the Company's other product and services offerings. COMMERCE
solutions include:
 
  .  Community management services that help companies build, manage and
     service their global commerce communities;
 
  .  Industry-specific value-added applications;
 
  .  EC network services that facilitate the exchange and distribution of
     electronic business documents, the completion of commercial business
     transactions and the provision of automated catalog information;
 
  .  Virtual Industry Networks (VIN);
 
  .  Electronic payment products;
 
  .  Year 2000 compliance testing solutions;
 
  .  Electronic catalogs; and
 
  .  Connectivity through the Internet or private networks.
 
  Service offerings released in fiscal 1998 include: COMMERCE:Tracker, a Web-
based shipment tracking solution; COMMERCE:Locator, a Web-based trading
partner matching service; COMMERCE:Y2K, a Year 2000 testing and compliance
solution for EDI trading communities; and COMMERCE:Advantage, a solution for
banks to provide electronic payments and other EC capabilities to their
corporate customers.
 
  The COMMERCE solutions are marketed to targeted vertical industry groups,
including the pharmaceutical, hardlines, grocery, healthcare, insurance,
retail, transportation, automotive, entertainment, telecommunications,
chemical and petroleum, paper and packaging and banking industries, as well as
government agencies. As of September 30, 1998, there were approximately 25,000
COMMERCE customers worldwide, including GTE Telecommunications, Inc., The Home
Depot, Pfizer, Roadway Express, Roche Laboratories, SUPERVALU, Toys "R' Us and
United Parcel Service (UPS).
 
 GENTRAN Family
 
  The GENTRAN family of products, offered by the Company's Interchange
Software Group, allows businesses to automate and manage the flow of internal
and external business transactions enabling companies to integrate their
business processes within commerce communities through the Internet,
electronic messaging and EDI. GENTRAN solutions offer:
 
  .  Software for integrating a company's business processes with their
     customers' and suppliers' systems;
 
  .  Messaging software for automating and managing the flow of internal and
     external business transactions across multiple platforms and
     environments; and
 
  .  Secure, scaleable Web-enabled electronic commerce and EDI solutions.
 
  GENTRAN software products are available for all major operating systems and
platforms, including UNIX, Windows, Windows NT, AS/400 and IBM mainframe.
GENTRAN products are designed for high-volume, commercial traffic and support
any-to-any message exchange and data transformation across platforms. Key
products within the GENTRAN family include GENTRAN:Server and GENTRAN Web
Suite. The GENTRAN family of products can be closely interfaced with
applications systems provided by major enterprise resource planning ("ERP")
vendors such as Baan, Oracle, PeopleSoft and SAP. In addition, companies such
as Lawson Software, and Symix resell GENTRAN solutions to their customers. As
of September 30, 1998, GENTRAN products were licensed to over 8,250 customers
worldwide, including Matsushita Electronics, SAP AG, the U.S. Department of
Defense and Wal-Mart Stores.
 
                                       5
<PAGE>
 
 CONNECT Family
 
  The CONNECT family of products, offered by the Company's Communications
Software Group, provides infrastructure software for EC and business
applications, enabling organizations to automatically manage remote systems
and electronically exchange information securely and reliably across
department and company boundaries. CONNECT product offerings include:
 
  .  Software for high-performance point-to-point data exchange;
 
  .  Software for data collection, warehousing and distribution;
 
  .  Software for data communications management;
 
  .  Software for message driven business process exchange;
 
  .  Software for remote and mobile systems management; and
 
  .  Mobile user management over the Internet, intranets and extranets.
 
  The CONNECT family of products is widely used as the communications solution
within many organizations and industries, including government agencies and
the telecommunications, banking and financial services industries. Key CONNECT
products include CONNECT:Direct, CONNECT:Mailbox, CONNECT:Remote and
CONNECT:Manage. As of September 30, 1998, CONNECT products were licensed to
over 6,850 customers worldwide, including British Telecom, Electronic Data
Services Corporation ("EDS"), HBO & Co., MCI WorldCom and Traveler's
Insurance.
 
 VECTOR Family
 
  The VECTOR family of products, offered by the Company's Banking Systems
Division, enables financial institutions to manage the flow of checks and
related items, to automate other banking processes and to offer new services
to their customers. VECTOR products include:
 
  .  Software that automates key item processing applications for financial
     institutions, such as statement sorting, check fraud control, electronic
     check presentment and return item processing; and
 
  .  Software that enables banks to offer integrated item processing services
     to their retail and corporate customers.
 
  At September 30, 1998, the Company had licensed over 1,300 copies of VECTOR
products to customers worldwide, including 99 of the top 100 U.S. banks, as
ranked by deposits as of December 31, 1997 in American Banker magazine.
Customers include BankAmerica, Chase Manhattan, Wells Fargo and ABN-AMRO.
 
INTERNET SOLUTIONS
 
  Companies today are looking for ways to extend their business processes to
the Internet or the Web. By extending these processes, they can increase
revenues and reduce costs. According to Dataquest, a unit of the Gartner Group
("Dataquest"), this market, known as the business-to-business Web-commerce
market, was $28.5 million in 1997 and is projected to grow to $1.27 billion by
2002. The Company is addressing this large and expanding market by providing
Internet-related electronic commerce solutions across its product and services
families. These include:
 
  .  Internet-based transport with the CONNECT family;
 
  .  Mobile user management for intranets and extranets with CONNECT:Manage;
 
  .  Web application integration and business process automation through
     GENTRAN Web Suite;
 
  .  Web-centric value-added application solutions through COMMERCE:Tracker
     and COMMERCE:Banker;
 
                                       6
<PAGE>
 
  .  Web community management for individual companies or industry groups
     with the COMMERCE family;
 
  .  Web managed services to provide Web core competence with the solutions
     provided by the Managed Services Division; and
 
  Customers include Booknet, Chanel, Freedom Furniture, Reuters, Whirlpool and
Xerox.
 
MANAGED SERVICES
 
  According to Dataquest, the worldwide EC services market is expected to grow
from $8 billion in 1998 to $21 billion by 2002. This acceleration is driven by
Year 2000 initiatives, the shortage of available technological personnel
within companies, the increasing trend for companies to focus on their core
businesses and the ongoing need to evaluate and integrate new developments in
information technology. In response to these developments, the Company formed
the Managed Services Division to offer customers of the Company's three
primary software and services families (COMMERCE, GENTRAN, and CONNECT) a
consolidated set of managed services to help them successfully implement their
EC programs. These services include custom and packaged solutions, education,
training and outsourcing. The Managed Services Division works closely with
leading systems integrators such as EDS, Andersen Consulting, KPMG and
Deloitte & Touche Consulting. Customers of the Managed Services Division
include Caliber Technology, Inc., Mitsubishi International, Owens Corning and
Union Carbide.
 
SALES AND MARKETING
 
  The Company's Commerce Services Group, Interchange Software Group and
Communications Software Group each has its own sales and marketing
organizations. These organizations license and market the Company's products
and services on a worldwide basis through a combination of direct sales,
indirect sales through distributors and resellers, telesales and
telemarketing. The Company has implemented a performance-based program of
sales commissions, awards and recognition designed to compensate and motivate
its sales forces.
 
EMPLOYEES
 
  The Company's business is dependent upon its ability to attract and retain
highly qualified personnel, who are currently in limited supply. The Company's
operations could be adversely affected if it were to lose the services of a
significant number of its employees or if the Company were unable to obtain
additional qualified personnel when needed. The market for highly qualified
personnel in the software and electronic commerce industries is extremely
competitive, making it difficult for companies in these industries, including
the Company, to attract and retain qualified employees. To attract and retain
qualified employees, the Company offers competitive compensation and benefits
packages and strives to maintain excellent employee relations, attractive
office facilities and challenging working environments. None of the Company's
employees are represented by a labor union. The Company has not experienced
any work stoppages and considers its employee relations to be excellent.
 
  At September 30, 1998, the Company employed approximately 2,300 full-time
employees.
 
CUSTOMERS
 
  The Company has a worldwide customer base in more than 15 industries,
including banking, telecommunications, manufacturing, insurance, healthcare,
automotive, retail, transportation, pharmaceuticals and consumer products.
While the Company's customer base includes some of the largest multinational
companies in the world, it also includes numerous regional and local
companies. As of September 30, 1998, the Company's customers included 95 of
the 100 largest U.S. industrial corporations, as ranked by 1997 sales in
 
                                       7
<PAGE>
 
Fortune magazine, and 99 of the top 100 U.S. commercial banks, as ranked by
deposits as of December 31, 1997, in American Banker magazine.
 
  Many of these customers use several of the Company's products and services,
including Internet-related electronic commerce solutions. Because large
companies drive electronic commerce across the supply chain, the Company often
works with these companies to market its electronic commerce solutions to their
trading partners, many of which are small to medium-sized companies. The
Company strives to develop and market products for companies of all sizes.
 
PRODUCT LICENSES AND PRODUCT SUPPORT
 
  The Company's software products are licensed for perpetual use or for a fixed
term. The Company typically does not sell its software products. The license
agreements generally restrict the use of the underlying product to designated
sites or central processing units and prohibit the reproduction, transfer or
disclosure of the product. However, some license agreements may cover multiple
sites or multiple central processing units at one site.
 
  In addition to licensing the use of its software products to customers, the
Company also often sells product support services to its customers. Typically,
the Company provides these services pursuant to product support agreements
having terms ranging generally from one to three years. The Company's product
support agreements generally allow customers to receive updated or enhanced
versions of the Company's software products as they become available and also
allow telephone and Internet access to the Company's technical personnel.
 
PRODUCT DEVELOPMENT
 
  The Company's product development strategy is to enhance existing products
and to introduce new products based upon current and anticipated customer
needs. The Company's approach to product development includes, among other
things, evaluating anticipated customer needs, analyzing the cost of developing
new products versus the cost of acquiring new products and analyzing
anticipated revenues from new and enhanced products. For example, the Company
may seek to acquire an existing product or to acquire a company that owns an
existing product rather than develop the product internally. In other
instances, the Company may contract with a third-party developer to develop the
product for the Company. Because of these and other factors, the Company is
unable to estimate future product development costs.
 
  The Company's Commerce Services Group, Interchange Software Group and
Communications Software Group each performs its own product development
functions. The Company believes that this decentralized structure facilitates
development cost control and focuses the development function on customer
needs. Gross product development costs in 1998, 1997 and 1996 were $47,300,000,
$38,400,000 and $27,800,000, respectively, of which the Company capitalized
$17,600,000, $13,500,000 and $12,300,000, respectively, as the cost of
developing and testing new or significantly enhanced software products. Product
development expense and the capitalization rate may fluctuate from period to
period depending, in part, upon the number and status of software development
projects in process.
 
  The Company is addressing Year 2000 issues that may have a material impact on
its product and services offerings. In this regard, see "Year 2000" in Item 7,
Part II of this report. Such information is incorporated herein by reference.
 
COMPETITION
 
  The Company believes that its ability to compete successfully in the
electronic commerce industry depends on numerous factors, both within and
outside its control, including product performance, functionality and
reliability, price and customer service and support. The Company's strategy is
to offer EC business solutions that are designed to meet the needs of the
various segments of the electronic commerce market on a local,
 
                                       8
<PAGE>
 
regional and worldwide basis. The Company seeks to differentiate itself through
superior products and services, its reputation for quality and value and its
ability to respond quickly and efficiently to the changing needs of its
electronic commerce customers. See "Risk Factors--Competition" in Item 7, Part
II of this report for additional information regarding the Company's
competitive environment, including a list of certain of the Company's
competitors. Such information is incorporated herein by reference.
 
INTELLECTUAL PROPERTY RIGHTS
 
  The Company relies primarily on a combination of copyright, patent and
trademark laws, confidentiality procedures and contractual provisions to
protect its intellectual property rights. The Company routinely enters into
nondisclosure and confidentiality agreements with employees, contractors,
consultants, vendors and customers to protect its proprietary rights.
 
  The Company does not believe that any of its products or services infringe on
the valid rights of third parties in any material respect. Licenses for a
number of software products have been granted to the Company for its own use or
for remarketing to its customers.
 
  See "Risk Factors--Limited Protection of Proprietary Rights; Risks of
Infringement and Loss of Licenses" in Item 7, Part II of this report for
additional information relating to the intellectual property rights of the
Company. Such information is incorporated herein by reference.
 
  The COMMERCE, GENTRAN, CONNECT and VECTOR product and service names used
herein are registered or unregistered trademarks owned by the Company.
 
SHARED MANAGEMENT AND CONTRACTUAL ARRANGEMENTS WITH STERLING SOFTWARE
 
 Shared Management
 
  The Board of Directors of the Company (the "Board") currently has seven
members. Messrs. Sterling L. Williams (Chairman), Sam Wyly, Charles J. Wyly,
Jr. and Evan A. Wyly are directors of the Company and are also directors of
Sterling Software. Mr. Williams, who serves as President and Chief Executive
Officer of Sterling Software, ceased his employment with the Company in May
1998, whereupon he and the Company entered into a consulting agreement.
 
  The Company and Sterling Software have certain contractual and other ongoing
relationships as discussed below under "Intercompany Agreements." Conflicts of
interest may arise between the Company and Sterling Software in a number of
areas relating to such ongoing relationships, including potential competitive
business activities, tax and employee benefit matters, indemnity arrangements
and the continued service of certain directors of each of the Company and
Sterling Software as directors of the other company. The Board utilizes such
procedures in evaluating the terms and provisions of any material transactions
between the Company and Sterling Software and their respective affiliates as
the Board may determine appropriate in light of its fiduciary duties under
applicable state law.
 
 Contractual Arrangements
 
  In anticipation of the Offering, the Company and Sterling Software entered
into a number of agreements (the "Intercompany Agreements") for the purpose of
defining certain relationships between them. As a result of Sterling Software's
ownership interest in the Company, the terms of such agreements were not the
result of arm's-length negotiation.
 
  The Intercompany Agreements included, among others, a tax allocation
agreement, an indemnification agreement and the International Marketing
Agreement, each of which is briefly described below:
 
  .  The tax allocation agreement provides that for periods during which the
     Company is included in Sterling Software's consolidated federal income
     tax returns or consolidated, combined or unitary state
 
                                       9
<PAGE>
 
     tax returns (which periods included the period between the Offering and
     the Distribution), the Company is required to pay to or is entitled to
     receive from Sterling Software its allocable portion of the consolidated
     federal and state income tax liability or refunds, respectively.
 
  .  The indemnification agreement provides, among other things, that each
     party thereto (the "Indemnifying Party") will indemnify the other party
     thereto and its directors, officers, employees, agents and
     representatives (each, an "Indemnified Party") for liabilities that may
     be incurred by an Indemnified Party relating to (1) the businesses,
     operations or assets conducted or owned or formerly conducted or owned
     by the Indemnifying Party and its subsidiaries (except, in the case
     where Sterling Software is the Indemnifying Party, the businesses,
     operations and assets of the Company and its subsidiaries) or (2) the
     failure by the Indemnifying Party to comply with any other agreements
     executed in connection with the Offering. In addition, the
     indemnification agreement provides that the Company will indemnify
     Sterling Software and its directors, officers, employees, agents and
     representatives for any liabilities resulting from or arising out of
     certain acts, failures to act or the provision of incorrect factual
     information by the Company in connection with the Internal Revenue
     Service ruling request that cause the Distribution to be taxable to
     Sterling Software or its stockholders. The indemnification agreement
     also provides that each party thereto (the "Obligor Party") (1) will use
     reasonable efforts to obtain the release of the other party thereto (the
     "Guarantor Party") from its obligation under or in respect of all
     material guarantees, surety and performance bonds, letters of credit and
     other arrangements guaranteeing or securing any liability or obligation
     of the Obligor Party, (2) will indemnify the Guarantor Party for any
     liabilities incurred under such guarantees, bonds, letters of credit and
     other arrangements and (3) will reimburse the Guarantor Party for its
     direct costs (or, in certain circumstances, the Obligor Party's pro rata
     share of such direct costs) of maintaining such guarantees, bonds,
     letters of credit and other arrangements pending the release of the
     Guarantor Party thereunder.
 
  .  The International Marketing Agreement, which was terminated effective as
     of June 30, 1997, defined the terms pursuant to which Sterling Software
     acted as the exclusive distributor of certain of the Company's products
     in markets outside the United States and Canada. See "Introduction" in
     Item 1, Part I of this report and Note 4 to the Notes to Consolidated
     Financial Statements included in Item 8, Part II of this report.
 
EXECUTIVE AND OTHER OFFICERS
 
  The following information regarding the executive officers of the Company is
as of November 13, 1998.
 
<TABLE>
<CAPTION>
NAME                   AGE                       POSITION
----                   ---                       --------
<S>                    <C> <C>
Warner C. Blow........  61 President and Chief Executive Officer; Director
J. Brad Sharp.........  41 Executive Vice President and Chief Operating Officer
Paul L. H. Olson......  48 Executive Vice President and Group President
Stephen R. Perkins....  54 Executive Vice President and Group President
Randall P. Harvey.....  45 Senior Vice President and Group President
Albert K. Hoover......  38 Senior Vice President and General Counsel; Secretary
Steven P. Shiflet.....  51 Senior Vice President and Chief Financial Officer
</TABLE>
 
  Warner C. Blow has served as President of the Company since December 1995
and as Chief Executive Officer and a director since October 1996. From
December 1995 to October 1996, Mr. Blow also served as Chief Operating Officer
of the Company. Prior to December 1995, Mr. Blow served as President of
Sterling Software's Electronic Commerce Group (the predecessor of the Company)
from July 1993 and as an Executive Vice President of Sterling Software from
October 1989.
 
  J. Brad Sharp has served as Executive Vice President of the Company since
November 1997 and as Chief Operating Officer since October 1998. Mr. Sharp
served as President of the Interchange Software Group from December 1995 to
October 1998. From December 1995 to November 1997, Mr. Sharp served as a
Senior Vice
 
                                      10
<PAGE>
 
President of the Company. Prior to March 1996, Mr. Sharp served as President
of the Interchange Software Division of Sterling Software's Electronic
Commerce Group (the predecessor of the Company) from August 1992.
 
  Paul L. H. Olson has served as Executive Vice President of the Company since
November 1997 and as President of the Commerce Services Group since December
1995. From December 1995 to November 1997, Mr. Olson served as a Senior Vice
President of the Company. Prior to March 1996, Mr. Olson served as President
of the Network Services Division of Sterling Software's Electronic Commerce
Group (the predecessor of the Company) from August 1992.
 
  Stephen R. Perkins has served as Executive Vice President of the Company
since November 1997 and as President of the Communications Software Group
since December 1995. From December 1995 to November 1997, Mr. Perkins served
as a Senior Vice President of the Company. Prior to March 1996, Mr. Perkins
served as President of the Communications Software Division of Sterling
Software's Electronic Commerce Group (the predecessor of the Company) from
July 1993.
 
  Randall P. Harvey has served as Senior Vice President of the Company and as
President of the Interchange Software Group since October 1998. From March
1996 to October 1998, Mr. Harvey served as Vice President of Labs for the
Interchange Software Group. Prior to March 1996, Mr. Harvey served as Vice
President of Labs of the Interchange Software Division of Sterling Software's
Electronic Commerce Group (the predecessor of the Company) from 1993.
 
