-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NLvhUmrIdAU4O1UyTBXFdfBIc8bswtkgqOCv1KVDoF7wOS+wej38hn5SpFQ34eXG GtnPmn1+idgOQgJ/j9lAdw== 0000930661-96-001010.txt : 19960814 0000930661-96-001010.hdr.sgml : 19960814 ACCESSION NUMBER: 0000930661-96-001010 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19960630 FILED AS OF DATE: 19960813 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: STERLING SOFTWARE INC CENTRAL INDEX KEY: 0000716714 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 751873956 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-08465 FILM NUMBER: 96609257 BUSINESS ADDRESS: STREET 1: 8080 N CENTRAL EXPWY STE 1100 CITY: DALLAS STATE: TX ZIP: 75206 BUSINESS PHONE: 2148918600 10-Q 1 QUARTERLY REPORT SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) (X) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 1996 or ( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from __________ to __________ COMMISSION FILE NO. 1-8465 STERLING SOFTWARE, INC. (Exact name of registrant as specified in its charter) DELAWARE 75-1873956 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 8080 NORTH CENTRAL EXPRESSWAY, SUITE 1100 DALLAS, TEXAS 75206 (Address of principal executive offices) (Zip Code) (214) 891-8600 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No - -- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Title Shares Outstanding as of August 12, 1996 - ----------------------------- ---------------------------------------- Common Stock, $0.10 par value 37,273,400 -1- PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) Index to Financial Statements
Page ---- Sterling Software, Inc. Consolidated Balance Sheets at June 30, 1996 and September 30, 1995.......................................... 3 Sterling Software, Inc. Consolidated Statements of Operations for the Three and Nine Months Ended June 30, 1996 and 1995......................... 4 Sterling Software, Inc. Consolidated Statements of Stockholders' Equity for the Nine Months Ended June 30, 1996 and 1995......................... 5 Sterling Software, Inc. Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 1996 and 1995................................ 6 Sterling Software, Inc. Notes to Consolidated Financial Statements........................... 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................... 14
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS... 21 ITEM 5 OTHER INFORMATION Pro Forma Financial Data....................................... 22 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K..................... 28
-2- STERLING SOFTWARE, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE INFORMATION) A S S E T S
JUNE 30 SEPTEMBER 30 1996 1995 ----------- ------------- (UNAUDITED) Current assets: Cash and cash equivalents................. $ 573,946 $ 179,305 Marketable securities..................... 172,851 61,341 Accounts and notes receivables, net....... 170,740 183,734 Deferred income taxes..................... 1,890 Prepaid expenses and other current assets.................... 20,860 17,784 ---------- --------- Total current assets................. 938,397 444,054 Property and equipment, net of accumulated depreciation of $68,306 at June 30, 1996 and $59,716 at September 30, 1995........ 75,204 68,412 Computer software, net of accumulated amortization of $121,655 at June 30, 1996 and $104,813 at September 30, 1995....... 89,952 80,966 Excess cost over net assets acquired, net of accumulated amortization of $28,007 at June 30, 1996 and $23,362 at September 30, 1995.................... 80,971 85,903 Noncurrent deferred income taxes............ 17,960 Other assets................................ 13,700 16,885 --------- -------- $1,198,224 $714,180 ========== ======== L I A B I L I T I E S A N D S T O C K H O L D E R S ' E Q U I T Y Current liabilities: Current portion of long term debt......... $ 1,519 $ 5,871 Income taxes payable...................... 32,000 4,679 Accounts payable and accrued liabilities............................ 93,637 114,391 Deferred revenue.......................... 104,630 96,708 ---------- -------- Total current liabilities.......... 231,786 221,649 Long-term debt.............................. 1,093 116,668 Deferred income taxes....................... 7,880 Other noncurrent liabilities................ 32,308 27,525 Commitments and contingencies (Note 5)...... Minority interest........................... 21,300 Stockholders' equity: Preferred stock, $.10 par value; 10,000,000 shares authorized........... Common stock, $.10 par value; 75,000,000 shares authorized; 38,346,000 and 26,529,000 shares issued at June 30, 1996 and September 30, 1995, respectively........................... 3,835 2,653 Additional paid-in capital................ 748,491 336,752 Retained earnings......................... 211,019 9,515 Less treasury stock; at cost; 1,381,000 and 56,000 shares at June 30, 1996 and September 30, 1995, respectively....... (59,488) (582) ---------- -------- Total stockholders' equity......... 903,857 348,338 ---------- -------- $1,198,224 $714,180 ========== ========
See accompanying notes. -3- STERLING SOFTWARE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE INFORMATION) (UNAUDITED)
THREE MONTHS NINE MONTHS ENDED JUNE 30 ENDED JUNE 30 ------------------ ----------------- 1996 1995 1996 1995 ------- ------- ------- ------- Revenue: Products.............................. $ 72,322 $ 60,990 $191,137 $160,957 Product support....................... 44,490 41,571 134,066 115,550 Services.............................. 57,506 48,387 161,756 139,066 -------- -------- -------- -------- 174,318 150,948 486,959 415,573 Costs and expenses: Cost of sales: Products and product support.......... 19,207 16,733 59,315 48,696 Services.............................. 33,467 32,191 96,256 86,547 -------- -------- -------- -------- 52,674 48,924 155,571 135,243 Product development and enhancement... 8,805 11,661 27,139 32,463 Selling, general and administrative... 72,799 56,452 197,241 157,383 Restructuring charge.................. 19,512 Purchased research and development.... 62,000 -------- -------- -------- -------- 134,278 117,037 379,951 406,601 -------- -------- -------- -------- Income before other income (expense), gain on subsidiary public offering, minority interest and income taxes.... 40,040 33,911 107,008 8,972 Other income (expense): Interest expense..................... (239) (2,189) (3,036) (6,389) Investment income.................... 9,350 2,592 16,815 5,719 Other................................ 19 512 471 776 ------- ------- -------- ------- 9,130 915 14,250 106 ------- ------- -------- ------- Income before gain on subsidiary public offering, minority interest and income taxes.................................. 49,170 34,826 121,258 9,078 Gain on subsidiary public offering..... 239,936 Minority interest...................... (2,714) (3,871) -------- ------- -------- ------- Income before income taxes.............. 46,456 34,826 357,323 9,078 Provision for income taxes.............. 17,062 12,537 154,604 28,284 -------- ------- -------- -------- Net income (loss)....................... 29,394 22,289 202,719 (19,206) Preferred stock dividends............... 49 147 -------- ------- -------- -------- Income (loss) applicable to common stockholders........................... $ 29,394 $ 22,240 $202,719 $(19,353) ======== ======== ======== ======== Income (loss) per common share: Net income (loss): Primary............................... $.80 $.79 $6.24 $(.84) ======== ======= ======== ======== Fully diluted......................... $.80 $.73 $5.80 $(.84) ======== ======= ======== ======== Average common shares outstanding....... 35,758 24,118 30,598 23,036 ======== ======= ======== ========
