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                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                               ----------------
                                 
                              FORM 10-K/A-1     
 
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
   ACT OF 1934 [FEE REQUIRED]
 
  FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1996
 
                                      OR
 
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
   EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
 
  FOR THE TRANSITION PERIOD FROM       TO
 
                          COMMISSION FILE NO. 1-14196
 
                               ----------------
 
                            STERLING COMMERCE, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
               DELAWARE                              75-2623341
                                        (I.R.S. EMPLOYER IDENTIFICATION NO.)
    (STATE OR OTHER JURISDICTION OF
    INCORPORATION OR ORGANIZATION)
 
                   8080 NORTH CENTRAL EXPRESSWAY, SUITE 1100
                              DALLAS, TEXAS 75206
         (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
      REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (214) 891-8600
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
 
<TABLE>
<CAPTION>
                                     NAME OF EACH EXCHANGE
        TITLE OF EACH CLASS           ON WHICH REGISTERED
        -------------------         -----------------------
     <S>                            <C>
     Common Stock, $0.01 Par Value  New York Stock Exchange
</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. [X]
 
  As of November 15, 1996, the aggregate market value of the voting stock held
by non-affiliates of the Registrant was $2,087,008,048 based on the closing
sales price of $28 7/8 of the Registrant's Common Stock on the New York Stock
Exchange.
 
  As of November 15, 1996, 75,000,000 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 1997 are incorporated by reference in Part III.
 
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<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington. D.C. 20549


                      AMENDMENT TO APPLICATION OR REPORT
               FILED PURSUANT TO SECTION 12, 13, OR 15(D) OF THE
                        SECURITIES EXCHANGE ACT OF 1934


                            STERLING COMMERCE, INC.

                                 FORM 10-K/A-1

        The undersigned Registrant hereby amends the following items of its 
Annual Report on Form 10-K for the fiscal year ended September 30, 1996, as set 
forth in this Form 10-K/A-1:


        Item 1.     Business.

        Item 8.     Financial Statements and Supplementary Data.

<PAGE>
 
                                    PART I
 
ITEM 1. BUSINESS.
 
INTRODUCTION
 
  Sterling Commerce, Inc. (the "Company") was incorporated in December 1995 as
a 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 ("Commerce
Stock"), and Sterling Software sold to the public 12,000,000 of the 73,200,000
shares of Commerce Stock then owned by it.
 
  In contemplation of the Offering, among other things: (i) Sterling Software
caused to be transferred to the Company certain assets relating to the
electronic commerce business previously conducted by Sterling Software, and
(ii) the Company entered into contractual arrangements with Sterling Software
related to, among other things, tax allocation, international marketing,
indemnification, space sharing and certain services. See "Shared Management
and Contractual Arrangements 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 Commerce 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.
 
GENERAL
 
  The Company is a provider of electronic data interchange ("EDI") and other
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 industries such as banking, pharmaceuticals and
retailing.
 
  A successful electronic commerce program requires the use of multiple
technologies and solutions. The Company offers a comprehensive range of
electronic commerce products and services for the electronic commerce market.
The Company continually strives to: (i) understand the business requirements
of the global electronic commerce market, (ii) address these requirements with
flexible, reliable and secure electronic commerce solutions, and (iii) deliver
these solutions in an effective and efficient manner. The Company believes
that many of today's businesses operate as extended enterprises that include
an entity's divisions, plant sites and sales offices. The extended enterprise
also includes close partnering relationships with customers, suppliers,
lenders and other trading partners. Reliable and secure communications
software is the foundation for transacting business electronically. Upon this
foundation, solutions are provided for messaging management, data translation,
network services and automated payment integration. The Company provides all
of these elements of electronic commerce, plus others, to support the extended
enterprise.
   
  The Company operates through five separate groups. The Commerce Services
Group, the Interchange Software Group, the Communications Software Group and
the Banking Systems Group each offers distinct families of products and
services in the United States and Canada. The Company's fifth group, the
International Group, markets electronic commerce services and related products
outside of the United States and Canada. 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.     
 
  A majority of the Company's software customers enter into product support
agreements and renew such agreements upon expiration. Moreover, although most
network services agreements are cancelable upon 30 days' notice, the Company's
experience is that once customers initiate use of the Company's network
services, they
 
                                       1
<PAGE>
 
generally continue to use such services. Accordingly, the Company considers
revenue from product support and network services as recurring revenue.
Recurring revenue represented 57% and 59% of the Company's total revenue in
1996 and 1995, respectively.
 
PRODUCTS AND SERVICES
 
  The Company offers four principal families of software products and
services.
 
  The COMMERCE family offers over a dozen service and software solutions to
facilitate the electronic exchange of business transactions and documents.
Serving businesses in many different industries, COMMERCE:Network provides an
electronic messaging system with mailbox facilities to accommodate the
exchange of EDI documents, electronic business forms, e-mail messages and
attachments and the posting of technical or reference data. All of the most
commonly used protocols for EDI and e-mail exchanges are accepted by
COMMERCE:Network. Along with many standard services, COMMERCE:Network offers
value-added services that help companies conduct business electronically with
their trading partners. These services include the programs that assist
companies in implementing electronic commerce with their trading partners;
strategic consulting to help define electronic commerce solutions that address
a company's needs; and shared applications to help trading communities and
companies to leverage common applications. Other value-added services include
extended customer support, product training and education. Software products
include COMMERCE:Connection, a Windows-based suite of products that provides
integrated access to a full range of electronic commerce services including
EDI, e-mail, file transfer and electronic libraries. With COMMERCE:Connection,
a company can communicate many types of business documents electronically from
CAD/CAM drawings to trading partner policies to price lists. This product can
also be used to relay business transactions, distribute software and collect
sales and database information. The Commerce Services' products and services
are marketed into targeted vertical industry groups which include the primary
markets of pharmaceuticals, hardlines, grocery, healthcare, insurance, retail,
train-truck-ship transportation, automotive, entertainment,
telecommunications, chemical and petroleum, paper and packaging, banking and
government. As of September 30, 1996, there were over 13,600 Commerce Services
customer sites worldwide.
 