  Albert K. Hoover has served as Senior Vice President and General Counsel of
the Company since June 1997 and as Secretary since June 1998. From December
1995 until June 1997, Mr. Hoover served as Vice President, Legal of the
Company. Prior to March 1996, Mr. Hoover served as Vice President, Legal of
Sterling Software from May 1994 and Assistant General Counsel of Sterling
Software from June 1990.
 
  Steven P. Shiflet has served as Senior Vice President and Chief Financial
Officer of the Company since January 1997. From December 1995 until January
1997, Mr. Shiflet served as Vice President, Finance of the Company. Prior to
March 1996, Mr. Shiflet served as Group Vice President, Finance &
Administration of Sterling Software's Electronic Commerce Group (the
predecessor of the Company) from 1986.
 
  The following information regarding certain other vice presidents of the
Company is also as of November 13, 1998.
 
<TABLE>
<CAPTION>
 NAME                                      AGE          POSITION
 ----                                      ---          --------
 <C>                                       <C> <S>
 William W. Hymes........................   62 Senior Vice President and
                                               Division President
 James W. Hoyt...........................   51 Vice President, Technology
 Thomas A. Lutz..........................   58 Vice President
 Dawn Wheeler............................   39 Vice President, Investor
                                               Relations
 G. Clark Woodford.......................   51 Vice President, Business
                                               Development
</TABLE>
 
  William W. Hymes has served as a Senior Vice President of the Company since
December 1995 and as President of the Banking Systems Division since June
1997. From December 1995 to June 1997, Mr. Hymes served as President of the
Company's former Banking Systems Group. Prior to March 1996, Mr. Hymes served
as President of the Banking Systems Division of Sterling Software's Electronic
Commerce Group (the predecessor of the Company) from July 1993.
 
  James W. Hoyt has served as Vice President, Technology of the Company since
July 1996. Mr. Hoyt served as Director of Product Architecture of the
Company's Communications Software Group from March 1996 until June 1996 and of
Sterling Software's Communications Software Division from July 1993 until
March 1996.
 
  Thomas A. Lutz has served as a Vice President of the Company since December
1995. Mr. Lutz served as President of the former International Division of the
Commerce Services Group from June 1997 until
 
                                      11
<PAGE>
 
September 1998. Mr. Lutz served as President of the Company's former
International Group from December 1995 until June 1997. Prior to March 1996,
Mr. Lutz served as President of Sterling Software's Creative Data Systems
Division from October 1991.
 
  Dawn Wheeler has served as Vice President, Investor Relations of the Company
since February 1996. Prior to March 1996, Ms. Wheeler served as Director of
Industry Relations of Sterling Software's Electronic Commerce Group (the
predecessor of the Company) from October 1994. Prior to October 1994, Ms.
Wheeler served in various capacities for Sterling Software's Network Services
Division from November 1988.
 
  G. Clark Woodford has served as Vice President, Business Development of the
Company since December 1995. Prior to December 1995, Mr. Woodford served as
Vice President, Business Development of Sterling Software's Electronic
Commerce Group (the predecessor of the Company) from November 1993.
 
ITEM 2. PROPERTIES.
 
  The Company's principal executive offices are located in Dallas, Texas. The
Company's principal administrative offices are located in Columbus, Ohio. Both
facilities are leased under operating leases. The Company also leases offices
and facilities in more than 39 other locations in the United States and
various other countries under operating leases. The Company believes that its
facilities will be adequate for its immediate needs and that additional or
substitute space is available if needed to accommodate expansion.
 
ITEM 3. LEGAL PROCEEDINGS.
 
  The information set forth in Note 5 of the Notes to Consolidated Financial
Statements included in Item 8, Part II of this report is incorporated herein
by reference.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
  The Company did not submit any matters to a vote of security holders during
the fourth quarter of the fiscal year covered by this report.
 
                                      12
<PAGE>
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
  The Company's Common Stock has traded on the New York Stock Exchange since
March 8, 1996, under the symbol "SE." The high and low sales prices for the
Company's Common Stock for the periods indicated are set forth below.
 
<TABLE>
<CAPTION>
                                                                  PRICE RANGE
                                                                ----------------
                                                                  HIGH     LOW
                                                                -------- -------
     <S>                                                        <C>      <C>
     YEAR ENDED SEPTEMBER 30, 1997:
     Quarter Ended:
     December 31, 1996......................................... $35 3/4  $25 1/2
     March 31, 1997............................................ $38 5/8  $26 3/4
     June 30, 1997............................................. $34 7/8  $24 1/8
     September 30, 1997........................................ $40 5/16 $29 1/2
     YEAR ENDED SEPTEMBER 30, 1998:
     Quarter Ended:
     December 31, 1997......................................... $39 1/8  $31 1/2
     March 31, 1998............................................ $50 1/4  $33 1/2
     June 30, 1998............................................. $48 3/4  $37 1/2
     September 30, 1998........................................ $48 1/2  $30
</TABLE>
 
  At November 13, 1998, the Company had approximately 1,130 holders of record
of Common Stock.
 
  The Company did not pay dividends on its Common Stock during the years ended
September 30, 1997 and 1998. Under the terms of the Company's Revolving Credit
and Term Loan Agreement, as amended (the "Credit Agreement"), the Company is
prohibited from making distributions in the form of cash dividends on its
Common Stock.
 
ITEM 6. SELECTED FINANCIAL DATA.
 
  The following selected financial data should be read in conjunction with the
consolidated financial statements of the Company included elsewhere herein.
 
<TABLE>
<CAPTION>
                                            YEARS ENDED SEPTEMBER 30
                                  ---------------------------------------------
                                    1998      1997     1996     1995     1994
                                  --------  -------- -------- -------- --------
                                  (IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
<S>                               <C>       <C>      <C>      <C>      <C>
OPERATING DATA:
Revenue.........................  $490,302  $350,597 $267,773 $203,578 $155,916
Cost of sales...................    96,161    70,615   54,418   41,550   36,282
Product development and enhance-
 ment expenses..................    29,717    24,853   15,553   14,807   12,497
Selling, general and administra-
 tive expenses..................   201,689   134,849  102,597   75,193   60,732
Income (loss) before other in-
 come (expense) and
income taxes(1).................   (21,161)   72,591   95,205   72,028   46,405
Net income (loss)...............   (61,156)   55,444   58,392   42,930   27,753
Income (loss) per common share:
  Basic.........................  $  (0.67) $   0.66 $   0.79
  Diluted.......................  $  (0.67) $   0.64 $   0.77
BALANCE SHEET DATA:
Working capital(2)..............  $545,114  $491,801 $ 77,159 $  3,692 $  2,198
Total assets....................   967,004   748,566  241,680  128,978  100,638
Stockholders' equity............   747,915   600,862  138,187
Stockholder's net investment....                                53,187   43,051
</TABLE>
--------
(1) Net of $116,460,000 of purchased research and development and $67,436,000
    of reorganization and unusual costs charged to expense in 1998 and
    $31,879,000 of purchased in-process research and development and
    $15,810,000 of reorganization and unusual costs charged to expense in
    1997.
 
(2) Prior to the consummation of the Offering, substantially all of the excess
    cash generated by the Company's operations was regularly remitted to
    Sterling Software pursuant to Sterling Software's centralized cash
    management program.
 
                                      13
<PAGE>
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
        RESULTS OF OPERATIONS.
 
INTRODUCTION
 
  The Company was incorporated in December 1995 as a wholly owned subsidiary
of Sterling Software. Pursuant to the Offering, which was completed in March
1996, the Company sold to the public 1,800,000 previously unissued shares of
Common Stock and Sterling Software sold to the public 12,000,000 of the
73,200,000 shares of Common Stock then owned by it.
 
  In contemplation of the Offering, among other things: (1) Sterling Software
caused to be transferred to the Company certain assets relating to the
electronic commerce business previously conducted by Sterling Software and (2)
the Company entered into contractual arrangements with Sterling Software
related to, among other things, tax allocation, indemnification and
international marketing. See "Shared Management and Contractual Arrangements
with Sterling Software" in Item 1, Part I of this report, for a discussion of
such contractual arrangements with Sterling Software.
 
  On September 23, 1996, the Board of Directors of Sterling Software declared
a special dividend consisting of the Distribution of all shares of Common
Stock held by Sterling Software on September 30, 1996, payable pro rata to the
holders of record of Software Stock as of the close of business on such date.
As a result, effective September 30, 1996, the Company ceased to be a
subsidiary of Sterling Software.
 
  On February 28, 1997, the Company completed the Follow-On Offering of
14,375,000 previously unissued shares of Common Stock. The net proceeds of
$400,145,000 were added to the Company's working capital and are being used
for general corporate purposes, including acquisitions. Pending such use, the
funds are being invested in investment grade debt securities and other
marketable securities. See "Acquisitions" in Item 1, Part I of this report and
Note 4 of the Notes to Consolidated Financial Statements included in Item 8,
Part II of this report for information regarding acquisitions made by the
Company since the Distribution, and see "1998 Business Combinations and
Reorganizations" below for further information regarding acquisitions
completed in fiscal 1998.
 
1998 BUSINESS COMBINATIONS AND REORGANIZATIONS
 
  On July 21, 1998, the Company completed the acquisition of all the issued
and outstanding stock of XcelleNet, an Atlanta, Georgia based provider of
remote systems management products and services. The aggregate purchase price
paid was approximately $224,000,000, consisting of approximately $83,000,000
of cash, which cash was funded from the Company's available cash balances,
approximately 2,442,000 shares of newly issued Common Stock and options to
purchase approximately 1,287,000 shares of Common Stock to replace outstanding
options to purchase XcelleNet common stock held by XcelleNet employees and
directors. The cash cost of the acquisition includes approximately $9,000,000
of costs directly related to the acquisition, consisting of employee
termination costs, transaction costs, costs associated with the elimination of
facilities and other direct costs. The results of operations of XcelleNet are
included in the Company's results of operations from the date of the
acquisition.
 
 
                                      14
<PAGE>
 
  The Company also completed the following acquisitions in 1998:
 
  .  In two separate transactions in April and August 1998, the Company
     acquired for cash certain assets and assumed certain liabilities
     associated with the EDI software and services unit of o.tel.o, a
     Dusseldorf, Germany based telecommunications company specializing in
     cellular, cable television and Internet access services.
 
  .  In June 1998, the Company acquired for cash all of the issued and
     outstanding capital stock of EDES, a London, England based provider of
     value-added electronic data interchange network services and related PC-
     based enabling software.
 
  .  In July 1998, the Company acquired for cash all of the issued and
     outstanding capital stock of NIS, a Singapore based provider of
     electronic commerce software and services.
 
  .  In July 1998, the Company acquired for cash all of the issued and
     outstanding capital stock of iCommerce, a Singapore based provider of
     Web based EC community management products and services.
 
  The aggregate cash purchase price for these acquisitions was approximately
$10,000,000, which was funded from the Company's available cash balances. The
results of operations of these acquisitions are included in the Company's
results of operations from the dates of acquisition.
 
  Results of operations for 1998 include $116,460,000 of purchased research
and development costs primarily related to the XcelleNet acquisition. This
amount was attributed to purchased research and development as valued by an
independent appraiser, and was charged to expense in accordance with the
purchase method of accounting.
 
REORGANIZATION AND UNUSUAL COSTS
 
  The Company's results of operations for 1998 include reorganization and
unusual costs of $67,436,000 primarily related to the reorganization of the
Company's operations in connection with the acquisitions noted above and the
Company's strategic decision to discontinue certain businesses and activities.
 
  Of the total reorganization and unusual costs, non-cash costs are
approximately $40,240,000 and the remaining costs of $27,196,000 require cash
outlays. Currently, the Company does not expect to incur costs related to
these reorganizations in excess of the amount charged to operations in 1998.
 
  The Company's results of operations for 1997 include reorganization and
unusual costs of $15,810,000 primarily related to the reorganization of the
Company in connection with the acquisitions of Automated Catalogue Services,
Inc. and Comfirst and the termination of the International Marketing
Agreement. During 1998, the Company disbursed the accrued balance remaining of
these costs at September 30, 1997 of $8,991,000. The Company does not expect
to incur any further costs related to these reorganizations.
 
RESULTS OF OPERATIONS
 
 Years Ended September 30, 1998 and 1997
 
  Total revenue increased $139,705,000 or 40% in 1998 as compared to 1997. The
revenue increase was due to a $80,746,000 increase in products revenue, a
$46,028,000 increase in services revenue and a $29,689,000 increase in product
support revenue, offset partially by a $16,758,000 decrease in royalties from
Sterling Software. Products revenue increased 73%, services revenue increased
30% and product support revenue increased 42% in 1998 as compared to 1997. The
Company's product lines experienced growth in products revenue and product
support due to the addition of new customers, new product offerings, certain
product price increases and a continuing expansion of the installed customer
base for product support. The increase in products
 
                                      15
<PAGE>
 
and product support revenue is primarily the result of increased licensing of
CONNECT and GENTRAN software products and is also the result of having direct
licensing of these products outside of the United States and Canada in 1998 as
opposed to having royalty revenue in the first three quarters of 1997. The
increase in services revenue is due primarily to growth in existing COMMERCE
services customer volume and the addition of new customers, primarily in the
hardlines, retail, grocery and healthcare markets, and also due to an increase
in education and consulting services. No royalty revenue was recorded in 1998
due to the termination of the International Marketing Agreement effective June
30, 1997.
 
  The Company's recurring revenue includes revenue from annual and multi-year
product support agreements having terms ranging generally from one to three
years, fixed term product lease and rental agreements having terms ranging
generally from month-to-month to year-to-year and electronic commerce service
agreements cancelable upon 30 days' notice. The Company includes the entire
portion of the recognized revenue from COMMERCE service agreements in
recurring revenue, although no assurances can be given that such agreements
will not be canceled. Recurring revenue increased $51,835,000 or 26% in 1998
as compared to 1997 and represented 51% of total revenue in 1998 and 57% in
1997. The decrease in the relative percentage is due to the Company receiving
100% of the revenues from the licensing of products outside the United States
and Canada in 1998 as opposed to a 50% royalty on such revenues from Sterling
Software in the first three quarters of 1997 pursuant to the International
Marketing Agreement and also in part to the significant growth in products
revenue in 1998. For 1998, 55% of the Company's products revenue was for
products designed for operating platforms other than mainframe operating
platforms, as compared to 54% for 1997. This increase in the relative
percentage of products revenue for products designed for operating platforms
other than mainframes is due primarily to an increase in sales of products for
the UNIX and Windows NT platforms. Revenue outside of the United States, as a
percentage of total revenue, increased to 21% in 1998 from 14% in 1997
primarily due to an increase in international licensing of CONNECT and GENTRAN
software, as well as to the termination of the International Marketing
Agreement.
 
  Total costs and expenses increased $233,457,000 in 1998 as compared to 1997
due primarily to charges in the fourth quarter of 1998 of $116,460,000 for
purchased research and development acquired primarily from XcelleNet and
$67,436,000 of reorganization and unusual costs. Excluding these charges and
similar charges in 1997, total costs and expenses increased $97,250,000 or 42%
on revenue growth of 40%. This percentage increase in total costs and expenses
is primarily due to a 50% increase in selling, general and administrative
expenses and to a lesser extent a 36% increase in cost of sales and a 20%
increase in product development and enhancement expenses compared with the
prior year. The Company believes further expenditures of approximately
$8,500,000 primarily for salaries, wages and benefits of development personnel
will be required during the next 18 months to develop into commercially viable
products the research and development purchased primarily from XcelleNet.
 
  The components of reorganization and unusual costs in 1998 consist primarily
of a write-down of software products and other assets and recognition of
liabilities associated with software products and services which will no
longer be actively marketed or supported in the amount of approximately
$40,010,000; write-off of excess costs over net assets acquired of
approximately $8,488,000; employee termination costs of approximately
$7,993,000; out-of-pocket costs related to the reorganization of approximately
$4,784,000; and other costs of approximately $6,161,000.
 
  Total cost of sales consists primarily of salaries and other related
expenses for product support, data center and communications personnel and
other related expenses for the Company's data center and other facilities,
communications, product media, duplication, packaging and shipping. Total cost
of sales increased $25,546,000 or 36% in 1998 as compared to 1997. As a
percentage of total revenue, total cost of sales remained unchanged at 20% for
1998 and 1997. Cost of sales for services increased $17,921,000 or 49% due to
higher COMMERCE services costs to support a growing customer base and greater
customer volume and also due to higher costs associated with providing
education and consulting services. As a percentage of total revenue, cost of
sales for services increased to 11% for 1998 from 10% in 1997. Cost of sales
for products and product support increased $7,625,000 or 22% due to increased
costs to support expanding software sales, a larger installed customer base
and higher amortization costs of capitalized development for software
products. Cost of sales for products and
 
                                      16
<PAGE>
 
product support decreased as a percentage of total revenue to 9% in 1998 from
10% in 1997. Cost of sales includes $28,649,000 of depreciation and
amortization for 1998 and $21,611,000 of depreciation and amortization for
1997.
 
  Product development and enhancement expense consists primarily of salaries
and other related expenses for product development personnel, together with
the cost of facilities and equipment. Product development and enhancement
expense for 1998 of $29,717,000, net of $17,600,000 capitalized pursuant to
Statement of Financial Accounting Standards No. 86, "Accounting for the Costs
of Computer Software to be Sold or Otherwise Marketed"("FAS 86"), increased
$4,864,000 or 20% compared to 1997 product development and enhancement expense
of $24,853,000, net of $13,519,000 of amounts capitalized pursuant to FAS 86.
The increase was primarily due to the higher gross product development expense
relating to products under development during 1998. As a percentage of total
revenue, product development and enhancement expense decreased to 6% in 1998
from 7% in 1997. As a percentage of total development and enhancement expense,
total capitalized costs increased to 37% in 1998 from 35% in 1997. Product
development expense and the capitalization rate may fluctuate from period to
period depending in part upon the number and status of software development
projects in process.
 
  Selling, general and administrative expense consists primarily of salaries,
commissions and other related expenses of sales, marketing, administrative,
executive and financial personnel, as well as outside professional fees,
facilities and depreciation expenses. Selling, general and administrative
expense increased $66,840,000 or 50% in 1998 as compared to 1997 due in part
to increases in personnel following the termination of the International
Marketing Agreement in June 1997. As a percentage of total revenue, selling,
general and administrative expenses increased to 41% for 1998 from 38% in
1997.
 
  Loss before other income and income taxes was $21,161,000 for 1998 as
compared to income before other income and income taxes of $72,591,000 for the
same period of 1997 due to the $139,705,000 increase in revenues offset by the
$233,457,000 increase in total costs and expenses including nonrecurring
charges of $183,896,000 for purchased research and development and
reorganization and other unusual costs in the fourth quarter of 1998 related
to the acquisitions and other activities noted above. Other income increased
$7,459,000 in 1998 as compared to 1997, primarily due to an increase in
investment income resulting generally from a higher average balance of
investments in cash, cash equivalents and marketable securities resulting
primarily from the net cash proceeds received by the Company from the Follow-
On Offering together with cash flows from operating activities. Excluding the
nonrecurring charges in 1998 and 1997, income before income taxes increased
$49,914,000 or 36% in 1998 as compared to 1997.
 