See accompanying notes. -4- STERLING SOFTWARE, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY NINE MONTHS ENDED JUNE 30, 1996 AND 1995 (IN THOUSANDS) (UNAUDITED)
PREFERRED STOCK COMMON STOCK TREASURY STOCK --------------- ------------ -------------- NUMBER NUMBER ADDITIONAL RETAINED NUMBER TOTAL OF PAR OF PAR PAID-IN EARNINGS OF STOCKHOLDERS' SHARES VALUE SHARES VALUE CAPITAL (Deficit) SHARES COST EQUITY ------ ----- ------ ----- --------- --------- ------ -------- ------------- Balance at September 30, 1994.................... 200 $ 20 22,378 $2,238 $192,064 $ 572 1,793 $(19,090) $ 175,804 Net loss................ (19,206) (19,206) Preferred stock dividends. (147) (147) Issuance of common stock and treasury stock for acquisition............. 720 72 56,260 (1,701) 18,111 74,443 Common stock issuance costs................... (730) (730) Issuance of common stock pursuant to stock options and warrants.... 1,730 173 30,535 30,708 Issuance of common stock to retirement plan....... 378 (18) 196 574 Tax benefit from exercise of stock options......... 12,651 12,651 Issuance of warrants upon conversion of preferred stock.................... (200) (20) 20 Other..................... 41 (362) (8) 93 (228) ----- ---- ------ ------ -------- -------- ------ -------- --------- Balance at June 30, 1995... 24,828 $2,483 $291,219 $(19,143) 66 $ (690) $ 273,869 ===== ==== ====== ====== ======== ======== ===== ======== ========= Balance at September 30, 26,529 $2,653 $336,752 $ 9,515 56 $ (582) $ 348,338 1995...................... Net income................ 202,719 202,719 Acquisition of common stock for treasury....... 1,336 (59,372) (59,372) Issuance of common stock pursuant to stock options and warrants, including a tax benefit of $45,284.... 7,761 776 267,049 267,825 Issuance of common stock pursuant to conversion of 5.75% Debentures.......... 4,056 406 111,970 112,376 Proceeds from subsidiary initial public offering, net of minority interest of $7,382................. 32,736 32,736 Issuance of common stock to retirement plan....... (55) (11) 466 411 Other..................... 39 (1,215) (1,176) ------ ------ -------- -------- ----- ------- ------- Balance at June 30, 1996... 38,346 $3,835 $748,491 $211,019 1,381 $(59,488) $903,857 ====== ====== ======== ======== ===== ======== ========
See accompanying notes. -5- STERLING SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED JUNE 30 -------------------- 1996 1995 -------- -------- Operating activities: Net income (loss)...................... $ 202,719 $(19,206) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Gain on subsidiary public offering... (239,936) Minority interest.................... 3,871 Depreciation and amortization........ 39,797 33,938 Provision for losses on accounts receivable.......................... 3,118 2,643 Provision for deferred income taxes.. 31,229 14,762 Purchased research and development... 62,000 Write-down of property and equipment and other assets.................... 2,462 Write-down of purchased and capitalized computer software costs. 6,215 Changes in operating assets and liabilities, net of effects of business acquisitions: Increase in accounts and notes receivable....................... (18,493) (24,604) Increase in prepaids and other assets........................... (3,055) (3,109) Increase (decrease) in accounts payable, accrued liabilities and income taxes payable............. 43,787 (10,407) Increase in deferred revenue...... 7,799 12,348 Other............................. (1,076) (1,168) --------- -------- Net cash provided by operating activities...................... 69,760 75,874 Investing activities: Purchases of property and equipment.... (24,518) (31,601) Purchases and capitalized cost of development of computer software...... (20,444) (16,016) Business acquisitions, net of cash acquired.............................. (7,186) (17,489) Purchases of investments............... (401,266) (81,808) Proceeds from sales of investments..... 289,822 51,415 Other................................ 774 316 --------- -------- Net cash used in investing activities...................... (162,818) (95,183) Financing activities: Purchases of treasury stock............ (59,372) Retirement and redemption of debt and capital lease obligations............. (12,057) (15,264) Proceeds from issuance of debt......... 4,049 22,661 Proceeds from sales of installment and lease contracts receivable............ 23,904 9,685 Preacquisition advances to business acquired.............................. (4,435) Net proceeds from subsidiary public offering.............................. 307,576 Proceeds from issuance of common stock pursuant to stock options and warrants 222,541 30,708 Other.................................. 1,432 (601) --------- -------- Net cash provided by financing activities...................... 488,073 42,754 Effect of foreign currency exchange rate changes on cash................... (374) 286 --------- -------- Increase in cash and cash equivalents... 394,641 23,731 Cash and cash equivalents at beginning of period.............................. 179,305 101,893 Cash and cash equivalents at end of period................................. $ 573,946 $125,624 ========= ======== Supplemental cash flow information: Interest paid.......................... $ 4,515 $ 4,667 ========= ======== Income taxes paid...................... $ 48,244 $ 8,665 ========= ======== Income tax refunds..................... $ 476 $ 1,184 ========= ========