  The GENTRAN family of products offers software solutions for electronic
commerce gateway messaging and EDI translation. GENTRAN software automates the
flow of internal business transactions within organizations and between
organizations and their customers and suppliers. GENTRAN translators and
intelligent messaging servers are available for the major operating systems
and platforms such as UNIX, Windows, Windows NT, AS/400 and IBM mainframes.
GENTRAN was designed for high-volume, commercial traffic and supports any-to-
any formatted message exchange ("FME") across platforms. This makes GENTRAN an
excellent tool for linking disparate applications and for the intelligent
dissemination of information received via the World Wide Web (the "Web"). The
GENTRAN family of products is packaged into three categories of electronic
commerce business solutions: EDI Complete, for companies that need plug-and-
play EDI with expert consultants to assist them through the start-up process;
EC Messaging Gateway or EC Gateway for the Internet, for companies who need a
full electronic commerce solution that integrates with core enterprise
applications; and, EC Desktop Solutions, for those who want to supply vendors,
customers or distributors with push-button, EDI-enabled applications that make
it easy to do business with their trading partners. Key products include
GENTRAN:Server, a sophisticated electronic commerce gateway that recognizes,
manages and routes all types of business messages; GENTRAN:Director for
Windows-based EDI processing; GENTRAN:Mentor, which uses expert systems
technology and graphical navigation to fully automate EDI mapping; and
GENTRAN:Basic, the base EDI translation product for the mainframe, AS/400 and
HP3000 platforms, that translates data from internal formats into standard
formats for EDI processing. GENTRAN products were installed at over 3,900
customer sites as of September 30, 1996.
 
  The CONNECT family of software products is a complete suite of automated
file transfer and communications management solutions that support a wide
variety of protocols. The CONNECT family of products provides an enterprise-
wide solution that integrates seamlessly with existing operations and supports
the addition of new applications, databases, hardware and software. These
products offer prompt access to
 
                                       2
<PAGE>
 
information and the highest levels of security for a company's computer data
and network. CONNECT:Direct is primarily used to move large volumes of data
with a focus on high performance, security, reliability and intelligent
automation. CONNECT:Direct addresses the information needs of electronic
commerce between internal departments and offices and external customer and
client locations. CONNECT:Mailbox is used primarily to move information
between companies with a focus on wide connectivity. The software works
independently of applications, platforms and protocols, and provides open
connections throughout the network to any host, midrange or remote workstation
or value-added network. CONNECT products were installed at over 2,500 customer
sites as of September 30, 1996.
 
  The VECTOR family of products enables banks to provide to their corporate
customers integrated trade-payment processing services for both paper-based
check payments and electronic payments. VECTOR:Connexion provides financial
EDI payment services. VECTOR:Banker provides PC-based cash management and
electronic payment software for medium and small sized banks. The VECTOR
products also automate several key functions in banks, including item
processing applications such as statement sorting, research and adjustments,
check fraud control, electronic check presentment, return item processing and
signature verification. Approximately 2,000 VECTOR systems have been installed
at approximately 830 customer sites worldwide, including 99 of the top 100
U.S. banks, as ranked by deposits as of December 31, 1995 in American Banker
magazine.
 
  The Company provides a wide range of solutions that enable enterprises to
conduct business electronically over the Internet in a safe, reliable
environment. The GENTRAN family of products provides two Web based products:
GENTRAN:Server with the Weblink module, designed for commercial-grade,
business-to-business transactions over the Web; and, GENTRAN:Server with the
Microsoft Merchant Server extension, designed for message management for
companies reaching consumers on the Web. Both products track, route and
reformat messages between an enterprise's Web server and its internal
applications. Additional Internet-based services include a customized home
page creation and hosting service, and the Internet Partners Program, designed
to help companies combine Internet technology with their existing electronic
commerce systems. CONNECT:Firewall provides multiple security capabilities to
Internet users as well as to other network environments, and
COMMERCE:Connection allows easy Internet protocol ("IP") connectivity to
COMMERCE:Network and Web-based forms applications. COMMERCE:Connection for the
Internet includes the Microsoft Internet Explorer browser and Internet access
capability.
 
SHARED MANAGEMENT AND CONTRACTUAL ARRANGEMENTS WITH STERLING SOFTWARE
 
Management
 
  The Board of Directors of the Company (the "Board") currently has seven
members. Messrs. Sam Wyly, Charles J. Wyly, Jr. and Evan A. Wyly are directors
of the Company and are also directors of Sterling Software. Mr. Sterling L.
Williams serves as Chairman of the Board of the Company and as President and
Chief Executive Officer and a member of the Board of Directors of Sterling
Software. In addition, Jeannette P. Meier serves as Executive Vice President,
Chief Financial Officer, General Counsel and Secretary of both companies and
Phillip A. Moore serves as an Executive Vice President of both companies.
Neither the length of service for any particular individual nor the capacity
or capacities in which he or she may serve either the Company or Sterling
Software (or both) has been determined as of the date of this report.
 
  The Company and Sterling Software have significant 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, international marketing functions, tax and
employee benefit matters, indemnity arrangements, and the continued service of
certain directors and executive officers of each of the Company and Sterling
Software as directors and executive officers of the other company. The Board
will utilize 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 state law.
 
                                       3
<PAGE>
 
Intercompany Agreements
 
  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. Certain of the more significant
Intercompany Agreements are summarized below. 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. Copies of certain of the
Intercompany Agreements, including those described below, have been filed as
exhibits to this report.
 
  Tax Allocation Agreement. The Company and Sterling Software have entered
into a tax allocation agreement (the "Tax Allocation Agreement") to provide
for (i) the allocation of payments of taxes for periods during which Sterling
Software (or any of its affiliates other than the Company and its
subsidiaries) and the Company or any of its subsidiaries are included in the
same consolidated group for federal income tax purposes or the same
consolidated, combined or unitary returns for state, local or foreign tax
purposes, (ii) the allocation of responsibility for the filing of tax returns,
(iii) the conducting of tax audits and the handling of tax controversies, and
(iv) various related matters. 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 include 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 Company is directly responsible for
separate state, local and foreign tax returns and related liabilities for
itself and its subsidiaries for all periods.
   
  International Marketing Agreement. Subsidiaries of the Company and of
Sterling Software have entered into a marketing and services agreement
pursuant to which Sterling Software acts as the exclusive distributor
(directly and through subdistributors) of the Company's specified interchange
and communications software products in markets outside the United States and
Canada and is responsible for sales, marketing and first level support of such
products in those markets. The International Marketing Agreement, which
expires in March 1999, provides for the payment to the Company of royalties
equal to 50% of the net revenue that Sterling Software derives from licenses
of the Company's interchange and communications software products and related
product support services, with the balance of such net revenue to be retained
by Sterling Software as payment for the services provided by it under the
International Marketing Agreement. The International Marketing Agreement
obligates Sterling Software to use efforts in the marketing of the Company's
software products and the provision of related services comparable to those
used by Sterling Software in connection with the marketing of its own products
and services. Although it is not anticipated that products and services
offered by Sterling Software will be directly competitive with the products
and services offered by it on behalf of the Company, the International
Marketing Agreement does not expressly prohibit Sterling Software from
offering such products and services (subject to the obligations described in
the preceding sentence).     
 