  Provision for income taxes increased $30,307,000 in 1998 as compared to
1997, primarily due to the increase in taxable income including non-deductible
charges in 1998 as compared to 1997.
 
 Years Ended September 30, 1997 and 1996
 
  Total revenue increased $82,824,000 or 31% in 1997 as compared to 1996. The
revenue increase was due to a $42,056,000 increase in services revenue, a
$29,671,000 increase in products revenue and a $15,087,000 increase in product
support revenue, offset partially by a $3,990,000 decrease in royalties from
Sterling Software. Services revenue increased 38% in 1997 as compared to 1996,
primarily from growth in existing commerce services customer volume and the
addition of new customers, primarily in the hardlines, retail, grocery and
healthcare markets. Products revenue increased 37%, product support revenue
increased 27% and royalty revenue decreased 19% in 1997 as compared to 1996.
The Company's product lines experienced growth in products revenue, product
support revenue and royalty revenue due to the addition of new customers, new
product offerings, certain product price increases and a continuing expansion
of the installed customer base for product support. The increase in products
and product support revenue is primarily the result of increased licensing of
CONNECT and GENTRAN software products and is also the result of having direct
licensing of these products outside of the United States and Canada for the
fourth quarter of 1997 as opposed to having royalty revenue in the fourth
quarter of 1996. The decrease in royalty revenue is largely due to the
termination of the International
 
                                      17
<PAGE>
 
Marketing Agreement effective June 30, 1997. Royalty revenue had increased 13%
in the first nine months of 1997 as compared to the same period of 1996.
 
  The Company's recurring revenue includes revenue from annual and multi-year
product support agreements having terms ranging generally from one to three
years, fixed term product lease and rental agreements having terms ranging
generally from month-to-month to year-to-year and electronic commerce service
agreements cancelable upon 30 days' notice. The Company includes the entire
portion of the recognized revenue from COMMERCE service agreements in
recurring revenue, although no assurances can be given that such agreements
will not be canceled. Recurring revenue increased $46,623,000 or 30% in 1997
as compared to 1996 and represented 57% of total revenue in both 1997 and
1996. For 1997, 54% of the Company's products revenue was for products
designed for operating platforms other than mainframe operating platforms, as
compared to 53% for 1996. Revenue outside of the United States, as a
percentage of total revenue, increased to 14% in 1997 from 12% in 1996.
 
  Total costs and expenses increased $105,438,000 in 1997 as compared to 1996
due in part to charges in the third quarter of 1997 of $31,879,000 for
purchased in-process research and development acquired primarily from ACS and
$15,810,000 of reorganization and unusual costs related to the acquisition of
Comfirst, ACS and the international distribution operations acquired from
Sterling Software. Excluding these charges, total costs and expenses increased
$57,749,000 or 33% on revenue growth of 31%. This percentage increase in total
costs and expenses is primarily due to a 30% increase in cost of sales, a 31%
increase in selling, general and administrative costs and to a lesser extent a
60% increase in product development and enhancement expense compared with the
prior year.
 
  The components of the reorganization and unusual costs consist primarily of
an early termination payment to Sterling Software of approximately $5,226,000;
transaction costs and professional fees of approximately $3,100,000; severance
and transition costs of approximately $2,400,000; and other out-of-pocket
costs of approximately $5,084,000.
 
  Total cost of sales consists primarily of salaries and other related
expenses for product support, data center and communications personnel and
other related expenses for the Company's data center and other facilities,
communications, product media, duplication, packaging and shipping. Total cost
of sales increased $16,197,000 or 30% in 1997 as compared to 1996. As a
percentage of total revenue, total cost of sales remained unchanged at 20% for
1997 and 1996. Cost of sales for services increased $9,427,000 or 35% due
primarily to higher COMMERCE services costs to support a growing customer base
and greater customer volume. As a percentage of total revenue, cost of sales
for services remained unchanged at 10% for 1997 and 1996. Cost of sales for
products and product support increased $6,770,000 or 25% due to increased
costs to support expanding software sales, a larger installed customer base
and higher amortization costs of capitalized development for software
products. Cost of sales for products and product support remained constant as
a percentage of total revenue at 10% in 1997 and in 1996. Cost of sales
includes $21,611,000 of depreciation and amortization in 1997 and $16,314,000
of depreciation and amortization in 1996.
 
  Product development and enhancement expense consists primarily of salaries
and other related expenses for product development personnel, together with
the cost of facilities and equipment. Product development and enhancement
expense for 1997 of $24,853,000, net of $13,519,000 of amounts capitalized
pursuant to FAS 86, increased $9,300,000 or 60% compared to 1996 product
development and enhancement expense of $15,553,000, net of $12,268,000 of
amounts capitalized pursuant to FAS 86. The increase was primarily due to the
higher gross product development expense relating to products under
development during 1997. As a percentage of total revenue, product development
and enhancement expense increased to 7% in 1997 from 6% in 1996. Total
capitalized costs represented 35% and 44% of total development and enhancement
expense for 1997 and 1996, respectively. Product development expense and the
capitalization rate may fluctuate from period to period depending in part upon
the number and status of software development projects in process.
 
 
                                      18
<PAGE>
 
  Selling, general and administrative expense consists primarily of salaries,
commissions and other related expenses of sales, marketing, administrative,
executive and financial personnel as well as outside professional fees,
facilities and depreciation expenses. Selling, general and administrative
expense increased $32,252,000 or 31% in 1997 as compared to 1996 due primarily
to increases in personnel in sales, marketing and administration in support of
the Company's revenue growth. As a percentage of total revenue, selling,
general and administrative expenses remained unchanged at 38% for 1997 and
1996.
 
  Income before other income and income taxes was $72,591,000 for 1997 as
compared to income before other income and income taxes of $95,205,000 for the
same period of 1996 due to the $82,824,000 increase in revenues offset by the
$105,438,000 increase in total costs and expenses including nonrecurring
charges of $47,689,000 for purchased in-process research and development and
reorganization and unusual costs in the third quarter of 1997 related to the
acquisition of Comfirst, ACS and the international distribution operations
acquired from Sterling Software. Other income increased $15,476,000 in 1997 as
compared to 1996, primarily due to an increase in investment income resulting
generally from a higher average balance of investments in cash, cash
equivalents and marketable securities resulting primarily from the net cash
proceeds received by the Company from the Follow-On Offering. Excluding the
nonrecurring charges, income before income taxes increased $40,551,000 or 42%
in 1997 compared to 1996.
 
  Provision for income taxes decreased $4,190,000 in 1997 as compared to 1996,
primarily due to the decrease in income before taxes in 1997 as compared to
1996.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  Net cash flows from operations were $108,950,000 for 1998 and $122,067,000
for 1997. Net cash flows from operations were affected in 1998 by a net loss
which reflected increased noncash expenses in depreciation and amortization
and purchased research and development and increases in accounts payable and
accrued liabilities and deferred revenue, offset by increases in accounts and
notes receivable and prepaid expenses and other assets. A portion of the
Company's cash flow from operations during 1998 and 1997 was used to fund
software additions and capital expenditures. Software expenditures in 1998
were $19,320,000 the majority of which were costs capitalized pursuant to FAS
86, compared to $13,855,000 in 1997. The expenditures during 1998 were
primarily for new products and enhancements of existing products. Property and
equipment purchases of $46,454,000 in 1998 included purchases made for
equipment upgrades for network processing systems, costs to add new network
service features and computer and other equipment purchases to support the
Company's growth particularly outside the United States and Canada due to the
termination of the International Marketing Agreement.
 
  The Company maintains a Credit Agreement, which provides for a domestic
borrowing capacity of $20,000,000 and an additional $10,000,000 international
borrowing capacity. An underlying letter of credit facility provides for
letters of credit up to the full domestic borrowing capacity. The Credit
Agreement, with final maturity of October 1, 1999, is unsecured and contains
various restrictive covenants including limitations on additional borrowings,
payment of cash dividends and acquisitions. The Credit Agreement also requires
that the Company maintain certain financial ratios. Borrowings under the
Credit Agreement bear interest at the higher of the lender's prime rate, the
Federal Funds Effective Rate plus one-half percent or, for borrowings obtained
for fixed periods of time, LIBOR plus one-half percent. There were no amounts
borrowed or outstanding under the Credit Agreement, nor the underlying letter
of credit facility, as of September 30, 1998.
 
  On February 28, 1997, the Company issued and sold 14,375,000 shares of
Common Stock in the Follow-On Offering for net proceeds of $400,145,000, after
deducting underwriting discounts and commissions and the Follow-On Offering
expenses.
 
  At September 30, 1998, the Company's capital resource commitments consisted
primarily of commitments under lease arrangements for office space and
equipment. The Company intends to meet such obligations from cash flows from
operations. Although no significant commitments exist for future capital
expenditures, the
 
                                      19
<PAGE>
 
Company has presently budgeted capital expenditures of approximately
$82,000,000 for fiscal 1999 (of which approximately $27,000,000 is expected to
consist of amounts capitalized pursuant to FAS 86). The Company believes
available balances of cash, cash equivalents and short-term investments
combined with cash flows from operations and amounts available under the
Credit Agreement are sufficient to meet the Company's cash requirements for
the foreseeable future.
 
EFFECTS OF INFLATION
 
  Demand for many of the Company's products and services tends to improve with
increased inflation as customers strive to increase employee productivity and
reduce costs. However, the effect of inflation on the Company's relatively
labor-intensive cost structure could adversely affect its results of
operations to the extent the Company is not able to recover increased
operating costs through increased prices and sales.
 
YEAR 2000
 
 General
 
  The Year 2000 issue is the result of computer programs that were written
using two digits rather than four to define the applicable year. Accordingly,
computer programs that perform date-related functions may recognize a date
using "00" as the year 1900 rather than the year 2000. This could result in a
system failure or miscalculation causing disruptions of operations, including
a temporary inability to process transactions, send invoices or engage in
similar normal business activities. The following discussion regarding Year
2000 matters constitutes a "Year 2000 Readiness Disclosure" within the meaning
of the Year 2000 Information and Readiness Disclosure Act.
 
  The Company has been and continues to assess and resolve Year 2000 issues
associated with its product and services offerings, material internal systems,
such as information technology ("IT") systems and non-IT systems, and material
third-party relationships. The Company believes that this program will be
completed prior to December 31, 1999.
 
 Product and Services Offerings
 
  The Company has completed a Year 2000 assessment of its currently offered
products and services. This assessment included internal testing of the Year
2000 capabilities of the Company's product and EC services offerings. The
Company has no plans to have its products or EC services tested by an
independent source. Based on this assessment, the Company believes that the
vast majority of its currently offered products and EC services are Year 2000
compliant, or will become compliant by early 1999 through new product releases
or modifications to internal systems. The increased amount of testing related
to the Year 2000 resulted in some delays in the release of new products or
product versions. However, because Year 2000 compliance is generally
integrated into its normal product development activities, the Company has not
incurred, and does not expect to incur, any significant incremental expenses
in addressing the Year 2000 issue in its product or EC services offerings.
 
  The Company believes that a small percentage of its customers who receive
product support from the Company are operating product versions that may not
be Year 2000 compliant or products or product versions that the Company has
replaced or intends to replace with comparable Year 2000 compliant products.
The Company believes that the majority of these customers are migrating and
will continue to migrate to Year 2000 compliant versions and products through
new releases, which the Company is strongly encouraging. In addition, certain
customers may be operating non-compliant versions of products in respect of
which the Company's agreed-upon product support and warranty periods have
expired. The Company has not undertaken an assessment of whether these
customers are taking appropriate steps to address any related Year 2000
issues.
 
 
                                      20
<PAGE>
 
  The Company provides a significant amount of its EC services through its
data center located in Columbus, Ohio. The data center utilizes third-party
software and hardware, as well as some Company software. Furthermore, the data
center requires electricity and other utilities and relies on the Internet and
third party communications providers for the transmission of data to and from
its customers. The Company has made provision for back-up systems and
established contingency plans. The Company has also conducted extensive
assessment and testing of the data center, including operating a back-up
system in a post year 2000 mode, and has taken appropriate remedial actions,
all in an effort to avoid Year 2000 failures. See "Risk Factors--Dependence on
Data Center" below.
 
  The Company does not believe that customers who license or migrate to Year
2000 compliant versions of its products, or customers who purchase the
Company's EC services, will experience any Year 2000 failures caused by such
products or services. In addition, the Company believes that its licenses and
other agreements contain customary and appropriate limitations on the
Company's obligations with respect to any Year 2000 failures that may be
caused by its current or former products and EC services. However, there can
be no assurance that the Company's expectations and beliefs as to these
matters will prove to be accurate. Moreover, the Company's products are used
in, and the provision of its services requires the use of, systems comprised
of third-party hardware and software, some of which may not be Year 2000
compliant.
 
 Internal Systems
 
  The Company has been conducting a Year 2000 assessment of its material
internal systems, both IT and non-IT, on a risk-priority basis. That
assessment, which includes an assessment of certain embedded systems, is
nearing completion. Based on the current results of that assessment, the
Company believes that its internal systems will require minimal remediation,
some of which has already been completed or is currently underway. As a result
of the Company's decentralized operating structure, non-compliant systems tend
to be more limited in their effect and easier to remediate. The vast majority
of the remediation required for such systems is expected to be completed by
mid-1999, with remediation of the remaining systems scheduled for completion
prior to December 31, 1999. Based upon the low number of material internal
systems expected to require remediation, the Company does not anticipate that
the internal and external costs of such remediation will have a material
adverse effect on the Company.
 
  There can be no assurance that the remediation of the Company's material
internal systems will be completed in a timely manner or that such remediated
systems will function as anticipated. Interruption of normal business
operations, including the Company's ability to effectively provide EC services
to customers, in such events could have a material adverse effect on the
Company's business, operating results and financial condition.
 
 Third-Party Relationships
 
  The Company has been conducting a Year 2000 assessment of its material third
party supplier relationships. The assessment is being conducted through
communications with such suppliers, testing of supplier equipment, systems or
interfaces, and a review of the Year 2000 information made publicly available
by such suppliers. The Company plans to complete the assessment of its
material third-party relationships prior to the end of calendar 1998 and,
promptly upon discovery of any material, non-compliant equipment or systems,
to begin remediation or adequate remediation assurances from third parties.
There can be no assurance, however, that the Company will receive all
information necessary to fully evaluate the Year 2000 readiness of all
material suppliers. Moreover, the Company relies in various ways, both
domestically and internationally, on government, utility and communications
service providers to conduct normal business operations. There can be no
assurance that such suppliers will not suffer business interruptions caused by
a Year 2000 issue. Such interruptions could have a material adverse effect on
the Company's business, operating results and financial condition.
 
 Additional Risks
 
  Additional aspects of the Year 2000 issue may pose risks to be considered in
evaluating the future growth of the Company. Some commentators predict that
normal purchasing patterns and trends in the software industry
 
                                      21
<PAGE>
 
may be affected by customers replacing or upgrading applications or systems to
address Year 2000 issues. The Company has not experienced any discernable trend
indicating a recent or impending material reduction in demand for the Company's
products and services. However, there can be no assurance that Year 2000 issues
will not affect future customer purchasing patterns possibly resulting in lower
demand for the Company's products and services. Furthermore, some commentators
have also predicted that a significant amount of litigation may arise out of
Year 2000 compliance issues. While the Company has not been subject to any Year
2000 claims or lawsuits to date, there can be no assurance that customers or
former customers will not bring claims or lawsuits against the Company seeking
compensation for losses associated with Year 2000-related failures. A material
adverse outcome in a Year 2000 claim or lawsuit could have a material adverse
effect on the Company's business, financial condition and results of
operations.
 
 Contingency Planning
 
  Although the Company believes that it is currently executing a timely,
effective plan for addressing material Year 2000 issues that may affect the
Company, there can be no assurance that the Company or a third party on which
the Company significantly relies will not experience unanticipated consequences
or material expenses which could have a material adverse effect on the
Company's business, operating results or financial condition. The Company
believes that it is difficult to specifically describe its most likely "worst
case" Year 2000 scenario. One "worst case" scenario is the failure of the
Company's products to correctly perform date-related functions through the year
2000, causing customer systems or operations dependent upon such products or
services to fail or be disrupted. Other "worst case" scenarios involve the
Company's EC services offerings. Failure of the Company's internal systems to
correctly perform date-related functions through the year 2000, or disruptions
in those systems, could result in errors or delays in the provision of the
Company's EC services. Another "worst case" Year 2000 scenario is the failure
of a material third-party supplier, such as a communications or utility
provider, to address its Year 2000 issues, resulting in errors or delays in the
provision of the Company's EC services. In the event of such failures or
disruptions, customers may commence legal action against the Company or
otherwise seek compensation for their losses.
 
  Except as described above, the Company has not established "contingency
plans" to address potential consequences of the Year 2000 issue. However, the
Company intends to continue to evaluate both existing and newly identified Year
2000 risks and to develop and implement such further responsive measures as it
deems appropriate.
 
NEW EUROPEAN CURRENCY
 
  Eleven of the 15 member countries of the European Union are scheduled to
establish fixed conversion rates between their existing sovereign currencies
and a new currency the "Euro" and to adopt the Euro as their common legal
currency effective January 1, 1999. The Company is currently reviewing its
products and business operations with respect to the Euro's requirements in
order to determine pricing strategies in the new economic environment, analyze
the legal and contractual implications for contracts, evaluate system
capabilities and ensure vendors can support the Company's operations with
respect to Euro transactions. Because its currently offered products and
services are currency neutral, the Company does not expect to have to modify
its products or internal systems used in the provision of services in order to
support Euro transactions. The Company does expect to modify its business
operations, however, in order to support Euro transactions, but does not
believe that the cost of such modifications will have a material adverse effect
on the Company's results of operations or financial conditions. There can be no
assurance, however, that the Company will be able to complete such
modifications to comply with Euro requirements or that any failure to complete
such modifications would not have a material adverse effect on the Company's
business, results of operations or financial conditions. In addition, the
Company faces risks to the extent that third-party suppliers upon which the
Company relies, or their suppliers, are unable to make appropriate
modifications to support Euro transactions.
 