See accompanying notes. -6- STERLING SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1996 (UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The consolidated financial statements include the accounts of Sterling Software, Inc. and its wholly owned subsidiaries, including but not limited to Sterling Commerce, Inc., (collectively, "Sterling Software", "Sterling" or the "Company") after elimination of all significant intercompany balances and transactions. Certain amounts for periods ended prior to June 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 require management to make estimates and assumptions that affect the reported amounts of assets, liabilities and the disclosure of contingencies at June 30, 1996 and September 30, 1995 and the results of operations for the three and nine months ended June 30, 1996 and 1995, respectively. While management has based its assumptions and estimates on the facts and circumstances known at June 30, 1996, final amounts may differ from such estimates. Revenue Revenue from license fees, including leasing transactions, for standard software products is recognized when the software is delivered, provided no significant future vendor obligations exist and collection is probable. Service revenue and revenue from certain products involving installation or other services are recognized as the services are performed. 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 ratably over the contract period. If software product transactions include the right to receive future products, a portion of the software product revenue is deferred and recognized as products are delivered. Contract accounting is applied for sales of software products requiring significant modification or customization, such that revenue is recognized only when the modification or customization is complete. 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. Revenue from professional services provided to the federal government under multi-year contracts is recognized as the services are performed. Revenue for services under long-term contracts is recognized using the percentage-of- completion method of accounting. Losses on long-term contracts are recognized when the current estimate of total contract costs indicates a loss on a contract is probable. -7- Cash Equivalents, Marketable Securities and Other Investments Cash equivalents consist primarily of highly liquid investments in repurchase agreements backed by U.S. Treasury securities and investment-grade commercial paper of various issuers, with maturities of three months or less when purchased. The carrying amount reported in the consolidated balance sheet for cash and cash equivalents approximates its fair value. The Company invests excess cash in a diversified portfolio consisting of a variety of securities including commercial paper, corporate notes and U.S. government obligations, which may include both investment-grade and non- investment-grade securities. The fair values for marketable securities are based on quoted market prices. All marketable securities and long-term investments are classified as available-for-sale securities. 2. UNAUDITED INTERIM FINANCIAL STATEMENTS The interim consolidated financial information contained herein is unaudited but, in the opinion of management, includes all adjustments, which are of a normal recurring nature, necessary for a fair presentation of the financial position and results of operations for the periods presented. Results of operations for the periods presented herein are not necessarily indicative of results of operations for the entire year. 3. SUBSIDIARY INITIAL PUBLIC OFFERING AND PROPOSED DISTRIBUTION Sterling Commerce, Inc. ("Commerce"), previously a wholly owned subsidiary of Sterling Software, completed its initial public offering (the "Offering") of 13,800,000 shares of common stock, par value $.01 per share ("Commerce Stock"), on March 13, 1996. Pursuant to the Offering, Sterling Software sold to the public 12,000,000 of the 73,200,000 shares of Commerce Stock then owned by it and Commerce sold 1,800,000 previously unissued shares of Commerce Stock. Sterling Software currently owns 61,200,000 shares of Commerce Stock, constituting 81.6% of the total number of outstanding shares of Commerce Stock. The Offering price was $24 per share of Commerce Stock resulting in net proceeds to Sterling Software of approximately $267,458,000 after deducting underwriting discounts and commissions and Sterling Software's pro rata share of Offering expenses. The Offering resulted in net proceeds to Commerce of approximately $40,118,000 after deducting underwriting discounts and commissions and Commerce's pro rata share of Offering expenses. Sterling Software recorded a gain of approximately $127,164,000, net of tax, from the sale of Commerce Stock in the Offering. Sterling Software incorporated Commerce as a wholly owned subsidiary in December 1995. In contemplation of the Offering, among other things, (i) Sterling Software caused to be transferred to or merged into Commerce all of the subsidiaries previously comprising Sterling Software's Electronic Commerce Group, (ii) Sterling Software caused to be transferred to Commerce certain assets relating to the electronic commerce -8- business previously conducted by Sterling Software's international operations and certain assets relating to the electronic commerce business conducted by Sterling Software's Federal Systems business segment, and (iii) Sterling Software entered into contractual arrangements with Commerce related to, among other things, space sharing, tax allocations, international marketing and certain services. In connection with the Offering, Sterling Software accelerated the vesting of substantially all outstanding options granted under Sterling Software's existing stock option plans. Sterling Software received proceeds of approximately $202,543,000 from the exercise of approximately 6,880,000 warrants and employee stock options for the period from January 1, 1996 to June 30, 1996. Proceeds of approximately $15,852,000 were received from the exercise of approximately 389,000 warrants and employee stock options for the period from July 1, 1996 to August 9, 1996. If all remaining outstanding options and warrants to purchase Sterling Software common stock, par value $.10 per share ("Software Stock"), at August 9, 1996 were exercised, approximately 1,176,000 additional shares of Software Stock would be issued and outstanding, resulting in additional proceeds to Sterling Software of approximately $42,519,000. There can be no assurance, however, as to whether or when any of such options or warrants will be exercised. Under the terms of Sterling Software's stock option plans, any outstanding options that are not exercised prior to the effective date of the anticipated Distribution (as defined and discussed more fully below) of Sterling Software's remaining shares of Commerce Stock, will be adjusted to preserve the economic value of such options. Although this adjustment will require approval of the applicable stock option committee, it is anticipated that the adjustment will be made pursuant to a formula that will both increase the number of shares subject to options and decrease the exercise price thereof. The magnitude of the adjustment (i.e., the increase in the number of shares subject to options and the decrease in the exercise price) is not presently determinable because it is expected to be determined based on the market price of the Software Stock prior to and following the Distribution. Further, the Company cannot predict what number of options may remain unexercised at the effective date of the Distribution. Sterling Software presently intends to distribute pro rata to its stockholders as a dividend all of its remaining shares of Commerce Stock by means of a tax-free distribution (the "Distribution"). Sterling Software's Board of Directors has conditioned the Distribution upon, among other things, (i) the approval of both the Distribution and the Company's 1996 Stock Option Plan by Sterling Software's stockholders, and (ii) the declaration by Sterling Software's Board of Directors of a dividend of the shares of Commerce Stock then owned by Sterling Software. At its Annual Meeting of Stockholders held on May 29, 1996, Sterling Software's stockholders approved the Distribution and the Company's 1996 Stock Option Plan. The declaration of the dividend by the Sterling Software Board to effect the Distribution is also conditioned upon the receipt of a favorable ruling from the Internal Revenue Service ("IRS") as to the tax-free nature of the Distribution and the absence of any change in market conditions or other circumstances that would cause the Board of Directors of Sterling Software to conclude that the Distribution is not in the best interests of the stockholders of Sterling Software. Sterling Software has applied to the IRS for a ruling as to the tax-free nature of the Distribution. Sterling Software and its advisors believe the ruling request is fully supported by relevant provisions of federal tax law and are not aware of any impediments to the receipt of a favorable ruling. While Sterling Software does not control the IRS ruling process and cannot assure the timing of the ruling, management continues to believe that the Company will receive a favorable ruling in time to complete the Distribution by September 30, 1996. Sterling Software has not determined what action, if any, it would take if it -9- were not to receive the favorable tax ruling. No assurance can be given that the favorable tax ruling will be obtained or that, in any event, the Distribution will occur, or that, if it does not receive the favorable tax ruling, Sterling Software will not sell its shares of Commerce Stock to reduce its investment in Commerce. In connection with the Distribution, the actual number of shares of Commerce Stock to be distributed with respect to each outstanding share of Software Stock will depend upon the number of shares of Software Stock outstanding on the record date established by the Sterling Software Board (the "Distribution Record Date") and the number of shares of Commerce Stock owned by Sterling Software on such date. The Company has included pro forma financial statements in Part II, Item 5 of this Form 10-Q to illustrate the effects of the proposed Distribution and the redemption and conversion of the Company's 5.75% Convertible Subordinated Debentures. See Note 7. 4. BUSINESS COMBINATION On November 30, 1994, Sterling Software acquired KnowledgeWare, Inc. ("KnowledgeWare"), a Georgia corporation based in Atlanta, Georgia which was a provider of applications development software and services, for approximately $106 million, in a stock-for-stock acquisition (the "Merger"). In connection with the Merger, the Company issued approximately 2,421,000 shares of Software Stock valued at approximately $74,443,000 and reserved approximately 340,000 shares of Software Stock for issuance upon exercise of KnowledgeWare's options and warrants. In addition, the Company incurred cash costs directly related to the Merger of approximately $31,672,000. The Merger, which was accounted for as a purchase, was completed pursuant to the terms of an Amended and Restated Agreement and Plan of Merger dated as of August 31, 1994, as amended (the "Merger Agreement"), among the Company, SSI Corporation, a Georgia corporation and a wholly owned subsidiary of the Company, and KnowledgeWare. The operating results of KnowledgeWare are included in the Company's results of operations from the date of the Merger. In addition, the results of operations for the first quarter of 1995 include $62,000,000 of purchased research and development costs, which is the portion of the purchase price attributed to in-process research and development and which is charged to expense in accordance with purchase accounting. The $62,000,000 charge has no related tax benefit. The results of operations also include a charge for restructure costs of $19,512,000 to integrate KnowledgeWare's business into the Company's operations. 5. COMMITMENTS AND CONTINGENCIES The Company is subject to certain legal proceedings and claims that arise in the ordinary conduct of its business. In the opinion of management, the amount of ultimate liability with respect to these actions, net of applicable reserves, will not materially affect the financial condition or results of operations of the Company. -10- 6. BUSINESS SEGMENT INFORMATION The Company acquires, develops, markets and supports a broad range of computer software products and services in four major markets classified as Electronic Commerce, Systems Management, Federal Systems and Applications Management. The Electronic Commerce business segment provides software and services to facilitate electronic commerce, defined by the Company as the worldwide electronic interchange of business information, including electronic data interchange software and services, data communications software and electronic payments software for financial institutions. The Systems Management business segment provides enterprise-wide systems management software for large computing environments. The Federal Systems business segment provides highly technical services to the federal government under several multi-year contracts primarily in support of National Aeronautics and Space Administration ("NASA") aerospace research projects and secure communications systems for the Department of Defense. The Applications Management business segment focuses exclusively on the applications management market. This business segment provides products for developing new applications and revitalizing existing applications and consulting services to ensure that customers are successful using the applications management products. The Company's international operations are responsible for sales and first level support of substantially all of the Company's products outside the United States and Canada. International operating results are included, as applicable, in the Company's Electronic Commerce, Systems Management and Applications Management business segments in the tables contained herein. International revenue of $42,742,000 and $38,581,000 and international operating profit, exclusive of intercompany royalties, of $19,797,000 and $18,320,000 for the three months ended June 30, 1996 and 1995, respectively, have been allocated to the appropriate business segments. International revenue of $122,718,000 and $105,990,000 and international operating profit, exclusive of intercompany royalties, of $55,664,000 and $52,002,000 for the nine months ended June 30, 1996 and 1995, respectively, have been allocated to these business segments. -11- Financial information concerning the Company's operations, by business segment, for the three and nine months ended June 30, 1996 and 1995, restated to conform to the current year presentation, is summarized as follows (in thousands):