  Indemnification Agreement. The Company and Sterling Software have entered
into an indemnification agreement (the "Indemnification Agreement"). Under the
Indemnification Agreement, subject to limited exceptions, the Company is
required to indemnify Sterling Software and its directors, officers,
employees, agents and representatives for liabilities under federal or state
securities laws as a result of the Offering or the Distribution. The
Indemnification Agreement also provides 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, resulting from or arising out of (i) 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 (ii) the failure by the Indemnifying
Party to comply with any other agreements executed in connection with the
Offering. In addition, the Indemnification Agreement and a subsequent
agreement between the Company and Sterling Software provide 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
("IRS") ruling request that cause the Distribution to be taxable to Sterling
Software or its stockholders.
 
                                       4
<PAGE>
 
  The Indemnification Agreement also provides that each party thereto (the
"Obligor Party") (i) 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, (ii) will indemnify the Guarantor Party for
any liabilities incurred under such guarantees, bonds, letters of credit and
other arrangements, and (iii) 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.
 
EMPLOYEES
   
  The Company's business is dependent upon its ability to attract and retain
highly qualified managerial, technical and sales personnel, who are in limited
supply. The Company's operations could be adversely affected if it were to
lose the services of a significant number of qualified employees or if it were
unable to obtain additional qualified personnel when needed. To attract and
retain qualified employees, the Company strives to maintain excellent employee
relations, attractive office facilities and challenging working environments,
and offers competitive compensation and benefits packages. 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, 1996, the Company employed approximately 1,266 full-time
employees.
 
SALES AND MARKETING
   
  Each of the Company's Commerce Services, Interchange Software,
Communications Software and Banking Systems Groups has its own sales and
marketing organizations. These organizations license and market the Company's
products and services in the United States and Canada through a combination of
direct sales, telesales and telemarketing. The Company's International Group,
headquartered in Paris, France, markets electronic commerce services and
related products outside the United States and Canada, primarily in Europe
(directly and through distributors). The Company's Banking Systems Group
markets its software products and product support services worldwide. The
Company has implemented a comprehensive, performance-based system of sales
commissions, awards and recognition designed to compensate and motivate its
sales force.     
   
  Pursuant to an agreement with Sterling Software, Sterling Software acts as
the exclusive distributor (directly and through subdistributors) of the
Company's specified interchange and communications software products in
markets outside the United States and Canada and is responsible for sales,
marketing and first level support of such products in those markets. Sterling
Software presently maintains offices throughout Europe and in Tokyo, Japan and
Sydney, Australia and has relationships with agents and distributors in Asia
(other than Japan), Central and South America, Eastern Europe, the Middle
East, Mexico and South Africa.     
 
CUSTOMERS
 
  The Company's customers include 96 of the 100 largest U.S. industrial
corporations, as ranked by 1995 sales in Fortune magazine, and 99 of the top
100 U.S. commercial banks, as ranked by deposits as of December 31, 1995, in
American Banker magazine.
 
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 or otherwise transfer title to
its software products. The license agreements generally restrict the use of
the product to designated sites or central processing units and prohibit
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 its 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 allow customers to receive updated or
enhanced versions of the Company's software products as they become available
and also allow telephone access to the Company's technical personnel.     
 
                                       5
<PAGE>
 
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. In addition, the Company has made a number of acquisitions to expand
the array of products and services available to its customers.
   
  Each of the Company's Commerce Services, Interchange Software,
Communications Software and Banking Systems Groups performs its own product
development function. Each group's development lab operates as a profit
center, with revenues derived from royalties earned on products sold in the
domestic and international markets. The Company believes that this
organizational structure facilitates development cost control and focuses the
development function on customer needs. Gross product development costs in
1996, 1995 and 1994 were $27,800,000, $24,900,000 and $21,700,000,
respectively, of which the Company capitalized $12,300,000, $10,100,000 and
$9,200,000, 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's disciplined 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, and
in other instances the Company may contract with a third-party developer to
develop the product on the Company's behalf. Because of these and other
factors, the Company is unable to estimate future product development costs.
 
COMPETITION
 
  The electronic commerce software product and services industry 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 is seeking to 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
effectively in a specific market niche. The Company may in the future
experience increased competition from telecommunications companies such as
AT&T Corp. and various regional telecommunications companies, among others.
The Company also competes with internal programming staffs of businesses, some
of which are capable of developing products similar to those offered by the
Company.
 
  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 total solutions, including sophisticated interchange and
communication software, software solutions for financial electronic commerce
and bank automation, reliable network services and other value-added services
designed to meet the needs of the various segments of the electronic commerce
market. 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.
 
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
 
                                       6
<PAGE>
 
into non-disclosure and confidentiality agreements with employees,
contractors, consultants and customers. 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. 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 technology.
 
  The Company does not believe that any of its products infringe on the
proprietary 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. In the aggregate, these licenses are
material to the business of the Company, but the Company believes that the
loss of any one of these licenses would not materially affect the Company's
results of operations or financial position.
 
  The COMMERCE, GENTRAN, CONNECT and VECTOR families of product names used
herein are registered or unregistered trademarks owned by the Company.
 
EXECUTIVE OFFICERS
 
  The following information regarding the executive officers of the Company is
as of November 15, 1996.
 
<TABLE>
<CAPTION>
             NAME          AGE                               POSITION
     --------------------  --- ---------------------------------------------------------------------
     <S>                   <C> <C>
     Sterling L. Williams   53 Chairman of the Board
     Warner C. Blow         59 President and Chief Executive Officer; Director
     Jeannette P. Meier     49 Executive Vice President, Chief Financial Officer and General Counsel
     Phillip A. Moore       54 Executive Vice President
     William W. Hymes       60 Senior Vice President and Group President
     Paul L. H. Olson       46 Senior Vice President and Group President
     Stephen R. Perkins     52 Senior Vice President and Group President
     J. Brad Sharp          39 Senior Vice President and Group President
     Thomas A. Lutz         56 Vice President and Group President
     Albert K. Hoover       36 Vice President, Legal
     James W. Hoyt          49 Vice President, Technology
     Steven P. Shiflet      49 Vice President, Finance
     Dawn Wheeler           37 Vice President, Investor Relations
     G. Clark Woodford      49 Vice President, Business Development
     John Blaine            34 Controller
</TABLE>
 
  Sterling L. Williams has served as Chairman of the Board of the Company and
a director since December 1995 and served as Chief Executive Officer of the
Company from December 1995 until October 1996. Mr. Williams co-founded
Sterling Software in 1981, and since such time has served and continues to
serve as President, Chief Executive Officer and a director of Sterling
Software. Mr. Williams also currently serves as a director of INPUT, an
information technology market research company. Mr. Williams is a member of
the Executive Committee and the Stock Option Committee of the Board.
 