FORWARD-LOOKING INFORMATION
 
  This report and other reports and statements filed by the Company from time
to time with the Securities and Exchange Commission (collectively, "SEC
Filings") contain, or may contain, certain forward-looking
 
                                       22
<PAGE>
 
statements and information that are based on the beliefs of, and information
currently available to, the Company's management, as well as estimates and
assumptions made by the Company's management. When used in SEC Filings, words
such as "anticipate," "believe," "estimate," "expect," "future," "intend,"
"plan" and similar expressions, as they relate to the Company or the Company's
management, identify forward-looking statements. Such statements reflect the
current views of the Company with respect to future events and are subject to
certain risks, uncertainties and assumptions relating to the Company's
operations and results of operations, competitive factors and pricing
pressures, shifts in market demand, the performance and needs of the
industries served by the Company, the costs of product development and other
risks and uncertainties, including, in addition to any risks and uncertainties
specifically identified in the text surrounding such statements, those risks
discussed in "Risk Factors" below and uncertainties with respect to changes or
developments in social, economic, business, industry, market, legal and
regulatory circumstances and conditions and actions taken or omitted to be
taken by third parties, including the Company's stockholders, customers,
suppliers, business partners, competitors, and legislative, regulatory,
judicial and other governmental authorities and officials. Should one or more
of these risks or uncertainties materialize, or should the underlying
estimates or assumptions prove incorrect, actual results or outcomes may vary
significantly from those anticipated, believed, estimated, expected, intended
or planned.
 
RISK FACTORS
 
  The Company and its businesses are subject to a number of risks including
those enumerated below. Any or all of such risks could have a material adverse
effect on the business, financial condition, results of operations and
prospects of the Company and on market prices for the Company's Common Stock.
See also "Forward-Looking Information" above.
 
 Competition
 
  The electronic commerce market is very competitive. Numerous companies
supply electronic commerce products and services, and several competitors
target specific customer requirements for which the Company presently is, or
may become, a provider. The Company's competitors include both large companies
with substantially greater resources than the Company and small, specialized
companies that may compete in one or more particular market niches.
Competitors that offer products and/or services that compete with various of
the Company's products and services include, among others, AT&T; Computer
Associates International, Inc.; General Electric Information Services;
Harbinger Corporation; IBM; MCI WorldCom; and Quick Response Services, as well
as the internal programming staffs of various businesses engaging in
electronic commerce.
 
  The Company expects competition to increase in the future from both existing
competitors and other companies that may enter the Company's existing or
future markets. The Company believes that its ability to compete successfully
in the electronic commerce market depends on numerous factors, some of which
are outside its control, including product performance, functionality and
reliability, price and customer service and support. There can be no assurance
that new or established competitors will not offer products and services that
are superior to and/or lower in price than those of the Company. In addition,
the Company could face increased competition as and to the extent the Internet
gains further acceptance as a method of conducting electronic commerce.
 
 Factors Affecting Operating Results; Potential Fluctuations in Quarterly
Results
 
  The Company's future quarterly operating results may vary and reduced levels
of earnings or losses could be experienced in one or more quarters.
Fluctuations in the Company's quarterly operating results could result from a
variety of factors, including changes in the levels of revenue derived from
sales of software products and electronic commerce services, the timing of new
product and service announcements by the Company or its competitors, changes
in pricing policies by the Company or its competitors, changes in accounting
requirements, dictated by regulatory agencies or standards bodies (including
possibly retroactive changes), market acceptance of new and enhanced versions
of the products and services of the Company or its competitors, the size and
timing
 
                                      23
<PAGE>
 
of significant orders, changes in operating expenses, changes in the Company's
strategy, the introduction of alternative technologies, the effect of
potential acquisitions and industry and general economic factors.
 
  The Company has limited or no control over many of these factors. In
addition, a somewhat greater portion of the Company's revenues tends to be
recognized in the fourth fiscal quarter as a result of a number of factors,
including the Company's incentive compensation structure for its sales
personnel (under which opportunities to earn higher commissions applicable to
sales in excess of annual quotas and to realize other benefits associated with
the achievement of such quotas are at their greatest during the fourth fiscal
quarter).
 
  The Company operates with virtually no product order backlog because its
software products typically are shipped shortly after orders are received. As
a result, product revenues in any quarter are substantially dependent on the
quantity of such products licensed in that quarter. The Company's expense
levels are based, in part, on its expectations as to future revenues. If
revenue levels are below expectations, the Company's operating results are
likely to be adversely affected unless the Company is willing and able to
reduce its expenses proportionately. As a result of the foregoing factors,
comparisons of results of operations between particular periods are not
necessarily meaningful and historical results of operations are not
necessarily indicative of future performance.
 
 Technological Change; Dependence on New Products and Related Risks
 
  The electronic commerce industry is characterized by rapid technological
change, frequent new product and service introductions and evolving industry
standards. The Company's future success will depend in significant part on its
ability to anticipate and guide industry standards, to continue to apply
advances in electronic commerce product and service technologies, to enhance
existing products and services and to introduce and acquire new products and
services on a timely basis to keep pace with technological developments.
 
  In this regard, there can be no assurance that the Company will be
successful in developing, acquiring or marketing new or enhanced products or
services that respond to technological change or evolving industry standards,
that the Company will not experience difficulties that could delay or prevent
the successful development, acquisition or marketing of such products or
services or that the Company's new or enhanced products and services will
adequately meet the requirements of the marketplace or achieve market
acceptance.
 
  Any delay or failure in the introduction of new or enhanced products or
services, or the failure of such products or services to achieve market
acceptance, could have a material adverse effect on the business, results of
operations and financial condition of the Company.
 
  The introduction and marketing of new or enhanced products and services
requires management of the transition from existing products and services in
order to minimize the disruption in customer purchasing patterns. There can be
no assurance that the Company will successfully manage the transition to new
or enhanced products and services. Further, there can be no assurance that
products, services or technologies developed by others will not render the
Company's products, services or technologies obsolete.
 
  From time to time, the Company or its competitors may announce new products,
services, capabilities or technologies that have the potential to replace or
shorten the life cycle of the Company's existing products and services
offerings. There can be no assurance that announcements of product
enhancements or new product or service offerings will not cause customers to
defer or cancel purchasing existing products and services. Any such deferrals
or cancellations could have a material adverse effect on the Company's
business, results of operations and financial condition.
 
  Software products as complex as those used in the electronic commerce
industry may contain undetected errors or failures when first introduced or
when new versions are released. If software errors are discovered after
introduction, the Company could experience delays or lost revenues during the
period required to correct these errors. There can be no assurance that,
despite testing by the Company and by current and potential customers, errors
will not be found in new products or releases after commencement of commercial
shipments, resulting in
 
                                      24
<PAGE>
 
loss of, or delay in, market acceptance, which could have a material adverse
effect on the Company's business, results of operations and financial
condition.
 
  The Company faces certain risks relating to Year 2000 issues. In this
regard, see the information set forth in "Year 2000" above, which is
incorporated herein by reference.
 
 Growth Through Acquisitions
 
  A key element of the Company's growth strategy has been strategic
acquisitions. There can be no assurance that in the future, acquisition
candidates will be found on terms suitable to the Company or that the Company
will have adequate resources to consummate any acquisition. Acquisitions
involve a number of other special risks, including time and expenses
associated with identifying and evaluating acquisitions, the diversion of
management's attention, the difficulty in the integration of acquired products
and services, the difficulty in combining different company cultures and the
potential loss of key employees of the acquired company. In addition, customer
satisfaction or performance problems at a single acquired firm could have a
material adverse effect on the reputation of the Company as a whole.
 
  Acquisitions may also result in potentially dilutive issuances of equity
securities, the incurrence of debt, the write-off of research and development
and capitalized product costs, integration costs and the amortization of
expenses related to goodwill and other intangible assets, all of which could
have a material adverse affect on the results of operations and financial
condition of the Company.
 
  The guidelines and requirements for the accounting of acquisitions,
including those for the pooling of interests method of accounting, the
expensing of certain costs and the write-down of certain assets, from time to
time are being changed or under consideration for change by various regulatory
agencies and standards bodies. Those changes and the related uncertainties
could make acquisitions less beneficial or attractive to the Company and could
impact the Company's ability to make future acquisitions.
 
 International Growth and Marketing
 
  Prior to June 1997, Sterling Software acted as the exclusive distributor of
certain of the Company's products outside the United States and Canada
pursuant to the International Marketing Agreement. In June 1997, the Company
and Sterling Software terminated the International Marketing Agreement.
Concurrently therewith, the Company acquired certain assets and assumed
certain liabilities associated with the distribution of its products, and the
Company hired certain Sterling Software employees, most of whom had been
dedicated to the sales and marketing of those products. The Company's ability
to maintain and expand this business and its services business internationally
will depend upon, among other things, its ability to attract and retain both
talented and qualified managerial, technical and sales personnel and
electronic commerce services customers outside the United States and Canada
and its ability to continue to effectively manage its domestic operations
while focusing on international expansion. Moreover, the Company's ability to
successfully implement its international strategy will require additional
improvements to its infrastructure and management information systems, and
particularly to its international customer support systems.
 
  International operations are subject to certain inherent risks, including
unexpected changes in regulatory requirements and tariffs, local political and
economic developments, difficulties in staffing and managing foreign
operations, exchange controls, expropriation, longer payment cycles, increased
difficulties in collecting accounts receivable, changes in foreign currency
exchange rates and potentially adverse tax consequences.
 
  To the extent international sales are denominated in foreign currencies,
fluctuations in the exchange rates between the U.S. dollar and applicable
international currencies may contribute to fluctuations in the Company's
results of operations. The Company has in the past, on a limited basis,
entered into hedging arrangements for the purpose of reducing the risk of
currency fluctuations. In addition, sales in Europe and certain other parts of
the world typically are adversely affected in the third calendar quarter of
each year because many customers reduce their business activities in the
summer months.
 
                                      25
<PAGE>
 
  The assets and liabilities of the Company's foreign operations are
translated into U.S. dollars at exchange rates in effect as of the respective
balance sheet dates, and revenue and expense accounts of these operations are
translated at average exchange rates during the month the transactions occur.
Unrealized translation gains and losses are included as an adjustment to
retained earnings.
 
  In the event of any dispute arising from international operations, the
Company may be subject to the exclusive jurisdiction of foreign courts and may
not be successful in subjecting foreign persons or entities to the
jurisdiction of the courts in the United States. The Company may also be
hindered in or prevented from enforcing its rights with respect to foreign
governments because of the doctrine of sovereign immunity. There can be no
assurance that the laws, regulations or administrative practices of foreign
countries relating to the Company's ability to do business in that country
will not change. Any such change could have a material adverse affect on the
business, results of operations and financial condition of the Company.
 
  The Company faces certain risks relating to the adoption of the Euro as a
new currency in Europe. In this regard, see the information set forth in "New
European Currency" above. Such information is incorporated herein by
reference.
 
 Ability to Attract Qualified Personnel
 
  The Company's business is dependent upon its ability to attract and retain
highly qualified managerial, technical and sales personnel. Competition for
such personnel is intense. There can be no assurance that the Company can
retain its key managerial, technical and sales personnel or that it can
attract, assimilate or retain such personnel in the future. The inability of
the Company to attract and retain such personnel could have a material adverse
effect on the business, results of operations and financial condition of the
Company.
 
 Dependence on Data Center
 
  The operations of the Company's Commerce Services Group are dependent upon
the Company's ability to protect its computer equipment and the information
stored in its data center against damage that may be caused by fire, power
loss, telecommunications failures, unauthorized intrusion, computer viruses
and disabling devices and other similar events. The data center is located in
a single facility in Columbus, Ohio and the Company has no present intention
of establishing an additional data center in a separate location.
 
  The Company is party to a disaster recovery agreement that provides
alternative off-site computer systems for use in such disastrous events. In
addition, the Company has taken precautions to protect itself and its
customers from events that could interrupt delivery of certain of the
Company's electronic commerce services. These precautions include, among
others, backup power generation equipment, fire protection and physical
security systems and an early warning detection and fire extinguishing system.
Notwithstanding such precautions, there can be no assurance that a fire or
other natural disaster, including national, regional or local
telecommunications disruptions, would not result in a prolonged disruption of
the Company's electronic commerce services.
 
  The Company is currently covered under a business interruption insurance
policy. However, even if lost revenues or increased costs experienced by the
Company during the pendency of any disruption of its services business were
substantially recovered under any such insurance policy (as to which,
depending upon the circumstances, there can be no assurance), longer term
revenue losses not recoverable under such policies could result from possible
losses of customers and, consequently, could have a material adverse effect on
the business, results of operations and financial condition of the Company.
 
  The Company faces certain risks relating to Year 2000 issues. In this
regard, see information set forth in "Year 2000" above. Such information is
incorporated herein by reference.
 
 Limited Protection of Proprietary Rights; Risks of Infringement and Loss of
Licenses
 
  Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or
to obtain and use information that the Company regards as proprietary
 
                                      26
<PAGE>
 
through reverse engineering or otherwise. There can be no assurance that the
Company's means of protecting its proprietary rights will be adequate or that
the Company's competitors will not independently develop similar technology.
In addition, the laws of some foreign countries do not protect the Company's
proprietary rights to the same extent as the laws of the United States.
However, the Company believes that, due to the rapid pace of innovation within
the electronic commerce industry, factors such as the technological and
creative skills of its personnel are more important in establishing and
maintaining a leadership position within this industry than are the various
legal protections afforded its proprietary rights.
 
  The Company does not believe that any of its products or services infringe
the valid proprietary rights of third parties in any material respect.
However, a large number of patents, trademarks and copyrights have been, and
are being, issued, registered or asserted in the software and electronic
commerce industries. There can be no assurance that the Company is aware of
all such intellectual property rights that may pose a risk of infringement by
the Company's products or services, especially with respect to United States
patents which can cover extremely broad concepts and the applications for
which are confidential until the patents are issued.
 
  The Company from time to time has received communications from third parties
alleging that the Company is infringing intellectual property rights. There
can be no assurance that third parties will not assert infringement claims in
the future or that the Company would prevail in any litigation to enjoin the
Company from offering affected products or services or be able to obtain a
license with respect to such rights on terms acceptable to the Company. Such
events could have a material adverse effect on the business, results of
operations and financial condition of the Company.
 
  Licenses for a number of third-party software products have been granted to
the Company for its own use or for remarketing to its customers. In the
aggregate, these licenses are material to the business of the Company.
Although management believes that the risk that the Company will lose a
significant number of licenses is remote, such a loss could have a material
adverse effect on the business, results of operations and financial condition
of the Company.
 
 Government Regulatory and Industrial Policy Risks
 
  Current United States and Canadian regulations and laws governing the
telecommunications industry generally do not apply to providers of electronic
commerce services and products. Except for government regulations in certain
foreign countries (which may affect the provision of certain of the Company's
services or use of certain of its products) and regulations governing the
ability of the Company to disclose the contents of communications by its
customers, there are no government regulations pertaining to the pricing,
service characteristics or capabilities, geographic distribution or quality
control features of the Company's electronic commerce services or products.
There exists, however, the risk that governmental policies affecting the
electronic commerce industry could be implemented by executive order,
legislation, administrative order or otherwise. If such policies are adopted,
they could have a material adverse effect on the business, results of
operations and financial condition of the Company.
 
  Although the Company does not believe that import and export control
regulations currently create significant impediments to the Company's
international growth strategy, such regulations are applicable to certain of
the Company's software products, and could interfere with such growth in the
future.
 
 Certain Anti-takeover Provisions
 
  Certain provisions of the Company's certificate of incorporation and bylaws
and the Delaware General Corporation Law may have the effect of delaying,
deterring or preventing a change in control of the Company.
 
  The Company is also a party to the Rights Agreement, dated as of December
18, 1996 (the "Rights Agreement"), between the Company and The First National
Bank of Boston, as rights agent. The Rights Agreement could also delay, deter
or prevent a change in control of the Company.
 
                                      27
<PAGE>
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
INTEREST RATE RISK
 
  The Company's exposure to market risk for changes in interest rates relates
primarily to the Company's investment portfolio of cash equivalents and
marketable securities. The Company does not use derivative financial
instruments in its investment portfolio. The stated objectives of the
Company's investment guidelines are: safety of principal; liquidity;
maximization of yield; and diversification of risk. The Company places its
investments with high credit quality issuers, principally states of the United
States, political subdivisions of the states and corporate debt issuers, and
limits the amount of credit exposure to any one issuer. The marketable
securities portfolio includes only those securities with active secondary or
resale markets to ensure portfolio liquidity. In any event, a substantial
reduction in overall interest rates could significantly reduce the Company's
interest income.
 
  The table below presents principal amounts and related weighted average
interest rates by date of maturity for the Company's investment portfolio.
Weighted average interest rates include the after-tax yield on debt securities
of states of the United States and political subdivisions of the states. The
total investment portfolio has an effective maturity of less than 180 days.
 
<TABLE>
<CAPTION>
                                       MATURITY
                          (IN THOUSANDS, EXCEPT PERCENTAGES)
                          -------------------------------------
                                                                  FAIR VALUE AT
                             1999         2000        TOTAL     SEPTEMBER 30, 1998
                          -----------  ----------- ------------ ------------------
<S>                       <C>          <C>         <C>          <C>
Cash equivalents........  $   355,779              $   355,779       $354,948
  Average interest
   rate.................         5.45%                    5.45%
Commercial paper........       52,650                   52,650         51,972
  Average interest
   rate.................         5.64%                    5.64%
Debt securities.........      118,223  $   12,658      130,881        131,479
  Average interest
   rate.................         5.90%       6.11%        5.92%
Total investment portfo-
 lio....................  $   526,652  $   12,658  $   539,310       $538,399
  Average interest
   rate.................         5.57%       6.11%        5.58%
</TABLE>
 
FOREIGN CURRENCY RISK
 
  The Company conducts business in various foreign currencies, primarily in
Canada and Europe and to a lesser extent in Australia, Japan and other Asian
countries. The Company monitors its foreign currency exposure and, from time
to time, will attempt to reduce its exposure through hedging. As of September
30, 1998, the Company has no foreign currency hedges outstanding. The Company
has mitigated, and expects to continue to mitigate, a portion of its currency
exposure through decentralized sales, marketing and support operations in
which all costs are local currency based.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
                            STERLING COMMERCE, INC.
 
                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           ----
<S>                                                                        <C>
Report of Ernst & Young LLP, Independent Auditors.........................  29
Consolidated Financial Statements:
  Consolidated Balance Sheets at September 30, 1998 and 1997..............  30
  Consolidated Statements of Operations for the Years Ended September 30,
   1998, 1997 and 1996....................................................  31
  Consolidated Statements of Stockholders' Equity for the Years Ended Sep-
   tember 30, 1998, 1997 and 1996.........................................  32
  Consolidated Statements of Cash Flows for the Years Ended September 30,
   1998, 1997 and 1996....................................................  33
  Notes to Consolidated Financial Statements..............................  34
</TABLE>
 
                                      28
<PAGE>
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors and Stockholders
Sterling Commerce, Inc.
 
  We have audited the accompanying consolidated balance sheets of Sterling
Commerce, Inc. (the "Company") as of September 30, 1998 and 1997, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended September 30, 1998. Our
audit also included the financial statement schedule listed under Item 14(a)
of the Company's Annual Report on Form 10-K for the year ended September 30,
1998. These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
 
  In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Sterling Commerce, Inc. at September 30, 1998 and 1997, and the
consolidated results of its operations and its cash flows for each of the
three years in the period ended September 30, 1998 in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
 
                                          Ernst & Young LLP
 
Dallas, Texas
November 17, 1998
 
                                      29
<PAGE>
 
                            STERLING COMMERCE, INC.
 