Three Months Nine Months Ended June 30 Ended June 30 ----------------- ------------------ 1996 1995 1996 1995 ------- -------- -------- ------- Revenue: Electronic Commerce.................... $ 74,745 $ 55,836 $201,574 $152,551 Systems Management..................... 42,558 37,821 118,737 108,482 Federal Systems........................ 27,553 25,372 80,630 73,627 Applications Management................ 28,244 29,548 82,931 74,905 Corporate and other.................... 1,218 2,371 3,087 6,008 -------- -------- -------- -------- Consolidated totals.................... $174,318 $150,948 $486,959 $415,573 ======== ======== ======== ======== Operating Profit (Loss): Electronic Commerce.................... $ 22,998 $ 18,548 $ 65,022 $ 47,752 Systems Management..................... 16,389 14,154 43,549 38,750 Federal Systems........................ 2,038 1,953 6,154 5,346 Applications Management................ 6,155 5,284 14,644 14,900 Restructuring charge................... (19,512) Purchased research and development ` (62,000) Corporate and other.................... (7,540) (6,028) (22,361) (16,264) -------- -------- -------- ------- Consolidated totals................... $ 40,040 $ 33,911 $107,008 $ 8,972 ======== ======== ======== =======
The amounts presented for "Corporate and other" include corporate expense, inter-segment eliminations and the results of operations of the Company's retail software division. The Electronic Commerce business segment financial information presented above is not presented on the same basis as the financial information presented in the Commerce Quarterly Report on Form 10-Q for the quarter ended June 30, 1996 primarily due to the allocations to the Electronic Commerce business segment of the results of operations of Sterling Software's international business segment and corporate expense. 7. REDEMPTION AND CONVERSION OF 5.75% CONVERTIBLE SUBORDINATED DEBENTURES On December 20, 1995, the Company gave notice of the redemption of all of the $114,922,000 then outstanding principal amount of its 5.75% Convertible Subordinated Debentures due February 1, 2003 (the "Debentures"). The effective date of the redemption was February 12, 1996 (the "Redemption Date"). The Debentures were convertible into shares of Software Stock. Approximately $114,912,000 principal amount of the Debentures was presented for conversion. In addition, approximately $78,000 principal amount of the Debentures had been converted prior to the announcement of the redemption. Approximately 4,056,000 shares of Software Stock were issued upon conversion of the Debentures. Approximately $10,000 principal amount of Debentures was redeemed for cash on February 12, 1996. If the conversion had taken place at October 1, 1995, supplemental primary earnings per share would have been $5.80 for the nine months ended June 30, 1996. -12- 8. SHARE REPURCHASE PROGRAM On October 2, 1995, the Company renewed a share repurchase program pursuant to which it may repurchase shares of Software Stock from time to time through open market transactions. Through March 31, 1996, approximately 1,336,000 shares of Software Stock were repurchased at an aggregate amount of approximately $59,372,000. No shares were repurchased during the third quarter of 1996. Any further purchases of Software Stock pursuant to this program will be made solely at the Company's discretion and may be discontinued at any time without prior notice. -13- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SUBSIDIARY INITIAL PUBLIC OFFERING AND PROPOSED DISTRIBUTION Commerce, previously a wholly owned subsidiary of Sterling Software, completed the Offering of 13,800,000 shares of Commerce Stock on March 13, 1996. Pursuant to the Offering, Sterling Software sold to the public 12,000,000 of the 73,200,000 shares of Commerce Stock then owned by it and Commerce sold 1,800,000 previously unissued shares of Commerce Stock. Sterling Software currently owns 61,200,000 shares of Commerce Stock, constituting 81.6% of the total number of outstanding shares of Commerce Stock. The Offering price was $24 per share of Commerce Stock resulting in net proceeds to Sterling Software of approximately $267,458,000 after deducting underwriting discounts and commissions and Sterling Software's pro rata share of Offering expenses. The Offering resulted in net proceeds to Commerce of approximately $40,118,000 after deducting underwriting discounts and commissions and Commerce's pro rata share of Offering expenses. Sterling Software recorded a gain of approximately $127,164,000, net of tax, from the sale of Commerce Stock in the Offering. In connection with the Offering, Sterling Software accelerated the vesting of substantially all outstanding options granted under Sterling Software's existing stock option plans. Sterling Software received proceeds of approximately $202,543,000 from the exercise of approximately 6,880,000 warrants and employee stock options for the period from January 1, 1996 to June 30, 1996. Proceeds of approximately $15,852,000 were received from the exercise of approximately 389,000 warrants and employee stock options for the period from July 1, 1996 to August 9, 1996. If all remaining outstanding options and warrants to purchase Software Stock at August 9, 1996 were exercised, approximately 1,176,000 additional shares of Software Stock would be issued and outstanding, resulting in additional proceeds to Sterling Software of approximately $42,519,000. There can be no assurance, however, as to whether or when any of such options or warrants will be exercised. Under the terms of Sterling Software's stock option plans, any outstanding options that are not exercised prior to the effective date of the Distribution of Sterling Software's remaining shares of Commerce Stock will be adjusted to preserve the economic value of such options. Although this adjustment will require approval of the applicable stock option committee, it is anticipated that the adjustment will be made pursuant to a formula that will both increase the number of shares subject to options and decrease the exercise price thereof. The magnitude of the adjustment (i.e., the increase in the number of shares subject to options and the decrease in the exercise price) is not presently determinable because it is expected to be determined based on the market price of the Software Stock prior to and following the Distribution. Further, the Company cannot predict what number of options may remain unexercised at the effective date of the Distribution. The Company has included pro forma financial statements in Part II, Item 5 of this Form 10-Q to illustrate the effects of the proposed Distribution and the redemption and conversion of the Debentures. -14- THREE MONTHS ENDED JUNE 30, 1996 AND 1995 Total revenue increased $23,370,000, or 15%, in the third quarter of 1996 over the same period of 1995. The Electronic Commerce business segment ("EC") revenue increased $18,909,000, or 34%, on the strength of a 40% increase in product revenue, a 19% increase in product support revenue and a 33% increase in network services revenue. The increase in EC products revenue is the result of increased revenue in the communications and interchange software product lines. EC product support revenue increased primarily as a result of an increase in the