  Warner C. Blow has served as Chief Executive Officer and a director of the
Company since October 1996 and as President since December 1995. From December
1995 until 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. Prior to July 1993, Mr. Blow also served as President of Sterling
Software's former EDI Group.
 
  Jeannette P. Meier has served as Chief Financial Officer since June 1996 and
Executive Vice President, General Counsel and Secretary of the Company since
December 1995. Ms. Meier has served and continues to
 
                                       7
<PAGE>
 
serve as Chief Financial Officer (since June 1996), Executive Vice President
(since July 1993) and General Counsel and Secretary (since 1985) of Sterling
Software. Prior to July 1993, Ms. Meier also served as Senior Vice President
of Sterling Software.
 
  Phillip A. Moore has served as Executive Vice President of the Company since
December 1995. Mr. Moore co-founded Sterling Software in 1981 and since such
time has served and continues to serve as a director of Sterling Software. Mr.
Moore has served and continues to serve as an Executive Vice President of
Sterling Software since December 1994. From July 1993 until December 1994, Mr.
Moore served as Executive Vice President, Technology of Sterling Software.
Prior to July 1993, Mr. Moore served as Senior Vice President, Technology of
Sterling Software.
 
  William W. Hymes has served as Senior Vice President and Group President of
the Company since December 1995. 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. Prior to July
1993, Mr. Hymes served as President of the former Directions Division of
Sterling Software.
 
  Paul L. H. Olson has served as Senior Vice President and Group President of
the Company since December 1995. 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. Prior to
August 1992, Mr. Olson served as Group Vice President of Business Development
for Sterling Software's former EDI Group.
 
  Stephen R. Perkins has served as Senior Vice President and Group President
of the Company since December 1995. 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.
Prior to July 1993, Mr. Perkins served as Vice President of Development for
Systems Center, Inc., a computer software company that was acquired by
Sterling Software in July 1993.
 
  J. Brad Sharp has served as Senior Vice President and Group President of the
Company since December 1995. 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.
Prior to August 1992, Mr. Sharp served as Vice President of Development of
Sterling Software's former EDI Labs Division.
 
  Thomas A. Lutz has served as Vice President and Group President of the
Company since December 1995. Prior to March 1996, Mr. Lutz served as President
of Sterling Software's Creative Data Systems Division from October 1991. Prior
to October 1991, Mr. Lutz served as Executive Vice President of Sterling
Software's Creative Data Systems Division. Mr. Lutz also served as Group Vice
President of Sterling Software's former EDI Group from August 1990 to July
1993.
 
  Albert K. Hoover has served as Vice President, Legal of the Company since
December 1995. Prior to March 1996, Mr. Hoover served as Vice President of
Sterling Software from May 1994 and Assistant General Counsel of Sterling
Software from June 1990.
 
  James W. Hoyt has served as Vice President, Technology of the Company since
July 1996. Mr Hoyt served as Director of Product Architecture of Sterling
Software's Communications Software Division from July 1993 until March 1996
and of the Company's Communications Software Group from March 1996 until June
1996. Prior to July 1993, Mr. Hoyt served as Director of Product Architecture
for Systems Center, Inc., a computer software company that was acquired by
Sterling Software in July 1993.
 
  Steven P. Shiflet has served as Vice President, Finance of the Company since
December 1995. 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.
 
  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.
 
                                       8
<PAGE>
 
  G. Clark Woodford has served as Vice President, Business Development of the
Company since December 1995. Prior to March 1996, Mr. Woodford served as Vice
President, Business Development of Sterling Software's Electronic Commerce
Group (the predecessor of the Company) from November 1993. Prior to November
1993, Mr. Woodford served as Vice President, National Accounts for the Network
Services Division of Sterling Software's Electronic Commerce Group (the
predecessor of the Company).
 
  John Blaine has served as Controller of the Company since April 1996. From
February 1995 until April 1996, Mr. Blaine served as Director, Finance &
Administration for the France Division of Sterling Software's International
Group. From July 1993 until February 1995, Mr. Blaine served as Vice President,
Finance and Administration for the former Americas Division of Sterling
Software's International Group. From September 1990 until July 1993, Mr. Blaine
served in various financial positions with Sterling Software.
 
                                       9
<PAGE>
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
                            STERLING COMMERCE, INC.
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           ----
<S>                                                                        <C>
Report of Independent Auditors............................................  16
Consolidated Financial Statements:
  Consolidated Balance Sheets at September 30, 1996 and 1995..............  17
  Consolidated Statements of Operations for the Years Ended September 30,
   1996, 1995 and 1994....................................................  18
  Consolidated Statements of Stockholders' Equity for the Years Ended
   September 30, 1996, 1995 and 1994......................................  19
  Consolidated Statements of Cash Flows for the Years Ended September 30,
   1996, 1995 and 1994....................................................  20
  Notes to Consolidated Financial Statements..............................  21
</TABLE>
 
                                       10
<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, 1996 and 1995, and the
related consolidated statements of income, stockholders' equity, and cash
flows for each of the three years in the period ended September 30, 1996. 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,
1996. These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Sterling
Commerce, Inc. at September 30, 1996 and 1995, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended September 30, 1996 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 20, 1996
 
                                      11
<PAGE>
 
                            STERLING COMMERCE, INC.
                          CONSOLIDATED BALANCE SHEETS
                          SEPTEMBER 30, 1996 AND 1995
                    (IN THOUSANDS, EXCEPT SHARE INFORMATION)
 
<TABLE>
<CAPTION>
                                                                 1996     1995
                                                               -------- --------
<S>                                                            <C>      <C>
                           ASSETS
Current assets:
  Cash and cash equivalents..................................  $ 23,484 $    395
  Marketable securities......................................    21,203
  Accounts and notes receivable, net.........................    61,292   49,155
  Amounts due from Sterling Software.........................    35,134
  Deferred income taxes......................................     3,087    3,463
  Prepaid expenses and other current assets..................     5,794    3,041
                                                               -------- --------
    Total current assets.....................................   149,994   56,054
Property and equipment, net..................................    43,199   25,838
Computer software, net of accumulated amortization of $42,110
 in 1996 and $34,112 in 1995.................................    34,404   32,263