                          CONSOLIDATED BALANCE SHEETS
 
                          SEPTEMBER 30, 1998 AND 1997
                    (IN THOUSANDS, EXCEPT SHARE INFORMATION)
 
<TABLE>
<CAPTION>
                                                                 1998     1997
                                                               -------- --------
<S>                                                            <C>      <C>
                           ASSETS
                           ------
Current assets:
  Cash and cash equivalents..................................  $354,948 $250,348
  Marketable securities......................................   183,451  234,314
  Accounts and notes receivable, net.........................   151,256  103,692
  Deferred income taxes......................................    11,627   10,431
  Prepaid expenses and other current assets..................    18,013   16,332
                                                               -------- --------
    Total current assets.....................................   719,295  615,117
Property and equipment, net..................................    74,391   59,723
Computer software, net of accumulated amortization of $62,257
 in 1998 and $51,306 in 1997.................................    91,409   48,163
Excess cost over net assets acquired, net of accumulated am-
 ortization of $2,339 in 1998 and $4,212 in 1997.............    63,382   17,156
Other assets.................................................    18,527    8,407
                                                               -------- --------
                                                               $967,004 $748,566
                                                               ======== ========
            LIABILITIES AND STOCKHOLDERS' EQUITY
            ------------------------------------
Current liabilities:
  Accounts payable and accrued liabilities...................  $ 90,599 $ 57,397
  Income taxes payable.......................................     7,992    5,919
  Deferred revenue...........................................    75,590   60,000
                                                               -------- --------
    Total current liabilities................................   174,181  123,316
Deferred income taxes........................................    30,335   13,592
Other noncurrent liabilities.................................    14,573   10,796
Contingencies and commitments
Stockholders' equity:
  Preferred stock $.01 par value, 50,000,000 shares autho-
   rized; no shares issued and outstanding...................
  Common stock $.01 par value, 150,000,000 shares authorized;
   94,511,000 and 89,644,000 shares issued and outstanding in
   1998 and 1997, respectively...............................       945      896
  Additional paid-in capital.................................   714,156  505,855
  Retained earnings..........................................    32,814   94,111
                                                               -------- --------
    Total stockholders' equity...............................   747,915  600,862
                                                               -------- --------
                                                               $967,004 $748,566
                                                               ======== ========
</TABLE>
 
                            See accompanying notes.
 
                                       30
<PAGE>
 
                            STERLING COMMERCE, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
                 YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
                  (IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
 
<TABLE>
<CAPTION>
                                                     1998      1997     1996
                                                   --------  -------- --------
<S>                                                <C>       <C>      <C>
Revenue:
  Products........................................ $191,380  $110,634 $ 80,963
  Product support.................................  101,005    71,316   56,229
  Services........................................  197,917   151,889  109,833
  Royalties from Sterling Software................             16,758   20,748
                                                   --------  -------- --------
                                                    490,302   350,597  267,773
Costs and expenses:
  Cost of sales:
    Products and product support..................   41,842    34,217   27,447
    Services......................................   54,319    36,398   26,971
                                                   --------  -------- --------
                                                     96,161    70,615   54,418
  Product development and enhancement expenses....   29,717    24,853   15,553
  Selling, general and administrative expenses....  201,689   134,849  102,597
  Purchased research and development..............  116,460    31,879
  Reorganization and unusual costs................   67,436    15,810
                                                   --------  -------- --------
                                                    511,463   278,006  172,568
Income (loss) before other income and income tax-
 es...............................................  (21,161)   72,591   95,205
Other income......................................   24,152    16,693    1,217
                                                   --------  -------- --------
Income before income taxes........................    2,991    89,284   96,422
Provision for income taxes........................   64,147    33,840   38,030
                                                   --------  -------- --------
Net income (loss)................................. $(61,156) $ 55,444 $ 58,392
                                                   ========  ======== ========
Income (loss) per common share:
  Basic........................................... $  (0.67) $   0.66 $   0.79
                                                   ========  ======== ========
  Diluted......................................... $  (0.67) $   0.64 $   0.77
                                                   ========  ======== ========
</TABLE>
 
 
 
                            See accompanying notes.
 
                                       31
<PAGE>
 
                            STERLING COMMERCE, INC.
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
 
                 YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                             COMMON STOCK
                          ------------------- ADDITIONAL           STOCKHOLDERS'     TOTAL
                          NUMBER OF            PAID-IN   RETAINED       NET      STOCKHOLDERS'
                           SHARES   PAR VALUE  CAPITAL   EARNINGS   INVESTMENT      EQUITY
                          --------- --------- ---------- --------  ------------- -------------
<S>                       <C>       <C>       <C>        <C>       <C>           <C>
Balance at September 30,
 1995...................                                             $ 53,187      $ 53,187
  Formation
   transactions.........   73,200     $732     $ 53,871               (54,603)
  Issuance of common
   stock for cash.......    1,800       18       40,100                              40,118
  Net cash distributed
   to Sterling
   Software.............                                              (17,819)      (17,819)
  Net income............                                 $ 39,157      19,235        58,392
  Other.................                          4,140       169                     4,309
                           ------     ----     --------  --------    --------      --------
Balance at September 30,
 1996...................   75,000      750       98,111    39,326                   138,187
  Issuance of common
   stock for cash.......   14,375      144      400,001                             400,145
  Issuance of common
   stock for
   acquisitions.........      194        2        4,998                               5,000
  Issuance of common
   stock pursuant to
   stock options
   including tax benefit
   of $1,200............       75                 3,000                               3,000
  Net income............                                   55,444                    55,444
  Other.................                           (255)     (659)                     (914)
                           ------     ----     --------  --------    --------      --------
Balance at September 30,
 1997...................   89,644      896      505,855    94,111                   600,862
  Issuance of common
   stock and stock
   options for
   acquisitions.........    2,442       24      140,987                             141,011
  Issuance of common
   stock pursuant to
   Employee Stock
   Purchase Plan
   including tax benefit
   of $75...............       77        1        3,775                               3,776
  Issuance of common
   stock pursuant to
   stock options
   including tax benefit
   of $9,871............    2,348       24       63,633                              63,657
  Net loss..............                                  (61,156)                  (61,156)
  Other.................                            (94)     (141)                     (235)
                           ------     ----     --------  --------    --------      --------
Balance at September 30,
 1998...................   94,511     $945     $714,156  $ 32,814                  $747,915
                           ======     ====     ========  ========    ========      ========
</TABLE>
 
 
                            See accompanying notes.
 
                                       32
<PAGE>
 
                            STERLING COMMERCE, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
                 YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                  1998       1997       1996
                                                ---------  ---------  --------
<S>                                             <C>        <C>        <C>
OPERATING ACTIVITIES:
Net income (loss).............................. $ (61,156) $  55,444  $ 58,392
 Adjustments to reconcile net income (loss) to
  net cash provided by
  operating activities:
 Depreciation and amortization.................    40,718     30,214    21,943
 Provision for losses on accounts receivable...     8,952      3,567     1,068
 Provision for (benefit of) deferred income
  taxes........................................     1,481    (15,586)    5,762
 Purchased research and development............   116,460     31,879
 Noncash reorganization and unusual costs......    36,192
 Changes in operating assets and liabilities,
  net of effects of business acquisitions:
  Accounts and notes receivable................   (47,073)   (45,885)  (13,149)
  Amounts due from Sterling Software...........               35,134   (35,134)
  Prepaid expenses and other assets............   (11,527)   (13,917)   (3,135)
  Accounts payable, accrued liabilities and in-
   come taxes payable..........................    14,371     20,877    12,710
  Deferred revenue.............................     7,823     17,067     7,598
  Other........................................     2,709      3,273     1,235
                                                ---------  ---------  --------
   Net cash provided by operating activities...   108,950    122,067    57,290
INVESTING ACTIVITIES:
 Purchases of property and equipment...........   (46,454)   (32,148)  (26,573)
 Purchases and capitalized cost of development
  of computer software.........................   (19,320)   (13,855)  (12,016)
 Business acquisitions, net of cash acquired...   (56,637)   (38,320)     (185)
 Purchases of investments......................  (257,730)  (313,460)  (21,203)
 Sales of investments..........................   308,593    100,349
                                                ---------  ---------  --------
   Net cash used in investing activities.......   (71,548)  (297,434)  (59,977)
FINANCING ACTIVITIES:
 Issuance of common stock......................    67,433    401,945    40,118
 Net cash distributed to Sterling Software.....                        (17,819)
 Other.........................................      (235)       286     3,477
                                                ---------  ---------  --------
   Net cash provided by financing activities...    67,198    402,231    25,776
Increase in cash and cash equivalents..........   104,600    226,864    23,089
                                                ---------  ---------  --------
Cash and cash equivalents at beginning of
 year..........................................   250,348     23,484       395
                                                ---------  ---------  --------
Cash and cash equivalents at end of year....... $ 354,948  $ 250,348  $ 23,484
                                                =========  =========  ========
SUPPLEMENTAL CASH FLOW INFORMATION:
  Income taxes paid............................ $  51,216  $  49,278  $ 32,268
                                                =========  =========  ========
</TABLE>
 
                            See accompanying notes.
 
                                       33
<PAGE>
 
                            STERLING COMMERCE, INC.
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
                       SEPTEMBER 30, 1998, 1997 AND 1996
 
1. GENERAL INFORMATION
 
 General
 
  Sterling Commerce, Inc. (together with its predecessors and subsidiaries,
the "Company") is a provider of electronic commerce ("EC") products, services
and solutions worldwide. The Company develops, markets and supports electronic
commerce software products, and provides electronic commerce services, that
enable businesses to engage in business-to-business electronic communications
and transactions. The Company has been providing electronic commerce solutions
for over 20 years and has numerous customers in many industries such as
banking, healthcare, manufacturing, pharmaceuticals, retailing,
telecommunications and transportation.
 
  The Company was incorporated in December 1995 as a wholly owned subsidiary
of Sterling Software, Inc. ("Sterling Software"). The Company completed its
initial public offering (the "Offering") on March 13, 1996. Pursuant to the
Offering, the Company sold to the public 1,800,000 previously unissued shares
of common stock, $0.01 par value, of the Company ("Common Stock") and Sterling
Software sold to the public 12,000,000 of the 73,200,000 shares of the
Company's Common Stock then owned by it.
 
  In contemplation of the Offering, among other things: (1) Sterling Software
caused to be transferred to the Company certain assets relating to the
electronic commerce business previously conducted by Sterling Software and (2)
the Company entered into contractual arrangements with Sterling Software
related to, among other things, tax allocation, indemnification and
international marketing. See Note 3--Agreements with Sterling Software.
 
  On September 23, 1996, the Board of Directors of Sterling Software declared
a special dividend consisting of the distribution (the "Distribution") of all
shares of Common Stock held by Sterling Software on September 30, 1996,
payable pro rata to the holders of record of Sterling Software's common stock,
$0.10 par value, as of the close of business on such date. As a result,
effective September 30, 1996, the Company ceased to be a subsidiary of
Sterling Software.
 
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
 
 Basis of Presentation
 
  The Company's consolidated financial statements for the year ended September
30, 1996 have been prepared using Sterling Software's historical basis in the
assets and liabilities of its Electronic Commerce Group, including goodwill
and other intangible assets recognized by Sterling Software in the original
acquisition of certain businesses conducted by the Company. The Company's
consolidated financial statements include the accounts and transactions of the
Company together with its subsidiaries. All significant intercompany accounts
among the Company and its consolidated subsidiaries have been eliminated.
Certain amounts for periods ended prior to September 30, 1998 have been
reclassified to conform to the current year presentation. The financial
statements have been prepared in conformity with generally accepted accounting
principles which require management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingencies at September 30, 1998 and 1997 and the results of operations for
the years ended September 30, 1998, 1997 and 1996. While management has based
its assumptions and estimates on the facts and circumstances currently known,
final amounts may differ from such estimates.
 
  The Company's consolidated financial statements for the year ended September
30, 1996 reflect the results of operations and cash flows of the Company as a
component or subsidiary of Sterling Software and may not be indicative of
actual results of operations and financial position of the Company which may
have been obtained under other ownership. Management believes that the
consolidated income statements include a reasonable allocation of the
incremental administrative costs previously incurred by Sterling Software,
including executive
 
                                      34
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
compensation and the related costs of a corporate staff function. The
allocation of such costs were approximately $875,000 for the first quarter of
1996 and represents management's estimate of the costs that would have been
incurred had the Company operated independently of Sterling Software.
Subsequent to the first quarter of 1996, these incremental administrative
costs were incurred directly by the Company and therefore no further
allocations of such costs were made by Sterling Software.
 
 Revenue
 
  Revenue from license fees for software products is recognized when the
software is delivered, provided no significant future vendor obligations exist
and collection is probable. If software product transactions include the right
to receive future products, a portion of the software product revenue is
deferred and recognized as such products are delivered. Services revenue and
revenue from products involving installation or other services are recognized
as the services are performed. Services revenue earned but not invoiced at the
end of a month is recognized as revenue in such month and recorded as unbilled
accounts receivable until invoiced in the following month. Royalties from
Sterling Software represent royalties earned from Sterling Software and
certain of its subsidiaries acting as distributors of certain of the Company's
products outside of the United States and Canada.
 
  Product support contracts generally entitle the customer to telephone
support, bug fixing and the right to receive software updates as they are
released. Revenue from product support contracts, including product support
included in initial license fees, is recognized ratably over the contract
period. All significant costs and expenses associated with product support
contracts are expensed as incurred, which approximates ratable expenses over
the contract period.
 
  When products, product support and services are billed prior to the time the
related revenue is recognized, deferred revenue is recorded and related costs
paid in advance are deferred.
 
 Software Development Costs
 
  The Company capitalizes the costs of developing and testing new or
significantly enhanced software products in accordance with the provisions of
Statement of Financial Accounting Standards No. 86, "Accounting for the Costs
of Computer Software to be Sold, Leased or Otherwise Marketed" ("FAS 86").
Unamortized software development costs of $38,967,000 and $34,095,000 are
included in "Computer software, net" at September 30, 1998 and 1997,
respectively. Pursuant to FAS 86, costs are capitalized when technological
feasibility of the product is established. Technological feasibility is
established either upon the completion of a detailed program design or the
completion of a working model. The establishment of technological feasibility
and the ongoing assessment of recoverability of capitalized software
development costs require judgment by management with respect to certain
external factors, including, but not limited to, anticipated future revenues,
estimated economic life and changes in software and hardware technologies.
Software development capitalized costs include, among other things,
programmers' salaries and benefits, outside contractor costs, computer time
and allocated facilities costs.
 
 Depreciation and Amortization
 
  Property and equipment are recorded at cost and depreciated using the
straight-line method over average useful lives of three to fifteen years.
Capitalized computer software costs are amortized on a product-by-product
basis using the greater of the amount determined by taking the ratio of
current year net revenue to estimated future net revenue or the straight-line
method over periods ranging from two to five years. Leasehold improvements are
amortized over the term of the lease. Excess costs over the net assets of
businesses acquired
 
                                      35
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
are amortized on a straight-line basis over periods of seven to forty years.
Other intangible assets are amortized on a straight-line basis over periods of
three to ten years.
 
  Depreciation and amortization consists of the following for the years ended
September 30, 1998, 1997 and 1996 (in thousands):
 
<TABLE>
<CAPTION>
                                                        1998    1997    1996
                                                       ------- ------- -------
   <S>                                                 <C>     <C>     <C>
   Property and equipment............................. $22,022 $16,617 $10,817
   Purchased computer software........................   3,122   1,720   1,412
   Capitalized computer software development costs....  11,535  10,252   8,463
   Excess costs over net assets of businesses ac-
    quired............................................   2,194     830     427
   Intangible assets..................................   1,845     795     824
                                                       ------- ------- -------
                                                       $40,718 $30,214 $21,943
                                                       ======= ======= =======
</TABLE>
 
 Income Taxes
 
  The Company computes its provision for income taxes in accordance with
Statement of Financial Accounting Standards No. 109 "Accounting for Income
Taxes" ("FAS 109"), which requires the use of the asset and liability method
of accounting for income taxes. Under the asset and liability method, a
deferred tax asset or liability is recognized for estimated future tax effects
attributable to temporary differences and carryforwards. The measurement of
deferred income tax assets is adjusted by a valuation allowance, if necessary,
to recognize future tax benefit only to the extent, based on available
evidence, it is more likely than not it will be realized. The effect on
deferred taxes of a change in income tax rates is recognized in the period
that includes the enactment date.
 
  Through September 30, 1996, income from the Company's operations was
included in consolidated income tax returns filed by Sterling Software as part
of its corporate group. The Company has entered into a tax allocation
agreement with Sterling Software covering the reporting periods through
September 30, 1996. Income tax expense in the accompanying financial
statements for periods prior to October 1, 1996, has been computed assuming
the Company filed returns separately from Sterling Software.
 
 Stock Options
 
  The Company has elected to follow Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees" ("APB 25") in accounting for its
employee stock options and stock based awards. Under APB 25, if the exercise
price of an employee stock option equals or exceeds the market price of the
underlying stock on the date of grant, no compensation expense is recognized.
 
 Earnings Per Share
 
  In 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 128 "Earnings per Share" ("FAS 128").
FAS 128 replaced the previously reported primary and fully diluted earnings
per share with basic and diluted earnings per share. Unlike primary earnings
per share, basic earnings per share excludes any dilutive effects of options,
warrants and convertible securities. Diluted earnings per share is very
similar to the previously reported fully diluted earnings per share. The
Company adopted FAS 128 in 1998, and earnings per share amounts for all prior
year periods presented have been restated to conform with the requirements of
FAS 128.
 
 
                                      36
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
  The following table sets forth the computation of basic and diluted earnings
per share (in thousands, except per share amounts):
 
<TABLE>
<CAPTION>
                                       YEAR ENDED    YEAR ENDED    YEAR ENDED
                                      SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
                                          1998          1997        1996 (2)
                                      ------------- ------------- -------------
<S>                                   <C>           <C>           <C>
Basic:
Net income (loss)...................    $(61,156)      $55,444       $58,392
                                        ========       =======       =======
Weighted average common shares out-
 standing...........................      91,307        83,561        74,233
                                        ========       =======       =======
Per share amount....................    $  (0.67)      $   .66       $   .79
                                        ========       =======       =======
Diluted:
Net income (loss)...................    $(61,156)      $55,444       $58,392
                                        ========       =======       =======
Weighted average common shares out-
 standing...........................      91,307        83,561        74,233
Net effect of dilutive stock options
 (1)................................                     3,254         1,242
                                        --------       -------       -------
Total...............................      91,307        86,815        75,475
                                        ========       =======       =======
Per share amount....................    $  (0.67)      $   .64       $   .77
                                        ========       =======       =======
</TABLE>
--------
(1)  In connection with the computation of the loss per share for the year
     ended September 30, 1998, all otherwise dilutive stock options have been
     excluded because the impact on the Company's net loss per share is anti-
     dilutive. In the absence of this net loss, 3,839,000 additional shares
     related to dilutive stock options would be included in the computation of
     diluted earnings per share. Also, 429,000, 265,000 and 3,000
     anti-dilutive stock options are excluded from the calculation in the
     years 1998, 1997 and 1996, respectively.
 