installed customer base across all three product lines. The increased network services revenue was primarily due to an increase in the network services customer base, primarily in the grocery, telecommunications and retail vertical markets, and increases in the network processing volume for existing customers. The Systems Management business segment ("SM") revenue increased $4,737,000, or 13%. Products revenue increased across all three product lines primarily due to several significant sales in the third quarter of 1996, higher volume and products acquired in the first quarter of 1996. The Applications Management business segment ("AM") revenue decreased $1,304,000, or 4%. The decrease is primarily attributable to revenue declines related to products no longer actively marketed and product marketing rights no longer owned. The Federal Systems business segment ("FS") revenue increased $2,181,000, or 9%, due to higher contract billings in the Information Technology Division offset in part by lower contract billings in the Scientific Systems Division due to the completion of certain contracts at NASA. Revenue from outside the United States and Canada represented approximately 25% of the Company's revenue in the third quarter of 1996 compared to 26% in the third quarter of 1995. Approximately 41% of the Company's total software revenue was derived from platforms other than stand-alone mainframes. This compares to 37% for the same period of 1995. Total costs and expenses increased $17,241,000, or 15%, in the third quarter of 1996 over the same period of 1995. Total cost of sales increased $3,750,000, or 8%, on a 15% increase in revenue, in part due to an increase of $985,000, or 11%, in depreciation and amortization resulting from a corresponding increase in property and equipment purchases and new products and enhancements released from development. In addition, cost of sales, products and product support, increased commensurate with higher levels of products and product support revenue. Cost of sales, services, increased 4% on a 19% increase in services revenue due primarily to the restructuring of the AM business segment in the first quarter of 1996 and to the reduction of the cost of sales, services, in Sterling Software's international operations. Product development and enhancement expense for the third quarter of 1996 was $8,805,000, net of $7,205,000 of capitalized software costs as compared to third quarter of 1995 product development and enhancement expense of $11,661,000, net of $6,323,000 of capitalized software costs. The decrease in gross product development and enhancement expense is primarily due to a reduction of costs in the AM business segment due to the restructuring of that segment in the first quarter of 1996. Development costs capitalized during the third quarter of 1996 and 1995 represented 45% and 35%, respectively, of the gross product development and enhancement expense of the same respective quarters. The higher capitalized rate is due to a greater number of development projects having reached technological feasibility in the third quarter of 1996 compared to the third quarter of 1995. Product development and enhancement 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. Software amortization expense was $5,915,000 and $5,477,000 for the third quarter of 1996 and 1995, respectively. Selling, general and administrative expense -15- increased $16,347,000, or 29%, primarily due to an increase in sales, marketing and customer support activities supporting the revenue growth in EC. Income before other income (expense), gain on the Offering, minority interest and income taxes was $40,040,000 in the third quarter of 1996 as compared to income before other income (expense), gain on the Offering, minority interest and income taxes of $33,911,000 in the third quarter of 1995. Interest expense in the third quarter of 1996 decreased $1,950,000 from the third quarter of 1995 primarily due to the redemption and conversion of the Debentures. Investment income increased $6,758,000 as a result of higher average balances of investments in cash equivalents and marketable securities resulting from the net proceeds from the Offering of approximately $307,576,000 and the proceeds from the exercise of stock options of approximately $93,363,000 during the third quarter of 1996. Income before gain on the Offering, minority interest and income taxes increased $14,344,000, or 41%, primarily due to higher operating profits in EC, up 24%, and SM, up 16%, lower interest expense due to the redemption and conversion of the Debentures, down 89%, and higher investment income, up 261%, on higher average investment balances of cash equivalents and marketable securities. -16- NINE MONTHS ENDED JUNE 30, 1996 AND 1995 Total revenue increased $71,386,000, or 17%, in the first nine months of 1996 over the same period of 1995. Total EC revenue increased $49,023,000, or 32%, in the first nine months of 1996 over the first nine months of 1995. EC products revenue increased $24,690,000, or 42%, related to revenue growth in the communications and interchange software product lines. EC product support revenue increased primarily as a result of an increase in the installed customer base across all three product lines. Network services revenue increased $16,801,000 on the growth in existing customer volume and the addition of new customers to the network primarily in the grocery, telecommunications and retail vertical markets. SM revenue increased $10,255,000, or 9%, primarily due to products and product support revenue increases across the operations management and storage management product lines. This increase was partially offset by a product support revenue decline in the VM product line due to the continuing trend of consolidation and downsizing by customers using the VM operating system. AM revenue grew $8,026,000, or 11%. AM products and product support revenue in the first nine months of 1996 increased $8,478,000, or 13%, over the first nine months of 1995. The increase was partially offset by revenue declines related to products no longer actively marketed and product marketing rights no longer owned. FS revenue increased $7,003,000, or 10%, in the first nine months of 1996 primarily due to higher contract billings in the Information Technology Division offset in part by lower contract billings in the Scientific Systems Division due to the completion of certain contracts at NASA. Revenue in the first nine months of 1996 from outside the United States and Canada grew $16,728,000, or 16%, over the first nine months of 1995. This revenue represented 25% of the Company's total revenue in the first nine months of 1996 as compared to 26% for the same period of 1995. For the nine months ended June 30, 1996, approximately 41% of the Company's total software revenue was derived from platforms other than stand-alone mainframes. This compares to 37% for the same period in 1995. Total costs and expenses decreased $26,650,000 in the first nine months of 1996 compared to the same period of 1995, due in part to a $62,000,000 charge in