Excess cost over net assets acquired, net of accumulated
 amortization of $3,382 in 1996 and $3,087 in 1995...........     9,789   10,259
Other assets.................................................     4,294    4,564
                                                               -------- --------
                                                               $241,680 $128,978
                                                               ======== ========
             LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:.........................................
  Accounts payable and accrued liabilities...................  $ 34,317 $ 21,442
  Deferred revenue...........................................    38,518   30,920
                                                               -------- --------
    Total current liabilities................................    72,835   52,362
Deferred income taxes........................................    23,135   17,749
Other noncurrent liabilities.................................     7,523    5,680
Contingencies and commitments
Stockholders' equity:
  Preferred stock $.01 par value, 50,000,000 shares
   authorized; no shares issued and outstanding..............

  Common stock $.01 par value, 150,000,000 shares authorized;
   75,000,000 shares issued and outstanding..................       750
  Additional paid-in capital.................................    98,111
  Retained earnings..........................................    39,326
  Stockholder's net investment...............................             53,187
                                                               -------- --------
    Total stockholders' equity...............................   138,187   53,187
                                                               -------- --------
                                                               $241,680 $128,978
                                                               ======== ========
</TABLE>
 
                            See accompanying notes.
 
                                       12
<PAGE>
 
                            STERLING COMMERCE, INC.
                       CONSOLIDATED STATEMENTS OF INCOME
                 YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
                  (IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
 
<TABLE>
<CAPTION>
                                                    1996     1995      1994
                                                  -------- --------  --------
<S>                                               <C>      <C>       <C>
Revenue:
  Products....................................... $ 87,527 $ 67,603  $ 56,291
  Product support................................   56,229   46,190    37,953
  Services.......................................  103,269   78,063    53,246
  Royalties from affiliated companies............   20,748   11,722     8,426
                                                  -------- --------  --------
                                                   267,773  203,578   155,916
Costs and expenses:
  Cost of sales:
   Products and product support..................   28,647   23,713    23,020
   Services......................................   25,771   17,837    13,262
                                                  -------- --------  --------
                                                    54,418   41,550    36,282
  Product development and enhancement............   15,553   14,807    12,497
  Selling, general and administrative............  102,597   75,193    60,732
                                                  -------- --------  --------
                                                   172,568  131,550   109,511
Income before other income (expense) and income
 taxes...........................................   95,205   72,028    46,405
Other income (expense)...........................    1,217     (478)     (150)
                                                  -------- --------  --------
Income before income taxes.......................   96,422   71,550    46,255
Provision for income taxes.......................   38,030   28,620    18,502
                                                  -------- --------  --------
Net income....................................... $ 58,392 $ 42,930  $ 27,753
                                                  ======== ========  ========
Income per common share:
  Pro forma......................................          $   0.59
                                                           ========
  Primary........................................ $   0.77
                                                  ========
  Fully diluted.................................. $   0.77
                                                  ========
Weighted average and proforma common shares
 outstanding.....................................   74,233   73,200
                                                  ======== ========
</TABLE>
 
 
                            See accompanying notes.
 
                                       13
<PAGE>
 
                            STERLING COMMERCE, INC.
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                 YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                             COMMON STOCK
                          ------------------- ADDITIONAL          SHAREHOLDERS'     TOTAL
                          NUMBER OF            PAID-IN   RETAINED      NET      STOCKHOLDERS'
                           SHARES   PAR VALUE  CAPITAL   EARNINGS  INVESTMENT      EQUITY
                          --------- --------- ---------- -------- ------------- -------------
<S>                       <C>       <C>       <C>        <C>      <C>           <C>
Balance at October 1,
 1993...................                                            $ 37,498      $ 37,498
  Net income............                                              27,753        27,753
  Net cash distributed
   to Sterling
   Software.............                                             (22,534)      (22,534)
  Other.................                                                 334           334
                                                                    --------      --------
Balance at September 30,
 1994...................                                              43,051        43,051
  Net income............                                              42,930        42,930
  Net cash distributed
   to Sterling
   Software.............                                             (32,354)      (32,354)
  Other.................                                                (440)         (440)
                                                                    --------      --------
Balance at September 30,
 1995...................                                              53,187        53,187
  Formation
   transactions.........   73,200     $732     $53,871               (54,603)
  Net proceeds from
   initial public
   offering.............    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
                           ======     ====     =======   =======    ========      ========
</TABLE>
 
 
 
                            See accompanying notes.
 
                                       14
<PAGE>
 
                            STERLING COMMERCE, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                 YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                      1996     1995     1994
                                                     -------  -------  -------
<S>                                                  <C>      <C>      <C>
Operating activities:
Net income.......................................... $58,392  $42,930  $27,753
  Adjustments to reconcile net income to net cash
   provided by operating activities:
  Depreciation and amortization.....................  21,943   17,517   14,497
  Provision for losses on accounts receivable.......   1,068     (466)   1,883
  Provision for deferred income taxes...............   5,762    4,537     (478)
  Changes in operating assets and liabilities, net
   of effects of business acquisitions:
    Increase in accounts and notes receivable....... (13,149) (14,308)  (8,982)
    Increase in amounts due from Sterling Software.. (35,134)
    Increase in prepaid expenses and other assets...  (3,135)    (989)    (632)
    Increase in accounts payable and accrued
     liabilities....................................  12,710    5,154    2,110
    Increase in deferred revenue....................   7,598    7,677    4,350
    Other...........................................   1,235     (588)   2,658
                                                     -------  -------  -------
      Net cash provided by operating activities.....  57,290   61,464   43,159
Investing activities:
  Purchases of property and equipment............... (26,573) (15,633) (10,346)
  Purchases and capitalized cost of development of
   computer software................................ (12,016) (10,244)  (9,624)
  Business acquisitions, net of cash acquired.......    (185)  (2,823)
  Purchases of investments.......................... (21,203)
  Other.............................................              192     (215)
                                                     -------  -------  -------
      Net cash used in investing activities......... (59,977) (28,508) (20,185)
Financing activities:
  Net proceeds from stock issuance..................  40,118
  Other.............................................   3,477     (586)    (521)
                                                     -------  -------  -------
      Net cash provided by (used in) financing
       activities...................................  43,595     (586)    (521)
Net cash distributed to Sterling Software........... (17,819) (32,354) (22,534)
                                                     -------  -------  -------
Increase (decrease) in cash and cash equivalents....  23,089       16      (81)
                                                     -------  -------  -------
Cash and cash equivalents at beginning of year......     395      379      460
                                                     -------  -------  -------
Cash and cash equivalents at end of year............ $23,484  $   395  $   379
                                                     =======  =======  =======
Supplemental cash flow information:
  Income taxes paid to Sterling Software............ $32,268  $24,083  $18,980
                                                     =======  =======  =======
</TABLE>
 
 
                            See accompanying notes.
 