(2)  Weighted average common shares outstanding for the year ended September
     30, 1996 were calculated as though there were 73,200,000 shares
     outstanding during the entire period, together with the weighted average
     of the additional 1,800,000 shares issued in the Offering.
 
 Foreign Currency Translation
 
  The assets and liabilities of consolidated non-U.S. operations are
translated into U.S. dollars at exchange rates in effect as of the respective
balance sheet dates. Revenue and expense accounts of those operations are
translated at average exchange rates prevailing during the period the
transactions occur. Unrealized translation gains and losses are included as an
adjustment to retained earnings.
 
 Cash and Cash Equivalents
 
  Cash and cash equivalents consist primarily of highly liquid investments in
investment-grade commercial paper of various issuers, with maturities of three
months or less when purchased. Cash and cash equivalents are recorded at their
fair value.
 
 Marketable Securities
 
  The Company invests excess cash in a diversified portfolio consisting of a
variety of securities, including commercial paper, corporate debt securities
and debt securities issued by states of the United States and political
subdivisions of the states. The fair values for marketable securities are
based on quoted market prices.
 
  All marketable securities are classified as available-for-sale securities.
Unrealized holding gains and losses on securities available-for-sale are
recorded as a component of stockholders' equity, net of any related tax
effect. The amortized cost of debt securities in this category is adjusted for
amortization of premiums and accretion of
 
                                      37
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
discounts to maturity. Such amortization is included in investment income.
Realized gains and losses and declines in values judged to be other-than-
temporary are included in investment income.
 
 Excess Cost Over Net Assets Acquired
 
  Excess cost over net assets acquired is amortized on a straight-line basis
over periods of seven to 40 years. The carrying amount of such costs which are
not associated with other assets acquired in a purchase business combination
is reassessed by management if facts and circumstances suggest that such
amount may be impaired. If such assessment indicates that the costs will not
be recoverable, as determined based on the estimated discounted future cash
flows of the business acquired over the remaining amortization period, the
carrying amount is reduced by the estimated shortfall of cash flows. The
carrying amount of costs associated with other assets acquired in a purchase
business combination is included in impairment evaluations when events or
circumstances exist that indicate the carrying amount of those assets may not
be recoverable.
 
 Recent Pronouncements
 
  There have been recent pronouncements by the FASB and the American Institute
of Certified Public Accountants ("AICPA") that may require certain changes in
accounting policies of the Company and which may also affect disclosure
requirements. These recent pronouncements do not affect the current year's
accounting or reporting requirements and are mentioned here for informational
purposes only.
 
  FAS No. 130: "Reporting Comprehensive Income." FAS 130 establishes standards
for reporting and display of comprehensive income and its components in a full
set of general-purpose financial statements. FAS 130 will be effective for the
Company's fiscal year beginning October 1, 1998. The adoption of FAS 130 will
require additional disclosure in the Company's financial statements but will
not have any impact on the financial position or results of operations of the
Company.
 
  FAS No. 131: "Disclosures about Segments of an Enterprise and Related
Information." FAS 131 establishes standards for the way that public business
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information
about operating segments in interim financial reports issued to stockholders.
It also establishes standards for related disclosures about products and
services, geographic areas and major customers. FAS 131 will be effective for
financial statements for the Company's fiscal year beginning October 1, 1998.
The adoption of FAS 131 will require additional disclosure in the Company's
financial statements but will not have any impact on the financial position or
results of operations of the Company.
 
  FAS No. 133: "Accounting for Derivative Instruments and Hedging
Activities." FAS 133 requires companies to record derivatives on the balance
sheet as assets or liabilities, measured at fair value. Gains or losses
resulting from changes in the values of those derivatives would be accounted
for depending on the use of the derivative and whether it qualifies for hedge
accounting. FAS 133 is effective for fiscal quarters of fiscal years beginning
after June 15, 1999. The adoption of FAS 133 is not expected to have a
material impact on the financial position or results of operations of the
Company.
 
  SOP 97-2: "Software Revenue Recognition." SOP 97-2 is effective for
transactions entered into by the Company in the Company's fiscal year
beginning October 1, 1998. In March 1998, the AICPA issued SOP 98-4 which
defers certain provisions of SOP 97-2 for one year (until fiscal years
beginning after December 15, 1998). Detailed implementation guidelines for the
provisions of SOP 97-2 which were deferred have not been issued. The Company's
accounting policy on software revenue recognition is generally in compliance
with SOP 97-2, as amended by SOP 98-4, and adoption of these SOP's, as
currently issued, is not expected to have a material impact on the financial
position or results of operations of the Company.
 
                                      38
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  SOP 98-1: "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." SOP 98-1 requires companies to capitalize
qualifying computer software costs which are incurred during the application
development stage and amortize them over the software's estimated useful life.
SOP 98-1 will be effective for the Company's fiscal year beginning October 1,
1999. The adoption of SOP 98-1 is not expected to have a material impact on
the financial position or results of operations of the Company.
 
3. AGREEMENTS WITH STERLING SOFTWARE
 
  As a result of Sterling Software's ownership interest in the Company, the
terms of the agreements entered into by the Company and Sterling Software in
contemplation of the Offering were not the result of arm's-length negotiation.
Two such agreements were the tax allocation agreement and the indemnification
agreement. The tax allocation agreement states that for periods during which
the Company and/or its subsidiaries are included in Sterling Software's
consolidated federal income tax returns or consolidated, combined or unitary
state tax returns (which periods included the period between the Offering and
the Distribution), the Company is required to pay to or is entitled to receive
from Sterling Software its allocable portion of the consolidated federal and
state income tax liability or refunds, respectively. The indemnification
agreement provides that the Company will indemnify Sterling Software and its
directors, officers, employees, agents and representatives for any liabilities
resulting from or arising out of certain acts, failures to act or the
provision of incorrect factual information by the Company in connection with
the Internal Revenue Service ruling request that would cause the Distribution
to be taxable to Sterling Software or its stockholders. The indemnification
agreement also provides that each party will indemnify the other party for
certain other liabilities, including those relating to the business,
operations or assets conducted or owned by the indemnifying party.
 
  Certain costs and expenses were initially incurred by Sterling Software on
behalf of the Company and charged to the Company. An analysis of significant
items (other than the expense allocations discussed in Note 2 under "Basis of
Presentation," tax allocations and the early termination payment discussed
below in Note 4 under "1997 Reorganization and Unusual Costs" follows (in
thousands):
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED SEPTEMBER 30
                                                       ------------------------
                                                        1998    1997     1996
                                                       ------- ------- --------
   <S>                                                 <C>     <C>     <C>
   Summary of expenses:
     Legal, accounting and professional fees.......... $   261 $   153 $  1,139
     Payroll related..................................     844   3,557    7,691
     Occupancy........................................   1,179   1,558    1,695
     Miscellaneous....................................   1,170   1,163      534
                                                       ------- ------- --------
                                                       $ 3,454 $ 6,431 $ 11,059
                                                       ======= ======= ========
</TABLE>
 
4. BUSINESS COMBINATIONS AND REORGANIZATIONS
 
 1998 Business Combinations
 
  On July 21 1998, the Company completed the acquisition of all of the issued
and outstanding stock of XcelleNet, Inc. ("XcelleNet"), an Atlanta, Georgia
based provider of remote systems management software products and services.
The Company's consolidated statements of operations reflect the results of
operations of XcelleNet from the date of the acquisition. The aggregate
purchase price paid was approximately $224,000,000, consisting of
approximately $83,000,000 of cash, approximately 2,442,000 shares of newly
issued Common Stock and options to purchase approximately 1,287,000 shares of
Common Stock to replace outstanding options to purchase XcelleNet stock held
by XcelleNet employees and directors.
 
 
                                      39
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
  The components of the aggregate purchase price were as follows (in
thousands):
 
<TABLE>
     <S>                                                               <C>
     Common Stock and options to purchase Common Stock................ $141,011
     Cash paid to XcelleNet Stockholders..............................   74,151
     Other direct costs of acquisition................................    9,036
                                                                       --------
                                                                       $224,198
                                                                       ========
</TABLE>
 
  Other direct costs of acquisition include employee termination costs,
transaction costs, costs associated with the elimination of excess facilities
and other direct costs.
 
  The XcelleNet acquisition has been accounted for in accordance with the
purchase method of accounting. The purchase price has been allocated to
identifiable tangible and intangible assets acquired and liabilities assumed
based on their estimated fair values as follows:
 
<TABLE>
     <S>                                                               <C>
     Working capital.................................................. $ 22,239
     Developed software and core technology...........................   49,751
     Property and equipment...........................................    3,560
     Other assets.....................................................    2,564
     Deferred tax liabilities.........................................  (14,066)
     Other liabilities................................................   (1,206)
     Purchased research and development...............................  114,650
     Excess cost over net assets acquired.............................   46,706
                                                                       --------
                                                                       $224,198
                                                                       ========
</TABLE>
 
  The estimates of fair value were determined by the Company's management
based on information furnished by the management of XcelleNet and an
independent valuation of developed software, core technology and purchased
research and development. The excess of cost over net assets acquired is being
amortized on a straight-line basis over ten years. Amounts allocated to
purchased research and development were expensed at the time of acquisition as
the Company determined that the purchased research and development had not
reached technological feasibility based on the status of design and
development activities that required further refinement and testing. The
development activities required to complete the acquired in-process
technologies include additional coding, cross-platform porting and validation,
quality assurance procedures and beta testing.
 
  To determine the fair market value of the developed software, core
technology and in-process research and development, the Company considered the
three traditional approaches of value: the cost approach, the market approach
and the income approach. The Company relied primarily on the income approach,
whereupon fair market value is a function of the future revenues expected to
be generated by an asset, net of all allocable expenses. The income approach
focuses on the income producing capability of the developed software, core
technology and purchased research and development projects and best represents
the present value of the future economic benefits expected to be derived. In
determining the amount of the purchase price to allocate to purchased research
and development, factors such as stage of completion and technological
uncertainties were considered by the Company and its independent appraiser in
determining the present value of the future benefits to be received. If these
projects are not successfully developed, the Company may not realize the value
assigned to the purchased research and development.
 
  The following unaudited pro forma information presents the Company's results
of operations as if the XcelleNet acquisition had occurred at October 1, 1996.
The pro forma information has been prepared by combining the results of
operations of the Company and XcelleNet for the years ended September 30, 1998
and
 
                                      40
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
1997, adjusted for additional amortization expense of developed software, core
technology and excess cost over net assets acquired and the resulting impact
on the provision for income taxes. This pro forma information does not purport
to be indicative of what would have occurred had the XcelleNet acquisition
occurred as of that date or of results of operations which may occur in the
future (in thousands, except per share data):
 
<TABLE>
<CAPTION>
                                                      YEAR ENDED SEPTEMBER 30
                                                            (UNAUDITED)
                                                      ------------------------
                                                         1998         1997
                                                      -----------  -----------
   <S>                                                <C>          <C>
   Revenue........................................... $   534,173  $   401,884
   Income (loss) before other income and income tax-
    es............................................... $   (54,682) $    59,920
   Net income (loss)................................. $   (83,435) $    46,258
   Income (loss) per common share:
     Basic........................................... $     (0.89) $      0.54
                                                      ===========  ===========
     Diluted......................................... $     (0.89) $      0.52
                                                      ===========  ===========
</TABLE>
 
  The Company also completed certain other acquisitions during 1998 for
aggregate cash consideration of approximately $10,000,000, which cash was
funded from the Company's available cash balances. The effect of these
acquisitions, individually and in the aggregate, was not material to the
Company's results of operations for 1998. The Company recorded approximately
$7,500,000 of excess cost over net assets acquired in connection with these
acquisitions.
 
 1998 Reorganization and Unusual Costs
 
  The Company's results of operations for 1998 include reorganization and
unusual costs of $67,436,000. These costs are primarily related to the
reorganization of the Company's operations in connection with the acquisitions
discussed above, the write-off of certain assets and excess cost over net
assets acquired and the accrual of costs in connection with the Company's
decision to exit the business of publishing CD-ROM based catalogs and the
write-off of certain other software products which the Company no longer
intends to actively market and support.
 
  The components of the reorganization and unusual costs were as follows (in
thousands):
 
<TABLE>
   <S>                                                                  <C>
   Write-down of software products and other assets and recognition of
    liabilities associated with software products and services which
    will no longer be actively marketed or supported................... $21,806
   Write-off of software and other assets and recognition of liabili-
    ties associated with exiting the business of publishing CD-ROM
    based catalogs.....................................................  18,204
   Write-off of excess costs over net assets acquired..................   8,488
   Employee termination costs..........................................   7,993
   Out of pocket costs related to the reorganization...................   4,784
   Other...............................................................   6,161
                                                                        -------
                                                                        $67,436
                                                                        =======
</TABLE>
 
  Of the total reorganization costs, non-cash costs are approximately
$40,240,000 and the remaining costs of $27,196,000 require cash outlays, of
which approximately $8,048,000 had been paid through September 30, 1998,
including approximately $2,761,000 of employee termination costs. Employees
terminated were primarily involved in the publishing of CD-ROM based catalogs.
 
                                      41
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 1997 Business Combinations
 
  In February 1997, the Company acquired for cash all of the outstanding stock
of Comfirst S.A., a Paris, France based provider of communication and file
transfer software. The acquisition has been accounted for using the purchase
method of accounting.
 
  In May 1997, the Company acquired Automated Catalogue Services L.P., a
provider of electronic product catalogs and information databases delivered
via CD-ROM and the Internet. The aggregate purchase price was approximately
$45,000,000, consisting of $28,800,000 in cash, 193,986 shares of Common Stock
valued at approximately $5,000,000 and promissory notes due January 2, 1998
(the "Notes"), having an aggregate principal amount of approximately
$11,200,000. The Notes were paid in full in July 1997. In addition, the
Company incurred costs directly related to the acquisition of approximately
$3,191,000. The acquisition has been accounted for using the purchase method
of accounting.
 
  The excess of cost over net assets acquired in these two acquisitions is
being amortized on a straight line basis over 7 and 10 years respectively. The
effect of the acquisitions, individually and in the aggregate, was not
material to the Company's results of operations for 1997.
 
 1997 Reorganization and Unusual Costs
 
  In June 1997, the Company entered into an agreement (the "Termination
Agreement") with Sterling Software, terminating effective as of June 30, 1997
the International Distributor Agreement dated March 4, 1996, as amended (the
"International Marketing Agreement"). Under the Termination Agreement, the
Company acquired certain assets and assumed certain liabilities associated
with the distribution of certain of the Company's products by Sterling
Software outside the United States and Canada. The Company also hired certain
Sterling Software employees, most of whom had been dedicated to the sales and
marketing of the Company's products.
 
  Under the terms of the Termination Agreement, the Company paid Sterling
Software (1) $5,226,000 for early termination of the International Marketing
Agreement and (2) approximately $10,076,000, which amount was equal to the net
book value of certain assets of Sterling Software acquired (principally
accounts receivable) less certain liabilities assumed by the Company related
to the international distribution of certain of the Company's products.
 
  The Company has recorded the $5,226,000 payment and other costs, principally
incurred to integrate the international distribution business formerly
conducted by Sterling Software into the Company's operations, as
reorganization and unusual costs in the accompanying statement of operations
for the year ended September 30, 1997.
 
  The components of the reorganization costs consist of (in thousands):
 
<TABLE>
     <S>                                                                <C>
     Early termination payment to Sterling Software.................... $ 5,226
     Transaction costs and professional fees...........................   3,100
     Severance and transition costs....................................   2,400
     Other.............................................................   5,084
                                                                        -------
                                                                        $15,810
                                                                        =======
</TABLE>
 
  Approximately $8,991,000 of these costs remained in accounts payable and
accrued liabilities at September 30, 1997 and were disbursed during fiscal
1998.
 
 
                                      42
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
5. LEGAL PROCEEDINGS AND CLAIMS
 
  From time to time the Company is subject to certain legal proceedings and
claims which arise in the normal course of its business. Pending matters
include claims against the Company involving alleged breaches of contract or
other nonperformance with respect to customer sales, alleged employment
discrimination and other matters. Such routine litigation matters are normally
settled or defended, depending on the circumstances of each claim.
 
  On February 20, 1997, David B. Shaev (the "Plaintiff") filed a derivative
complaint in the Court of Chancery in the State of Delaware (the "Delaware
Chancery Court") against the Company and its directors challenging the
Company's initial grant of stock options to the Company's directors. On April
6, 1998, the Plaintiff filed a motion to amend the complaint to challenge the
Company's grants of additional stock options to certain of the Company's
directors. In his complaint, the Plaintiff alleges that the individual
defendants breached their fiduciary duties and wasted corporate assets by
granting themselves an excessive number of options pursuant to the Company's
1996 Stock Option Plan. The complaint seeks recission and injunctive relief
with respect to the stock options, as well as compensatory damages in an
unspecified amount.
 
  On June 3, 1997, the individual defendants in the action filed a motion for
summary judgment. The Delaware Chancery Court denied the motion, which
decision was upheld on appeal. The parties subsequently held settlement
discussions and recently signed a memorandum of understanding for settlement
of the lawsuit. The memorandum of understanding provides for, among other
things, the term of certain options granted pursuant to the Company's 1996
Stock Option Plan to be reduced from ten to seven years and the Company to
follow certain procedural requirements in connection with any future stock
option grants to executive officers and directors of the Company. The
settlement provided for in the memorandum of understanding is subject to,
among other things, the execution of a formal stipulation and the approval of
the Delaware Chancery Court, after notice to the Company's stockholders and a
hearing.
 
  While any legal proceeding has elements of uncertainty, in the opinion of
management, based on presently available information, the amount of any
liability with respect to any existing claims, net of any applicable reserves
and available insurance, will not have a material effect on the financial
condition or results of operations of the Company.
 
                                      43
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
6. MARKETABLE SECURITIES
 
  At September 30, 1998 and 1997, all of the Company's marketable securities
were classified as available-for-sale and consist of the following (in
thousands):
 
<TABLE>
<CAPTION>
                                                          GROSS      GROSS
                                                        UNREALIZED UNREALIZED
                                  AGGREGATE  AMORTIZED   HOLDING    HOLDING
                                  FAIR VALUE COST BASIS   GAINS      LOSSES
                                  ---------- ---------- ---------- ----------
   <S>                            <C>        <C>        <C>        <C>
   SEPTEMBER 30, 1998
   Corporate commercial paper,
    scheduled maturities within
    one year.....................  $ 51,972   $ 51,972
   Government obligations,
    scheduled maturities within
    one year.....................   118,644    118,576     $ 78       $10
   Government obligations,
    scheduled maturities between
    one and five years...........    12,835     12,813       22
                                   --------   --------     ----       ---
                                   $183,451   $183,361     $100       $10
                                   ========   ========     ====       ===
   SEPTEMBER 30, 1997
   Corporate commercial paper,
    scheduled maturities within
    one year.....................  $ 38,744   $ 38,744
   Corporate debt securities,
    scheduled maturities within
    one year.....................    33,839     33,816     $ 23
   Government obligations,
    scheduled maturities within
    one year.....................    75,588     75,503       94       $ 9
   Government obligations,
    scheduled maturities between
    one and five years...........    86,143     85,937      265        59
                                   --------   --------     ----       ---
                                   $234,314   $234,000     $382       $68
                                   ========   ========     ====       ===
</TABLE>
 
  Government obligations are debt securities of states of the United States
and political subdivisions of the states. In the above, the Company has
reflected debt securities whose issuers may call the debt prior to the
scheduled maturity date as maturing on the earliest call date.
 