the first quarter of 1995 for the portion of the purchase price of KnowledgeWare attributed to in-process research and development and to a $19,512,000 charge for restructuring in the first quarter of 1995 resulting from the Merger. Total cost of sales increased $20,328,000, or 15%, in part due to an increase of $3,381,000, or 13%, in depreciation and amortization resulting from a corresponding increase in property and equipment purchases and new products and enhancements released from development. In addition, cost of sales increased commensurate with higher levels of products, product support and services revenue. Product development and enhancement expense for the first nine months of 1996 of $27,139,000 is net of $20,118,000 of capitalized software development costs. This compares to product development and enhancement expense of $32,463,000 for the first nine months of 1995, which is net of $15,795,000 of capitalized costs for the same period. The decrease in gross product development and enhancement expense is primarily due to a reduction of costs in the AM business segment due to the restructuring of that segment in the first quarter of 1996. Development costs capitalized during the first nine months of 1996 and 1995 represented 43% and 33%, respectively, of the gross product development expense incurred in the same respective periods. The higher capitalized rate is due to a greater number of development projects having reached technological feasibility. Software amortization expense was $17,692,000 and $16,973,000 in the first nine months of 1996 and 1995, -17- respectively. Selling, general and administrative expense increased $39,858,000, or 25%, primarily due to an increase in sales, marketing and customer support activities supporting the revenue growth in EC and the international operations. Income before other income (expense), gain on the Offering, minority interest and income taxes was $107,008,000 in the first nine months of 1996 as compared to income before other income (expense), gain on the Offering, minority interest and incomes taxes of $8,972,000 in the first nine months of 1995. Interest expense in the first nine months of 1996 decreased $3,353,000 from the first nine months of 1995 primarily due to the redemption and conversion of the Debentures. Investment income in the first nine months of 1996 increased $11,096,000 over the first nine months of 1995 as a result of higher average balances of cash equivalents and marketable securities resulting from the net proceeds from the Offering of approximately $307,576,000 and the proceeds from the exercise of stock options of approximately $222,541,000. Excluding the $62,000,000 non-recurring charge for purchased research and development and the $19,512,000 non-recurring charge for restructuring in the first nine months of 1995, income before gain on the Offering, minority interest and income taxes increased $30,668,000, or 34%, in part due to higher operating profits in EC, up 36%, and SM, up 12%. In addition, interest expense declined and investment income increased for the reasons noted above. LIQUIDITY AND CAPITAL RESOURCES The Company maintained a strong liquidity and financial position with $706,611,000 of working capital at June 30, 1996, which includes $573,946,000 of cash and cash equivalents and $172,851,000 of marketable securities. Net cash flows from operations was $69,760,000 in the first nine months of 1996 as compared to $75,874,000 in the first nine months of 1995. Days sales outstanding at June 30, 1996 measured on a quarterly basis was 89 versus 93 at March 31, 1996, 107 at December 31, 1995 and 96 at September 30, 1995. Cash flows from operations, proceeds from the Offering and the exercise of stock options, and available cash balances were used to fund operations, purchases of cash equivalents and marketable securities and capital expenditures, including software additions. Sterling Software received net proceeds from the Offering of approximately $267,458,000 after deducting underwriting discounts and commissions and Sterling Software's pro rata share of offering expenses. The Offering resulted in net proceeds to Commerce of approximately $40,118,000 after deducting underwriting discounts and commissions and Commerce's pro rata share of offering expenses. In connection with the Offering, Sterling Software accelerated the vesting of substantially all outstanding options granted under Sterling Software's existing stock option plans. Sterling Software received proceeds of approximately $222,541,000 from the exercise of approximately 7,761,000 warrants and employee stock options for the period from October 1, 1995 to June 30, 1996. Proceeds of approximately $15,852,000 were received from the exercise of approximately 389,000 warrants and employee stock options for the period from July 1, 1996 to August 9, 1996. At August 9, 1996, approximately 1,176,000 additional shares of Software Stock would be issued and outstanding if all remaining outstanding options and warrants were exercised and would -18- result in additional proceeds of approximately $42,519,000. At September 30, 1996, the combined total of cash, cash equivalents and marketable securities is estimated to be approximately $700,000,000 plus the proceeds, if any, from the exercise of the warrants and employee stock options that remain unexercised as of August 9, 1996. This estimate is based on management's assessment of certain future events and circumstances and constitutes a forward-looking statement. As such, this estimate is subject to inherent uncertainties and there can be no assurance that actual results will be consistent with this estimate. See "Forward-Looking Information" below. On December 20, 1995, the Company gave notice of the redemption of all of the $114,922,000 then outstanding principal amount of the Debentures. The effective date of the redemption was February 12, 1996 (the "Redemption Date"). The Debentures were convertible into shares of Software Stock. Approximately $114,912,000 principal amount of the Debentures was presented for conversion. In addition, approximately $78,000 principal amount of the Debentures had been converted prior to the announcement of the redemption. Approximately 4,056,000 shares of Software Stock were issued upon conversion of the Debentures. Approximately $10,000 principal amount of Debentures was redeemed for cash on February 12, 1996. The conversion and redemption of the Debentures will reduce the Company's interest charges by approximately $1,700,000 per quarter. At June 30, 1996, after the utilization of $1,146,000 for standby letters of credit, $33,854,000 was available for borrowing on the Company's $35 million revolving credit and term loan agreement. Certain of the Company's foreign subsidiaries have separate lines of credit available for foreign exchange exposure management and working capital requirements. These lines of credit are guaranteed by Sterling Software. At June 30, 1996, $1,350,000 was outstanding pursuant to foreign lines of credit and $21,350,000 was available for borrowing thereunder. On October 