                                       15
<PAGE>
 
                            STERLING COMMERCE, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                       SEPTEMBER 30, 1996, 1995 AND 1994
 
1. GENERAL INFORMATION
 
 General
 
  Sterling Commerce, Inc., (the "Company") is a provider of electronic data
interchange ("EDI") and other electronic commerce 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 industries such as banking,
pharmaceuticals and retailing.
 
 Initial Public Offering and Distribution
 
  The Company was incorporated in December 1995 as a 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 ("Commerce Stock") and Sterling
Software sold to the public 12,000,000 of the 73,200,000 shares of Commerce
Stock then owned by it.
   
  In contemplation of the Offering, among other things: (i) Sterling Software
caused to be transferred to the Company certain assets relating to the
electronic commerce business previously conducted by Sterling Software, and
(ii) the Company entered into contractual arrangements with Sterling Software
related to, among other things, tax allocation, international marketing,
indemnification, space sharing and certain services. See "Shared Management
and Contractual Arrangements 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 Commerce 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.
 
Shared Management and Contractual Arrangements with Sterling Software
 
 Management.
 
  The Board of Directors of the Company (the "Board") currently has seven
members. Messrs. Sam Wyly, Charles J. Wyly, Jr. and Evan A. Wyly are directors
of the Company and are also directors of Sterling Software. Mr. Sterling L.
Williams serves as Chairman of the Board of the Company and as President and
Chief Executive Officer and a member of the Board of Directors of Sterling
Software. In addition, Jeannette P. Meier serves as Executive Vice President,
Chief Financial Officer, General Counsel and Secretary of both companies; and
Phillip A. Moore serves as an Executive Vice President of both companies.
Neither the length service for any particular individual nor the capacity or
capacities in which he or she may serve either the Company or Sterling
Software (or both) has been determined as of the date of this report.
 
  The Company and Sterling Software have significant 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, international marketing functions, tax and
employee benefit matters, indemnity arrangements, and the continued service of
certain directors and executive officers of each of the Company and Sterling
Software as directors and executive officers of the other company. The Board
will utilize such procedures in
 
                                      16
<PAGE>
 
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 state law.
 
 Intercompany Agreements.
 
  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
include a tax allocation agreement, an international marketing agreement and a
space sharing 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 include 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.
Additionally, the tax allocation agreement contains provisions for the
handling of tax controversies. The international marketing agreement defines
the terms pursuant to which Sterling Software acts as the exclusive
distributor through March 1999 of certain of the Company's products and
services in markets outside the United States and Canada. The international
marketing agreement provides for the payment to the Company of royalties equal
to 50% of the net revenue that Sterling Software derives from licenses of the
Company's interchange and communications software products and related product
support services. The space sharing agreement defines the terms pursuant to
which the Company and Sterling Software are allowed to utilize a portion of
each other's office facilities.
 
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
 
 Basis of Presentation
 
  The Company's consolidated financial statements 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. All significant intercompany accounts
among the Company and its consolidated subsidiaries have been eliminated.
Certain amounts for periods ended prior to September 30, 1996 have been
reclassified to conform to the current year presentation. The financial
statements have been prepared in conformity with generally accepted accounting
principles which requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities and the disclosure of
contingencies at September 30, 1996 and 1995, and the results of operations
for the years ended September 30, 1996, 1995 and 1994. While management has
based its assumptions and estimates on the facts and circumstances known at
September 30, 1996, final amounts may differ from such estimates.
 
  The Company's consolidated financial statements reflect the results of
operations, financial condition 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 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 compensation and the
related costs of a corporate staff function. The allocations of such costs
were approximately $875,000 for the first quarter of 1996 and $3,500,000 in
each of 1995 and 1994 and represent 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
 
                                      17
<PAGE>
 
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
affiliated companies 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 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 $31,058,000 and $27,555,000 are
included in "Computer software, net" at September 30, 1996 and 1995,
respectively. Pursuant to FAS No. 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.
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 three to five years. Leasehold improvements are amortized
over the term of the lease. Excess costs over the net assets of businesses
acquired are amortized on a straight-line basis over periods of ten 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, 1996, 1995 and 1994 (in thousands):
 
<TABLE>
<CAPTION>
                                                        1996    1995    1994
                                                       ------- ------- -------
   <S>                                                 <C>     <C>     <C>
   Property and equipment............................. $10,817 $ 7,084 $ 4,579
   Purchased computer software........................   1,412   1,405   1,385
   Capitalized computer software development costs....   8,463   7,772   7,353
   Excess costs over net assets of businesses
    acquired..........................................     427     426     407
   Intangible assets..................................     824     830     773
                                                       ------- ------- -------
                                                       $21,943 $17,517 $14,497
                                                       ======= ======= =======
</TABLE>
 
 
                                      18
<PAGE>
 
 Income Taxes
 
  The Company computes its income taxes in accordance with Statement of
Financial Accounting Standard No. 109, "Accounting for Income Taxes" ("FAS No.
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.
 
  The Company's operations have historically been 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 periods through September 30, 1996, when the Company was included
in Sterling Software's consolidated tax returns. Income tax expense in the
accompanying financial statements has been computed assuming the Company filed
returns separately from the Sterling Software group of companies.
 
 Stock Options
 
  In October 1995, the Financial Accounting Standards Board issued FASB
Statement No. 123, "Accounting for Stock-Based Compensations" ("FASB No.
123"). The Company intends to continue applying the existing accounting
requirements for stock options and stock-based awards as contained in APB
Opinion No. 25, "Accounting for Stock Issued to Employees." The Company will
provide pro forma disclosures as required under FASB No. 123.
 
 Earnings Per Share
 
  Pro forma net income per common share is calculated as though there were
73,200,000 shares outstanding for the year ended September 30, 1995. Primary
and fully diluted income per common share is calculated as though there were
73,200,000 shares outstanding, together with the weighted average of the
additional 1,800,000 shares issued in the Offering, and common stock
equivalents.
 