7. ACCOUNTS AND NOTES RECEIVABLE
 
  Accounts and notes receivable consist of the following at September 30 (in
thousands):
 
<TABLE>
<CAPTION>
                                                                1998     1997
                                                              -------- --------
   <S>                                                        <C>      <C>
   Trade accounts receivable................................. $161,587 $108,481
   Less: Allowance for doubtful accounts.....................   10,331    4,789
                                                              -------- --------
                                                              $151,256 $103,692
                                                              ======== ========
</TABLE>
 
  The Company's accounts receivable are due principally from corporations in
diverse industries located in North America and Europe and are generally
unsecured.
 
                                      44
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
8. PROPERTY AND EQUIPMENT
 
  Property and equipment consist of the following at September 30 (in
thousands):
 
<TABLE>
<CAPTION>
                                                                1998     1997
                                                              -------- --------
   <S>                                                        <C>      <C>
   Computers and peripheral equipment........................ $ 85,798 $ 82,690
   Furniture, fixtures and other equipment...................   27,991    9,471
   Building improvements.....................................   18,144   10,548
                                                              -------- --------
                                                               131,933  102,709
   Less accumulated depreciation.............................   57,542   42,986
                                                              -------- --------
                                                              $ 74,391 $ 59,723
                                                              ======== ========
</TABLE>
 
9. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
 
  Accounts payable and accrued liabilities consist of the following at
September 30 (in thousands):
 
<TABLE>
<CAPTION>
                                                                 1998    1997
                                                                ------- -------
   <S>                                                          <C>     <C>
   Trade accounts payable...................................... $30,096 $19,092
   Accrued compensation........................................  28,039  22,899
   Accrued reorganization and unusual costs....................  18,925   8,991
   Other accrued liabilities...................................  13,539   6,415
                                                                ------- -------
                                                                $90,599 $57,397
                                                                ======= =======
</TABLE>
 
10. INCOME TAXES
 
  The provision for income taxes is composed of the following (in thousands):
 
<TABLE>
<CAPTION>
                                                       YEARS ENDED SEPTEMBER 30
                                                       -------------------------
                                                        1998     1997     1996
                                                       ------- --------  -------
   <S>                                                 <C>     <C>       <C>
   Current:
     Federal.......................................... $52,917 $ 41,547  $26,225
     State............................................   8,848    7,443    5,867
     Foreign..........................................     901      436      176
   Deferred:
     Federal..........................................     609  (13,174)   4,975
     State............................................     872   (2,412)     787
                                                       ------- --------  -------
                                                       $64,147 $ 33,840  $38,030
                                                       ======= ========  =======
</TABLE>
 
  The provision for income taxes differs from the income taxes computed at the
federal income tax statutory rate for the following reasons (in thousands):
 
<TABLE>
<CAPTION>
                                                   YEARS ENDED SEPTEMBER 30
                                                  ----------------------------
                                                    1998      1997      1996
                                                  --------  --------  --------
   <S>                                            <C>       <C>       <C>
   Tax expense at U.S. federal statutory rate.... $  1,047  $ 31,249  $ 33,748
   State income taxes, net of federal benefit....    6,318     3,384     4,223
   Reorganization and unusual costs..............   20,061
   Purchased in-process research and develop-
    ment.........................................   40,761
   Tax exempt interest income....................   (3,324)   (1,032)
   Other.........................................     (716)      239        59
                                                  --------  --------  --------
                                                  $ 64,147  $ 33,840  $ 38,030
                                                  ========  ========  ========
</TABLE>
 
                                      45
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Income before income taxes includes foreign pretax earnings of $2,518,000,
$958,000, and $356,000 for the years ended September 30, 1998, 1997, and 1996,
respectively.
 
  Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's net deferred tax liability as of September 30 are as follows
(in thousands):
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED
                                                                SEPTEMBER 30
                                                               ---------------
                                                                1998    1997
                                                               ------- -------
   <S>                                                         <C>     <C>
   Deferred current income tax assets:
     Deferred revenue......................................... $   361 $ 1,301
     Reserves and accruals....................................   8,888   9,130
     Loss and credit carryforwards............................   2,378
                                                               ------- -------
                                                                11,627  10,431
                                                               ------- -------
   Deferred non-current income tax assets:
     Deferred revenue.........................................     484   1,241
     Accrued employee benefits................................   2,454   1,257
                                                               ------- -------
                                                                 2,938   2,498
                                                               ------- -------
   Deferred non-current income tax liabilities:
     Capitalized software costs...............................  14,963  13,536
     Depreciation and amortization............................  18,310   2,554
                                                               ------- -------
                                                                33,273  16,090
                                                               ------- -------
   Deferred income tax liability net of deferred income tax
    assets.................................................... $18,708 $ 3,161
                                                               ======= =======
</TABLE>
 
  At September 30, 1998, the Company had loss and tax credit carryforwards
acquired through the XcelleNet acquisition of approximately $6,794,000 and
$200,000, respectively. These carryforwards will expire, if unutilized, on
September 30, 2013.
 
11. COMMITMENTS
 
 Lease Obligations
 
  The Company leases certain facilities and equipment under operating leases.
Total rent expense for the years ended September 30, 1998, 1997 and 1996 was
$20,969,000, $17,252,000 and $10,000,000, respectively. At September 30, 1998,
minimum future rental payments due under all operating leases, net of future
sublease income, are as follows (in thousands):
 
<TABLE>
       <S>                                               <C>
       1999............................................. $21,098
       2000.............................................  23,609
       2001.............................................  19,686
       2002.............................................  17,755
       2003.............................................  15,223
       Thereafter.......................................  47,786
</TABLE>
 
  Additionally, the Company has entered into an operating lease for a new
office facility in Dallas, Texas. The initial term of the lease extends
through February 2003, with two optional five-year renewal periods thereafter.
At the end of each renewal period the Company is required to renew the lease
(if a renewal option
 
                                      46
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
exists), purchase the property for its original cost or arrange for the sale
of the property to a third party, with the Company guaranteeing to the lessor
proceeds on such sale at least equal to 85% of the original fair value of the
leased facility. Such guarantee amount is estimated to be approximately
$55,000,000. The Company could also be required to purchase the property if
the Company is in default with respect to certain obligations or covenants
contained in the lease or related agreements.
 
 Credit Agreement
 
  The Company maintains a Revolving Credit and Term Loan Agreement, as amended
(the "Credit Agreement"), which provides for a domestic borrowing capacity of
$20,000,000 and an additional $10,000,000 international borrowing capacity. An
underlying letter of credit facility provides for letters of credit up to the
full domestic borrowing capacity. The Credit Agreement, with final maturity
October 1, 1999, is unsecured and contains various restrictive covenants,
including limitations on additional borrowings, payment of cash dividends and
acquisitions. The Credit Agreement also requires that the Company maintain
certain financial ratios. Borrowings under the Credit Agreement bear interest
at the higher of the lender's prime rate, the Federal Funds Effective Rate
plus one-half percent or, for borrowings obtained for fixed periods of time,
LIBOR plus one-half percent. As of September 30, 1998 and 1997, there were no
amounts borrowed or outstanding under the Credit Agreement, nor the underlying
letter of credit facility.
 
12. STOCKHOLDER'S EQUITY
 
 Common Stock
 
  At September 30, 1998, the Company was authorized to issue 150,000,000
shares of Common Stock. Since inception, the Company has not declared any
dividends on its Common Stock.
 
 Preferred Stock
 
  The Company is authorized to issue up to 50,000,000 shares of preferred
stock, par value $0.01 per share ("Preferred Stock"). The Board of Directors
of the Company has authorized the issuance of up to 1,500,000 shares of
Preferred Stock, designated as Series A Junior Participating Preferred Stock
("Series A Junior Preferred Stock") pursuant to the terms of the Rights
Agreement, dated as of December 18, 1996 (the "Rights Plan"). The Board of
Directors of the Company is also authorized, without action by the
stockholders, to issue Preferred Stock and fix for each series the number of
shares, designation, dividend rights, voting rights, redemption rights and
other rights.
 
 Rights Plan
 
  On December 18, 1996, the Board of Directors of the Company declared a
dividend distribution of one right (a "Right") for each share of Common Stock
outstanding at the close of business on December 31, 1996 (the "Record Date"),
pursuant to the terms of the Rights Plan. The Rights Plan also provides,
subject to specified exceptions and limitations, that shares of Common Stock
issued after the Record Date will be entitled to and accompanied by Rights.
Pursuant to the Rights Plan, one Right to purchase 1/100th of a share of
Series A Junior Preferred Stock (structured so as to be substantially the
equivalent of a share of Common Stock) is attached to each issued and
outstanding share of Common Stock. Subject to certain conditions, each Right
entitles the holder to purchase 1/100th of a share of Series A Junior
Preferred Stock at a price (the "Purchase Price") of $200.00 per 1/100th of a
share of Series A Junior Preferred Stock (subject to adjustment).
 
  In general, the Rights will not become exercisable, or transferable apart
from the shares of Common Stock, unless a person or group of affiliated or
associated persons becomes the beneficial owner of, or commences a
 
                                      47
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
tender offer that would result in beneficial ownership of, 15% or more of the
outstanding shares of Common Stock (any such person or group of persons being
referred to in the Rights Plan as an "Acquiring Person"). Thereafter, under
certain circumstances, each Right (other than any Rights that are or were
beneficially owned by an Acquiring Person, which Rights will be void) could
become exercisable to purchase at the Purchase Price a number of shares of
Common Stock (or, in certain circumstances, the common stock of a company into
which the Company is merged or consolidated or to which the Company sells all
or substantially all of its assets) having a market value equal to two times
the Purchase Price. The Rights will expire on December 31, 2006, unless
earlier redeemed by the Company at a redemption price of $.01 per Right
(subject to adjustment), or otherwise exchanged or amended in accordance with
the terms of the Rights Plan.
 
 Stock Purchase Plan
 
  In March 1998, the Company's shareholders approved the Company's Employee
Stock Purchase Plan ("ESPP"). Pursuant to the ESPP, employees can purchase the
Common Stock at a specified price through payroll deductions during an
offering period, currently established on a semi-annual basis. In June 1998,
approximately 77,000 shares were issued to employees under the ESPP. At
September 30, 1998, approximately $1,118,000 had been contributed by employees
that will be used to purchase shares at the end of the offering period on
December 31, 1998. Under the ESPP, the Company can issue up to 4,000,000
shares of which, at September 30, 1998, approximately 77,000 shares had been
purchased and issued and approximately 58,000 shares were subscribed for
issuance in December 1998, assuming no employees withdrawal from the plan.
 
 Stock Options
 
  The Company has a stock option plan that provides for the grant of options
to purchase shares of Common Stock by officers, directors, key employees and
advisors. All option grants were made at the fair market value of the Common
Stock at the date of the grant. Options granted pursuant to the plan generally
become exercisable at a rate of 25% per year or become exercisable immediately
or within one year from the date of grant. Options granted pursuant to the
plan generally expire five or ten years from the date of grant. At September
30, 1998, approximately 2,886,000 shares were reserved for future grants of
options under the stock option plan.
 
  Stock option transactions are summarized below for the three years ended
September 30, 1998:
 
<TABLE>
<CAPTION>
                                1998               1997               1996
                          ------------------ ------------------ ------------------
                                   WEIGHTED-          WEIGHTED-          WEIGHTED-
                                    AVERAGE            AVERAGE            AVERAGE
                          SHARES   EXERCISE  SHARES   EXERCISE  SHARES   EXERCISE
                          (000'S)    PRICE   (000'S)    PRICE   (000'S)    PRICE
                          -------  --------- -------  --------- -------  ---------
<S>                       <C>      <C>       <C>      <C>       <C>      <C>
Outstanding at beginning
 of year................. 17,727      $26    12,252      $24
  Granted................  1,241      $44     5,640      $27    12,285      $24
  Options issued for
   XcelleNet acquisi-
   tion..................  1,287      $25
  Exercised.............. (2,349)     $24       (75)     $24
  Canceled...............   (427)     $33       (90)     $26       (33)     $24
                          ------             ------             ------
Outstanding at end of
 year.................... 17,479      $26    17,727      $26    12,252      $24
                          ======             ======             ======
Options exercisable at
 year-end................ 11,672      $24     1,000      $24
                          ======             ======
</TABLE>
 
                                      48
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The following table summarizes information about stock options outstanding
at September 30, 1998:
 
<TABLE>
<CAPTION>
                                     OPTIONS OUTSTANDING                OPTIONS EXERCISABLE
                         ------------------------------------------- --------------------------
                                        WEIGHTED-
                           NUMBER        AVERAGE        WEIGHTED-      NUMBER      WEIGHTED-
RANGE OF                 OUTSTANDING    REMAINING        AVERAGE     EXERCISABLE    AVERAGE
EXERCISE PRICES            (000'S)   CONTRACTUAL LIFE EXERCISE PRICE   (000'S)   EXERCISE PRICE
---------------          ----------- ---------------- -------------- ----------- --------------
<S>                      <C>         <C>              <C>            <C>         <C>
$1 to $23...............      311          6.3             $16            202         $15
$24 to $26..............   14,522          7.1             $24         10,961         $24
$27 to $31..............      575          5.1             $29            162         $29
$32 to $49..............    2,071          5.5             $39            347         $34
                           ------
$1 to $49...............   17,479          6.8             $26         11,672         $25
                           ======                                      ======
</TABLE>
 
  Statement of Financial Accounting Standards No. 123, "Accounting for Stock-
Based Compensation" ("FAS 123") requires disclosure of pro forma net earnings
and net earnings per common share information computed as if the Company had
accounted for its employee stock options and employee stock purchase plan
awards under the fair value method as set forth in FAS 123.
 
  The fair value of the Company's employee stock awards was estimated using a
Black-Scholes option pricing model with the following weighted-average
assumptions for 1998, 1997 and 1996, respectively: risk-free interest rates of
4.8% to 6.7%; stock price volatility factors of 0.405%, 0.368% and 0.368% and
expected option lives of 1 year to 5 years. The Company does not have a
history of paying dividends, and none have been assumed in estimating the fair
value of the options.
 
  The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because, among other things, changes in the subjective input assumptions can
materially affect the fair value estimate, in the Company's opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of its employee stock options.
 
  For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information follows (in thousands, except per share
information):
 
<TABLE>
<CAPTION>
                                                       1998     1997    1996
                                                     --------  ------- -------
   <S>                                               <C>       <C>     <C>
   Net income (loss):
     As reported.................................... ($61,156) $55,444 $58,392
     Pro forma......................................  (86,426)  10,570  40,600
   Basic earnings per share:
     As reported....................................     (.67)     .66     .79
     Pro forma......................................     (.95)     .12     .54
   Diluted earnings per share:
     As reported....................................     (.67)     .64     .77
     Pro forma......................................     (.95)     .12     .54
   Weighted-average fair value of options granted
    during the year................................. $  15.28  $  8.45 $  7.41
</TABLE>
 
13. DEFINED CONTRIBUTION PLAN
 
  Prior to October 1, 1996, the Company participated in Sterling Software's
plan that provides retirement benefits under the provisions of Section 401(k)
of the Internal Revenue Code (the "Software Plan") for all full-
 
                                      49
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
time employees and for part-time employees that have completed a specified
term of service. Pursuant to the Software Plan, eligible participants may
elect to contribute a percentage of their annual gross compensation and the
Company contributed additional amounts, as provided by the Software Plan.
Company contributions charged to expense during 1996 were $2,035,000.
 
  Effective September 30, 1996, the Company ceased participating in the
Software Plan. The Company established a plan with similar attributes (the
"Commerce Plan") effective October 1, 1996 and the Company's pro rata share of
the assets of the Software Plan were transferred to the Commerce Plan. A
portion of the Commerce Plan consisting of the Company's contribution has been
designated as an employee stock ownership plan. One half of the Company's
contributions are invested in Common Stock. Company contributions charged to
expense during 1998 and 1997 were $2,478,000 and $1,951,000, respectively.
 
14. CHANGE-IN-CONTROL AND SEVERANCE AGREEMENTS
 
  The Company has change-in-control agreements with 19 executive and other
officers that grant the right to receive payments based on the individual's
respective salary, bonus and benefits in the event a change in control (as
defined in such change-in-control agreements) of the Company occurs and a
covered officer's employment is terminated. In addition, the Company has
entered into a consulting agreement with its chairman that grants similar
rights as the change-in-control agreements described above. The change-in-
control agreements further provide that the Company will make certain payments
to the individual to compensate such individual for the economic effect of the
individual's liability to pay excise taxes to the extent such payments
received by such individual, pursuant to the change-in-control agreements,
stock option agreements or otherwise, are considered contingent on a change in
ownership or control under Section 280G of the Internal Revenue Code (a "Tax
Payment"). Based on certain assumptions, at September 30, 1998, the maximum
liability for compensation including bonuses, benefits and Tax Payments under
these agreements was estimated to be approximately $30,000,000. The actual
liability, if any, under these agreements will depend on a number of factors,
including the level of compensation including bonuses and benefits being
received by the covered individuals prior to a change in control and the price
at which any change-in-control transaction occurs.
 
  The Company has entered into severance agreements with 19 executive and
other officers of the Company providing for payments based on the individual
officer's salary and bonus and continuation of benefits. In addition, the
Company has entered into a consulting agreement with its chairman that
provides for annual base compensation plus agreed-upon bonuses. At September
30, 1998, the maximum estimated liability for future compensation including
bonuses and benefits under these agreements was estimated to be approximately
$23,000,000.
 
                                      50
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
15. OPERATIONS BY GEOGRAPHIC AREA
 
  The Company's operations in the United States and international markets at
September 30, 1998 and for the year then ended are summarized as follows (in
thousands):
 
<TABLE>
<CAPTION>
                                                                  YEAR ENDED
                                                              SEPTEMBER 30, 1998
                                                              ------------------
<S>                                                           <C>
Revenue:
  United States..............................................      $390,226
  Europe.....................................................        63,305
  Canada and Latin America...................................        27,057
  Asia-Pacific...............................................         9,714
                                                                   --------
                                                                    490,302
                                                                   ========
Operating Profit (Loss):
  United States..............................................      $146,776
  Europe.....................................................        19,554
  Canada and Latin America...................................        14,468
  Asia-Pacific...............................................        (1,489)
  Re-organization and unusual costs..........................       (67,436)
  Purchased research and development.........................      (116,460)
  Corporate and other........................................       (16,574)
                                                                   --------
                                                                    (21,161)
                                                                   ========
Identifiable Assets:
  United States..............................................      $298,026
  Europe.....................................................        71,724
  Canada and Latin America...................................        16,611
  Asia-Pacific...............................................        11,643
  Corporate and other........................................       569,000
                                                                   --------
                                                                    967,004
                                                                   ========
</TABLE>
 
  The amounts presented for "Corporate and other" include corporate expense,
intersegment eliminations, cash balances, marketable securities, deferred
income tax balances and other assets.
 
  The Company had no significant international operations from the date of the
Offering until June 30, 1997, upon the termination of the International
Marketing Agreement with Sterling Software. The results of the Company's
international operations during the fourth quarter of 1997 were not material.
 
                                      51
<PAGE>
 
                            STERLING COMMERCE, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 
16. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
 
  The Company's consolidated operating results for each quarter of 1998 and
1997 are summarized as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                THREE MONTHS ENDED
                                    -------------------------------------------
                                    DECEMBER 31 MARCH 31 JUNE 30   SEPTEMBER 30
                                    ----------- -------- --------  ------------
<S>                                 <C>         <C>      <C>       <C>
Year ended September 30, 1998:
  Revenue..........................  $106,283   $111,076 $122,095   $ 150,848
  Cost of sales....................    20,462     24,029   24,099      27,570
  Product development and enhance-
   ment expenses...................     7,648      6,393    7,343       8,334
  Selling, general and administra-
   tive expenses...................    45,577     44,789   47,666      63,657
  Income (loss) before other income
   and income taxes(1).............    32,596     35,865   42,987    (132,609)
  Net income (loss)................  $ 24,200   $ 26,977 $ 31,226   $(143,559)
  Earnings (loss) per share:
    Basic..........................  $   0.27   $   0.30 $   0.34   $   (1.53)
    Diluted........................  $   0.26   $   0.29 $   0.33   $   (1.53)
Year ended September 30, 1997:
  Revenue..........................  $ 74,769   $ 79,534 $ 87,798   $ 108,496
  Cost of sales....................    15,735     16,392   18,073      20,415
  Product development and enhance-
   ment expenses...................     5,071      6,191    7,147       6,444
  Selling, general and administra-
   tive expenses...................    28,950     29,371   32,484      44,044
  Income (loss) before other income
   and income taxes(2).............    25,013     27,580  (17,595)     37,593
  Net income (loss)................  $ 16,060   $ 18,817 $ (7,476)  $  28,043
  Earnings (loss) per share:
    Basic..........................  $   0.21   $   0.23 $  (0.08)  $    0.31
    Diluted........................  $   0.21   $   0.23 $  (0.08)  $    0.30
</TABLE>
--------
(1) Net of $116,460,000 of purchased research and development and $67,436,000
    of reorganization and unusual costs charged to expense in the quarter
    ended September 30, 1998.
 
(2) Net of $31,879,000 of purchased research and development and $15,810,000
    of reorganization and unusual costs charged to expense in the quarter
    ended June 30, 1997.
 
                                      52
<PAGE>
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE
 
  None.
 
                                   PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
  Information required by this Item 10 concerning the directors of the Company
is set forth in the Proxy Statement to be provided to stockholders in
connection with the Company's 1999 Annual Meeting of Stockholders, under the
heading "Proposal I--Election of Directors," which information is incorporated
herein by reference. Information concerning compliance with Section 16 of the
Securities Act of 1934, as amended, by persons subject to such Section is set
forth in the Proxy Statement under the heading "Section 16(a) Beneficial
Ownership Reporting Compliance," which information is incorporated herein by
reference. The name, age and position of each executive officer of the Company
is set forth under the heading "Executive Officers" in Part I of this report,
which information is incorporated herein by reference.
 
ITEM 11. EXECUTIVE COMPENSATION
 
  Information required by this Item 11 concerning executive compensation is
set forth in the Proxy Statement under the heading "Management Compensation,"
which information is incorporated herein by reference. Information contained
in the Proxy Statement under the caption "Management Compensation--Report of
the Executive and Option Committees on Executive Compensation" and "Stock
Performance Chart" is not incorporated by reference herein.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
  Information required by this Item 12 concerning security ownership of
certain beneficial owners and management is set forth in the Proxy Statement
under the heading "Security Ownership of Certain Beneficial Owners and
Management," which information is incorporated herein by reference.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
  Information required by this Item 13 concerning certain relationships and
related transactions is set forth in the Proxy Statement under the headings
"Management Compensation--Executive and Stock Option Committee Interlocks and
Insider Participation" and "Certain Transactions," which information is
incorporated herein by reference.
 
                                      53
<PAGE>
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
 
(a) The following documents are filed as a part of this Annual Report on Form
10-K.
 
  1. Consolidated Financial Statements:
 
  See Index to Consolidated Financial Statements at Item 8.
 
  2. Consolidated Financial Statement Schedules:
 
  Schedule II--Valuation and Qualifying Accounts for the Years Ended September
30, 1998, 1997 and 1996
 
  All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under
the related instructions or are inapplicable and therefore have been omitted.
 
  3. Exhibits
 
<TABLE>
<CAPTION>
 EXHIBIT
   NO.                                 DESCRIPTION
 -------                               -----------
 <C>     <S>
  2.1    Agreement and Plan of Merger dated as of April 16, 1998 by and among
          Sterling Commerce, Inc., Sterling Commerce (Southern), Inc. and
          XcelleNet, Inc.(1)
  3.1    Third Amended and Restated Certificate of Incorporation of the
          Company, as amended(2)
  3.2    Amended and Restated Bylaws of the Company(3)
  4.1    Rights Agreement dated December 18, 1996 by and between the Company
          and The First National Bank of Boston, as Rights Agent(4)
 10.1.1  International Marketing Agreement dated March 4, 1996 between Sterling
          Commerce International, Inc. and Sterling Software International,
          Inc.(5)
 10.1.2  Amendment No. 1 to the International Distributor Agreement dated as of
          January 31, 1997 between Sterling Commerce B.V. and Sterling Software
          International, Inc. (a.k.a. the International Marketing Agreement)(6)
 10.2    Termination Agreement dated June 30, 1997 between Sterling Commerce
          B.V. and Sterling Software International, Inc.(7)
 10.3    Tax Allocation Agreement dated March 4, 1996 between the Company and
          Sterling Software(8)
 10.4    Indemnification Agreement dated March 4, 1996 between the Company and
          Sterling Software(5)
 10.5    Master Software License Agreement dated March 4, 1996 among the
          Company, Sterling Software and their respective subsidiaries parties
          thereto(5)
 10.6    Agreement dated as of September 19, 1996 by the Company for the
          benefit of Sterling Software(9)
 10.7    Form of Indemnification Agreement between the Company and each of its
          officers and directors(8), (10)
 10.8    Form of Director Agreement dated as of January 27, 1997 between the
          Company and each of Sam Wyly and Charles J. Wyly, Jr.(6), (10)
 10.9    Agreement dated May 31, 1998 between the Company and Sterling L.
          Williams(3)
 10.10   Form of Change-in-Control Severance Agreement between the Company and
          each of Warner C. Blow, J. Brad Sharp, Paul L.H. Olson, Stephen R.
          Perkins and certain other executive officers of the Company(5), (10)
 10.11   Form of Severance Agreement between the Company and each of Warner C.
          Blow, J. Brad Sharp, Paul L.H. Olson, Stephen R. Perkins and certain
          other executive officers of the Company(5), (10)
 10.12   Supplemental Executive Retirement Plan(10), (11)
 10.13   Sterling Commerce, Inc. Amended and Restated 1996 Stock Option
          Plan(10), (12)
 10.14.1 Sterling Commerce, Inc. Deferred Compensation Plan(10), (13)
</TABLE>
 
 
                                      54
<PAGE>
 
<TABLE>
<S>      <C>
10.14.2  First Amendment to Sterling Commerce, Inc. Deferred Compensation Plan dated as of October 30,
          1997(10), (11)
10.14.3  Second Amendment to Sterling Commerce, Inc. Deferred Compensation Plan dated as of June 1, 1998(3),
          (10)
10.15.1  Revolving Credit and Term Loan Agreement dated as of October 1, 1996 among the Company and The First
          National Bank of Boston, as agent, and Bank One, Texas, National Association(9)
10.15.2  Amendment and Modification Agreement to the Revolving Credit and Term Loan Agreement among the
          Company and The First National Bank of Boston, as agent, and Bank One, Texas, National
          Association(12)
21.1     Subsidiaries of the Company(3)
23.1     Consent of Ernst & Young LLP(3)
27.1     Financial Data Schedule(3)
</TABLE>
--------
 (1) Previously filed as an exhibit to the Current Report on Form 8-K dated
     April 16, 1998 and incorporated herein by reference. (The copy of the
     Agreement and Plan of Merger incorporated by reference in this report
     does not include the Schedules thereto. The Company agrees to furnish
     supplementally to the Commission any such omitted Schedule upon request.)
 
 (2) Previously filed as an exhibit to the Company's Registration Statement
     No. 333-20565 and incorporated herein by reference.
 
 (3) Filed herewith.
 
 (4) Previously filed as an exhibit to the Current Report on Form 8-K dated
     December 18, 1996 and incorporated herein by reference.
 
 (5) Previously filed as an exhibit to the Quarterly Report on Form 10-Q for
     the quarter ended March 31, 1996 and incorporated herein by reference.
 
 (6) Previously filed as an exhibit to the Quarterly Report on Form 10-Q for
     the quarter ended December 31, 1996 and incorporated herein by reference.
 
 (7) Previously filed as an exhibit to the Current Report on Form 8-K dated
     June 30, 1997 and incorporated herein by reference.
 
 (8) Previously filed as an exhibit to the Company's Registration Statement
     No. 33-80595 and incorporated herein by reference.
 
 (9) Previously filed as an exhibit to the Annual Report on Form 10-K, as
     amended, for the fiscal year ended September 30, 1996 and incorporated
     herein by reference.
 
(10) Management contract or compensatory plan or arrangement required to be
     filed as an exhibit to this form pursuant to Item 14(c) of the form.
 
(11) Previously filed as an exhibit to the Annual Report on Form 10-K for the
     fiscal year ended September 30, 1997 and incorporated herein by
     reference.
 
(12) Previously filed as an exhibit to the Quarterly Report on Form 10-Q for
     the quarter ended June 30, 1997 and incorporated herein by reference.
 
(13) Previously filed as an exhibit to the Company's Registration Statement
     No. 333-37523 and incorporated herein by reference.
 
(b) Reports on Form 8-K.
 
  During the three-month period ended September 30, 1998, the Company filed a
Current Report on Form 8-K. The report, dated July 21, 1998, included
information requested under Item 2--Acquisition or Disposition of Assets.
 
(c) Exhibits.
 
  The response to this portion of Item 14 is submitted as a separate section
of this report.
 
(d) Financial Statement Schedules.
 
  The response to this portion of Item 14 is submitted as a separate section
of this report.
 
                                      55
<PAGE>
 
                                  SIGNATURES
 
  Pursuant to the requirements of Section 13 or 15(d) 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.
 
                                          STERLING COMMERCE, INC.
 
 
                                                   /s/ Warner C. Blow
                                          By: _________________________________
                                                       Warner C. Blow
                                               President and Chief Executive
                                                          Officer
 
Date: November 19, 1998
 
  Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
 
<TABLE>
<S>                                  <C>                           <C>
    /s/ Sterling L. Williams         Chairman of the Board and      November 19, 1998
____________________________________  Director
        Sterling L. Williams
 
       /s/ Warner C. Blow            President and Chief            November 19, 1998
____________________________________  Executive Officer and
           Warner C. Blow             Director
                                      (Principal Executive
                                      Officer)
 
    /s/ Charles J. Wyly, Jr.         Director                       November 19, 1998
____________________________________
        Charles J. Wyly, Jr.
 
          /s/ Sam Wyly               Director                       November 19, 1998
____________________________________
              Sam Wyly
        /s/ Evan A. Wyly             Director                       November 19, 1998
____________________________________
            Evan A. Wyly
 
       /s/ Honor R. Hill             Director                       November 19, 1998
____________________________________
           Honor R. Hill
 
 
       /s/ Robert E. Cook            Director                       November 19, 1998
____________________________________
           Robert E. Cook
 
     /s/ Steven P. Shiflet           Senior Vice President and      November 19, 1998
____________________________________  Chief Financial Officer
         Steven P. Shiflet            (Principal Financial and
                                      Accounting Officer)
</TABLE>
 
                                      56
<PAGE>
 
                                                                     SCHEDULE II
 
                            STERLING COMMERCE, INC.
 
                       VALUATION AND QUALIFYING ACCOUNTS
 
                 YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
 
<TABLE>
<CAPTION>
                        BALANCE AT               CHARGED TO
                        BEGINNING  ADDITION FROM COSTS AND  DEDUCTIONS--     BALANCE AT END
                        OF PERIOD   ACQUISITION   EXPENSES    DESCRIBE         OF PERIOD
                        ---------- ------------- ---------- ------------     --------------
<S>                     <C>        <C>           <C>        <C>              <C>
Allowance for doubtful
 accounts at September
 30, 1998.............. $4,789,000  $2,096,000   $6,013,000 $(2,567,000)(1)   $10,331,000
                        ==========  ==========   ========== ===========       ===========
Allowance for doubtful
 accounts at September
 30, 1997.............. $2,416,000               $3,567,000 $(1,194,000)(1)   $ 4,789,000
                        ==========               ========== ===========       ===========
Allowance for doubtful
 accounts at September
 30, 1996.............. $2,000,000               $1,068,000 $  (652,000)(1)   $ 2,416,000
                        ==========               ========== ===========       ===========
</TABLE>
--------
(1)Accounts written off.
 
                                      II-1
<PAGE>
 
                               INDEX TO EXHIBITS
 
<TABLE>
<CAPTION>
 EXHIBIT
   NO.                                 DESCRIPTION
 -------                               -----------
 <C>     <S>
  2.1    Agreement and Plan of Merger dated as of April 16, 1998 by and among
          Sterling Commerce, Inc., Sterling Commerce (Southern), Inc. and
          XcelleNet, Inc.(1)
  3.1    Third Amended and Restated Certificate of Incorporation of the
         Company, as amended(2)
  3.2    Amended and Restated Bylaws of the Company(3)
  4.1    Rights Agreement dated December 18, 1996 by and between the Company
          and The First National Bank of Boston, as Rights Agent(4)
 10.1.1  International Marketing Agreement dated March 4, 1996 between Sterling
          Commerce International, Inc. and Sterling Software International,
          Inc.(5)
 10.1.2  Amendment No. 1 to the International Distributor Agreement dated as of
          January 31, 1997 between Sterling Commerce B.V. and Sterling Software
          International, Inc. (a.k.a. the International Marketing Agreement)(6)
 10.2    Termination Agreement dated June 30, 1997 between Sterling Commerce
          B.V. and Sterling Software International, Inc.(7)
 10.3    Tax Allocation Agreement dated March 4, 1996 between the Company and
         Sterling Software(8)
 10.4    Indemnification Agreement dated March 4, 1996 between the Company and
         Sterling Software(5)
 10.5    Master Software License Agreement dated March 4, 1996 among the
          Company, Sterling Software and their respective subsidiaries parties
          thereto(5)
 10.6    Agreement dated as of September 19, 1996 by the Company for the
         benefit of Sterling Software(9)
 10.7    Form of Indemnification Agreement between the Company and each of its
          officers and directors(8), (10)
 10.8    Form of Director Agreement dated as of January 27, 1997 between the
          Company and each of Sam Wyly and Charles J. Wyly, Jr.(6), (10)
 10.9    Agreement dated May 31, 1998 between the Company and Sterling L.
         Williams(3)
 10.10   Form of Change-in-Control Severance Agreement between the Company and
          each of Warner C. Blow, J. Brad Sharp, Paul L.H. Olson, Stephen R.
          Perkins and certain other executive officers of the Company(5), (10)
 10.11   Form of Severance Agreement between the Company and each of Warner C.
          Blow, J. Brad Sharp, Paul L.H. Olson, Stephen R. Perkins and certain
          other executive officers of the Company(5), (10)
 10.12   Supplemental Executive Retirement Plan(10), (11)
 10.13   Sterling Commerce, Inc. Amended and Restated 1996 Stock Option
         Plan(10), (12)
 10.14.1 Sterling Commerce, Inc. Deferred Compensation Plan(10), (13)
 10.14.2 First Amendment to Sterling Commerce Inc. Deferred Compensation Plan
         dated as of October 30, 1997(10), (11)
 10.14.3 Second Amendment to Sterling Commerce Inc. Deferred Compensation Plan
         dated as of June 1, 1998(3), (10)
 10.15.1 Revolving Credit and Term Loan Agreement dated as of October 1, 1996
          among the Company and The First National Bank of Boston, as agent,
          and Bank One, Texas, National Association(9)
 10.15.2 Amendment and Modification Agreement to the Revolving Credit and Term
          Loan Agreement among the Company and The First National Bank of
          Boston, as agent, and Bank One, Texas, National Association(12)
</TABLE>
 
                                       57
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
   NO.             DESCRIPTION
 -------           -----------
 <C>     <S>
 21.1    Subsidiaries of the Company(3)
 23.1    Consent of Ernst & Young LLP(3)
 27.1    Financial Data Schedule(3)
</TABLE>
--------
(1) Previously filed as an exhibit to the Current Report on Form 8-K dated
    April 16, 1998 and incorporated herein by reference. (The copy of the
    Agreement and Plan of Merger incorporated by reference in this report does
    not include the Schedules thereto. The Company agrees to furnish
    supplementally to the Commission any such omitted Schedule upon request.)
 
(2) Previously filed as an exhibit to the Company's Registration Statement No.
    333-20565 and incorporated herein by reference.
 
(3) Filed herewith.
 
(4) Previously filed as an exhibit to the Current Report on Form 8-K dated
    December 18, 1996 and incorporated herein by reference.
 
(5) Previously filed as an exhibit to the Quarterly Report on Form 10-Q for
    the quarter ended March 31, 1996 and incorporated herein by reference.
 
(6) Previously filed as an exhibit to the Quarterly Report on Form 10-Q for
    the quarter ended December 31, 1996 and incorporated herein by reference.
 
(7) Previously filed as an exhibit to the Current Report on Form 8-K dated
    June 30, 1997 and incorporated herein by reference.
 
(8) Previously filed as an exhibit to the Company's Registration Statement No.
    33-80595 and incorporated herein by reference.
 
(9) Previously filed as an exhibit to the Annual Report on Form 10-K, as
    amended, for the fiscal year ended September 30, 1996 and incorporated
    herein by reference.
 
(10) Management contract or compensatory plan or arrangement required to be
     filed as an exhibit to this form pursuant to Item 14(c) of the form.
 
(11) Previously filed as an exhibit to the Annual Report on Form 10-K for the
     fiscal year ended September 30, 1997 and incorporated herein by
     reference.
 
(12) Previously filed as an exhibit to the Quarterly Report on Form 10-Q for
     the quarter ended June 30, 1997 and incorporated herein by reference.
 
(13) Previously filed as an exhibit to the Company's Registration Statement
     No. 333-37523 and incorporated herein by reference.
 
                                      58