 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, and U.S. government
obligations. The fair values for marketable securities are based on quoted
market prices.
 
  In accordance with Statement of Financial Accounting Standard No. 115,
"Accounting for Certain Investments in Debt and Equity Securities" ("FAS No.
115"), 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 discounts to maturity. Such
amortization is included in investment income. Realized gains and losses and
declines in values judged to be other-than-temporary on available-for-sale
securities are included in investment income.
 
                                      19
<PAGE>
 
3. TRANSACTIONS WITH AFFILIATED COMPANIES
 
  Amounts payable and receivable from Sterling Software arise as a result of
various transactions between the Company and Sterling Software, including
royalties paid to the Company as a result of Sterling Software acting as an
international distributor, tax expense charged to the Company, other expenses
incurred on behalf of the Company and the Company's participation in Sterling
Software's central cash management program (which participation terminated
upon completion of the Distribution on September 30, 1996). At September 30,
1996, the Company had amounts due from Sterling Software of $35,134,000, which
were collected subsequent to September 30, 1996.
 
  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" and tax allocations) follows (in thousands):
 
<TABLE>
<CAPTION>
                                                        YEAR ENDED SEPTEMBER 30
                                                        ------------------------
                                                          1996    1995    1994
                                                        -------- ------- -------
   <S>                                                  <C>      <C>     <C>
   Summary of Expenses:
     Legal, accounting and professional fees........... $  1,139 $   600  $1,376
     Payroll related...................................    7,691   1,403     739
     Occupancy.........................................    1,695     661     694
     Miscellaneous.....................................      534     374     349
                                                        -------- ------- -------
                                                         $11,059  $3,038  $3,158
                                                        ======== ======= =======
</TABLE>
 
4. BUSINESS COMBINATIONS
 
  In August 1994, Sterling Software acquired, in a stock-for-stock
acquisition, accounted for as a pooling of interests, all of the outstanding
common stock of American Business Computer Company ("ABC"), a corporation
which developed, marketed and supported UNIX-based electronic data interchange
products, including products that provide sophisticated electronic commerce
gateway functionality. The business formerly conducted by ABC is included in
the results of operations of the Company.
 
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. In the opinion of
management, the amount of any liability with respect to any existing actions
will not have a material effect on the financial condition or results of
operations of the Company.
 
6. MARKETABLE SECURITIES
 
  At September 30, 1996, all of the Company's marketable securities were
classified as available-for-sale and consist of the following (in thousands):
 
<TABLE>
<CAPTION>
                                                                       GROSS
                                                                     UNREALIZED
                                               AGGREGATE  AMORTIZED   HOLDING
                                               FAIR VALUE COST BASIS   GAINS
                                               ---------- ---------- ----------
<S>                                            <C>        <C>        <C>
September 30, 1996
Current:
  U.S. government obligations, scheduled
   maturity within one year...................  $ 9,678    $ 9,652      $26
  U.S. government obligations, scheduled
   maturities between one
   and five years.............................   11,525     11,463       62
                                                -------    -------      ---
                                                $21,203    $21,115      $88
                                                =======    =======      ===
</TABLE>
 
                                      20
<PAGE>
 
7. ACCOUNTS AND NOTES RECEIVABLE
 
  Accounts and notes receivable consist of the following at September 30 (in
thousands):
 
<TABLE>
<CAPTION>
                                                                  1996    1995
                                                                 ------- -------
     <S>                                                         <C>     <C>
     Trade accounts receivable.................................. $63,708 $51,155
     Less: Allowance for doubtful accounts......................   2,416   2,000
                                                                 ------- -------
                                                                 $61,292 $49,155
                                                                 ======= =======
</TABLE>
 
  The Company's accounts and notes receivable are due principally from
corporations in diverse industries located in the United States and Canada.
 
8. PROPERTY AND EQUIPMENT
 
  Property and equipment consist of the following at September 30 (in
thousands):
 
<TABLE>
<CAPTION>
                                                                  1996    1995
                                                                 ------- -------
     <S>                                                         <C>     <C>
     Computer and peripheral equipment.......................... $57,231 $36,634
     Furniture, fixtures and other equipment....................   6,693   5,016
     Building improvements......................................   6,302   3,131
                                                                 ------- -------
                                                                  70,226  44,781
     Less accumulated depreciation..............................  27,027  18,943
                                                                 ------- -------
                                                                 $43,199 $25,838
                                                                 ======= =======
</TABLE>
 
9. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
 
  Accounts payable and accrued liabilities consist of the following at
September 30 (in thousands):
 
<TABLE>
<CAPTION>
                                                                 1996    1995
                                                                ------- -------
     <S>                                                        <C>     <C>
     Trade accounts payable.................................... $12,323 $ 7,204
     Accrued compensation......................................  16,945  11,113
     Other accrued liabilities.................................   5,049   3,125
                                                                ------- -------
                                                                $34,317 $21,442
                                                                ======= =======
</TABLE>
 
10. INCOME TAXES
 
  The provision for income taxes is composed of the following (in thousands):
 
<TABLE>
<CAPTION>
                                                      YEARS ENDED SEPTEMBER 30
                                                     --------------------------
                                                       1996     1995     1994
                                                     -------- -------- --------
     <S>                                             <C>      <C>      <C>
     Current:
       Foreign...................................... $    176
       Federal......................................   26,225  $19,147  $15,363
       State........................................    5,867    4,936    3,617
     Deferred:
       Federal......................................    4,975    3,970     (418)
       State........................................      787      567      (60)
                                                     -------- -------- --------
                                                      $38,030  $28,620  $18,502
                                                     ======== ======== ========
</TABLE>
 
 
                                      21
<PAGE>
 
  The effective income tax rate on income before taxes differed from the
federal income tax statutory rate for the following reasons (in thousands):
<TABLE>
<CAPTION>
                                                     YEARS ENDED SEPTEMBER 30
                                                    --------------------------
                                                      1996     1995     1994
                                                    -------- -------- --------
     <S>                                            <C>      <C>      <C>
     Tax expense at U.S. federal statutory rate....  $33,748  $25,043  $16,189
     State income taxes, net of federal benefit....    4,223    3,577    2,313
     Other.........................................       59
                                                    -------- -------- --------
                                                     $38,030  $28,620  $18,502
                                                    ======== ======== ========
</TABLE>
 
  In accordance with the tax allocation agreement with Sterling Software, the
Company's income tax payments have been reduced and paid in capital has been
increased by approximately $5,148,000 due to income tax deductions associated
with the exercise, after the Offering, of Sterling Software stock options held
by Company employees.
 
  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
                                                               ---------------
                                                                1996    1995
                                                               ------- -------
   <S>                                                         <C>     <C>
   Deferred income tax assets:
     Deferred revenue......................................... $   362 $   843
     Reserves and restructuring accruals......................   2,725   2,620
                                                               ------- -------
       Deferred income tax assets.............................   3,087   3,463
                                                               ------- -------
   Deferred income tax liabilities:
     Capitalized software costs...............................  15,214  11,361
     Depreciation and amortization............................   7,921   6,388
                                                               ------- -------
       Deferred income tax liabilities........................  23,135  17,749
                                                               ------- -------
       Deferred income tax liability net of deferred income
        tax assets............................................ $20,048 $14,286
                                                               ======= =======
</TABLE>
 
11. COMMITMENTS
 
  The Company leases certain facilities and equipment under operating leases.
Total rent expense for the years ended September 30, 1996, 1995 and 1994 was
$10,000,000, $7,537,000 and $6,071,000, respectively. At September 30, 1996,
minimum future rental payments due under all operating leases, net of future
sublease income, are as follows (in thousands):
 
<TABLE>
      <S>                                                            <C>
      1997.......................................................... $11,662,000
      1998..........................................................  11,270,000
      1999..........................................................  10,372,000
      2000..........................................................   5,838,000
      2001..........................................................   5,667,000
      Thereafter....................................................  24,148,000
</TABLE>
 
12. STOCK OPTIONS
 
  The Company has a stock option plan that provides for the grant of options
to purchase shares of Commerce Stock by officers, directors, key employees and
advisors. All option grants were made at the fair market value of the Commerce
Stock at the date of the grant. Options granted pursuant to the plan generally
become exerciseable at a rate of 25% per year or become exerciseable
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.
 
 
                                      22
<PAGE>
 
  Stock option transactions are summarized below for the year ended September
30, 1996:
 
<TABLE>
<CAPTION>
                                                                   AGGREGATE
                                         NUMBER       EXERCISE      EXERCISE
                                       OF SHARES       PRICE         PRICE
                                       ----------  -------------- ------------
<S>                                    <C>         <C>            <C>
Outstanding at September 30, 1995
 (0 shares exerciseable)
  Granted during the year............. 12,285,000  $24.00--$43.88 $297,753,750
  Terminated and canceled during the
   year...............................    (33,000)          24.00     (792,000)
                                       ----------                 ------------
Outstanding at September 30, 1996
 (0 shares exerciseable).............. 12,252,000  $24.00--$43.88 $296,961,750
                                       ==========                 ============
</TABLE>
 
  At September 30, 1996, a maximum of 5,198,400 shares were reserved for
future grants of options under the plan. Subsequent to September 30, 1996,
options for 4,453,000 additional shares were granted under the plan.
 
13. DEFINED CONTRIBUTION PLAN
 
  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-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. Benefits under the Software Plan
were limited to the assets of the Software Plan. Company contributions charged
to expense during 1996, 1995 and 1994 were $2,035,000, $930,000 and $861,000,
respectively. A provision of the Software Plan required a portion of the
Company contributions to be invested in Software Stock.
 
  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. The 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
Commerce Stock. The Company's pro-rata share of the assets of the Software
Plan were transferred to the Commerce Plan.
 
14. SUBSEQUENT EVENTS
 
  Effective October 1, 1996, the Company entered into a Revolving Credit and
Term Loan Agreement ("Loan Agreement") with a domestic borrowing capacity of
$20,000,000. The Loan Agreement also provides for an additional $10,000,000
international borrowing capacity. The Loan Agreement is unsecured and contains
various restrictions on the Company, including limitations on additional
borrowings, payment of dividends, acquisitions and capital expenditures. The
Loan Agreement also requires that the Company maintain certain financial
ratios. Borrowings under the Loan Agreement bear interest at the higher of the
lender's prime rate, the Federal Funds Effective Rate plus one-half percent (
1/2%) or LIBOR plus one and three-quarters percent (1 3/4%). Borrowings, if
any, outstanding on October 1, 1998 will convert to four payments in
substantially equal installments due at the end of each subsequent quarter.
There were no amounts borrowed or outstanding under the Loan Agreement as of
November 15, 1996. At November 15, 1996, after utilization of approximately
$1,000,000 for standby letters of credit, approximately $29,000,000 was
available for borrowing on the Loan Agreement.
 
15. CHANGE-IN-CONTROL AND SEVERANCE AGREEMENTS
   
  As of September 30, 1996, the Company had change-in-control agreements with
fourteen 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) of the Company occurs and a covered officer's employment
is terminated. In addition, the stock option agreements with five of the
directors of the Company provide for certain other benefits in the event of a
change in control (as defined) of the Company. At September 30, 1996, the
maximum liability for salaries, bonuses and benefits under these agreements
would be approximately $22,000,000.     
 
                                      23
<PAGE>
 
  As of September 30, 1996, the Company had entered into severance agreements
with twelve 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 an agreement with another officer that
provides for an annual base salary plus agreed-upon bonuses or benefits and
converts to a five-year consulting agreement upon the occurrence of certain
events. At September 30, 1996, the aggregate commitment for future salaries,
bonuses and benefits under these agreements would be approximately
$15,000,000.
 
16. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
 
  The Company's consolidated operating results for each quarter of 1996 and
1995 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, 1996:
  Revenue............................   $56,150   $62,076  $69,225   $80,322
  Cost of sales......................    11,916    13,336   13,695    15,471
  Product development and
   enhancement.......................     3,288     3,777    4,187     4,301
  Selling, general and
   administrative....................    20,255    22,904   27,684    31,754
  Income before other expense and
   income taxes......................    20,691    22,059   23,659    28,796
                                        -------   -------  -------   -------
  Net income.........................   $12,289   $13,235  $14,750   $18,118
                                        =======   =======  =======   =======
Year ended September 30, 1995:
  Revenue............................   $45,096   $46,275  $51,637   $60,570
  Cost of sales......................     9,592     9,648   10,233    12,077
  Product development and
   enhancement.......................     3,599     4,032    3,706     3,470
  Selling, general and
   administrative....................    17,303    16,535   19,284    22,071
  Income before other expense and
   income taxes......................    14,602    16,060   18,414    22,952
                                        -------   -------  -------   -------
  Net income.........................   $ 8,726   $ 9,568  $10,946   $13,690
                                        =======   =======  =======   =======
</TABLE>
 
 
                                      24