2, 1995, the Company renewed a share repurchase program pursuant to which it may repurchase shares of Software Stock from time to time through open market transactions. Through March 31, 1996, approximately 1,336,000 shares of Software Stock were repurchased at an aggregate amount of approximately $59,372,000. No shares were repurchased during the third quarter of 1996. At June 30, 1996, the Company's capital resource commitments consisted of commitments under lease arrangements for office space and equipment. The Company intends to meet such obligations primarily from existing cash balances and internally generated funds. No significant commitments exist for future capital expenditures. The Company believes available balances of cash, cash equivalents and investments in marketable securities combined with cash flows from operations and amounts available under credit and term loan agreements are sufficient to meet the Company's cash requirements for the foreseeable future. OTHER MATTERS Demand for many of the Company's products tends to increase with increases in the rate of inflation as customers strive to improve employee productivity and reduce costs. However, the effect of inflation on the Company's relatively labor intensive cost structure could adversely affect its results of operations to the extent the Company might not be able to recover increased operating costs through increased prices for products and services. -19- The assets and liabilities of non-U.S. operations are translated into U.S. dollars at exchange rates in effect as of the respective balance sheet dates, and revenue and expense accounts of these operations are translated at average exchange rates during the month the transactions occur. Unrealized translation gains and losses are included as an adjustment to retained earnings. The Company has mitigated a portion of its currency exposure through decentralized sales, marketing and support operations and through international development facilities, in which all costs are local currency based. When necessary, the Company may also enter into hedge transactions in an effort to reduce its exposure to currency exchange risks. The Company maintains a strategy of acquiring businesses and products that fill strategic market niches. This acquisition strategy contributes in part of the Company's growth in revenue and operating profit before restructuring charges. The impact of future acquisitions on continued growth in revenue and operating profit cannot presently be determined. FORWARD-LOOKING INFORMATION This report and other reports and statements filed by the Company from time to time with the Securities and Exchange Commission (collectively, "SEC Filings") contain or may contain certain forward-looking statements and information that are based on information available to the Company's management and various estimates, assumptions and predictions made by the Company's management. When used in SEC Filings, the words "anticipate," "contemplate," "estimate," "expect," "future," "intend," "plan" and similar expressions are intended to identify forward-looking statements. Such statements are subject to inherent uncertainties, including, in addition to any uncertainties specifically identified in the text surrounding such statements, uncertainties with respect to changes or developments in social, economic, business, industry, market, legal and regulatory circumstances and conditions and actions taken or omitted to be taken by third parties, including the Company's stockholders, customers, suppliers, business partners and competitors, and legislative, regulatory, judicial and other governmental authorities and officials. Consequently, actual events, circumstances, consequences, effects and results may vary significantly from those described in or contemplated by such forward-looking statements or information. -20- PART II - OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held its Annual Meeting of Stockholders (the "Meeting") on May 29, 1996, at which the stockholders of the Company voted on and approved the following proposals: 1. A special dividend, if declared by the Board of Directors, consisting of the distribution to the holders of Sterling Software's then outstanding shares of common stock, par value $0.10 per share, on a pro rata basis, of shares of common stock, par value $0.01 per share, of Sterling Software's subsidiary, Sterling Commerce, Inc., and ratification of certain Intercompany Agreements described in the Company's Proxy Statement for the Meeting. 2. Adoption of the Sterling Software, Inc. 1996 Stock Option Plan. 3. The election of three Class C directors of the Company for terms expiring in 1995. The proposals were approved by the following votes:
1. Special Dividend ---------------- FOR AGAINST ABSTENTIONS BROKER NON-VOTES --- ------- ----------- ---------------- 25,438,331 389,365 167,507 4,319,285 2. Adoption of 1996 Stock Option Plan ---------------------------------- FOR AGAINST ABSTENTIONS BROKER NON-VOTES --- ------- ----------- ---------------- 19,602,950 6,219,944 177,309 4,319,285 3. Election of Directors ---------------------------------- NAME FOR WITHHELD ---- --- -------- Sam Wyly 29,025,893 1,288,595 Sterling L. Williams 29,276,998 1,037,490 Donald R. Miller, Jr. 29,026,900 1,287,588
-21- ITEM 5. OTHER INFORMATION PRO FORMA FINANCIAL DATA The following unaudited financial data illustrate the effects on Sterling Software of the Distribution and the conversion and redemption of the Debentures (as such terms are defined in Notes 3 and 7 of the Notes to Consolidated Financial Statements included in Part I of this report). The pro forma balance sheet is based on the June 30, 1996 balance sheet of Sterling Software and assumes the Distribution was consummated on that date. The pro forma statements of operations data are based on the statements of operations data of Sterling Software for the nine months ended June 30, 1996 and 1995 and assumes that the Distribution and the conversion and redemption of the Debentures were consummated at the beginning of the fiscal periods presented. The pro forma financial data of Sterling Software do not purport to represent what the financial position or results of operations of Sterling Software would have been if the transactions had in fact been consummated on such date or at the beginning of the periods indicated or to project the financial position or results of operations for any future date or period. The pro forma adjustments are estimates based upon currently available information and upon certain assumptions that Sterling Software's management believes are reasonable in the circumstances. Actual results may vary from these estimates. -22- STERLING SOFTWARE, INC. PRO FORMA CONSOLIDATED BALANCE SHEETS JUNE 30, 1996 (IN THOUSANDS)
PRO FORMA HISTORICAL ADJUSTMENTS STERLING STERLING FOR THE SOFTWARE AS SOFTWARE AT DISTRIBUTION ADJUSTED AT JUNE 30, 1996 OF COMMERCE(1) JUNE 30, 1996 ------------- -------------- ------------- Current assets: Cash and cash equivalents.............. $ 573,946 $ (21,706) $552,240 Marketable securities.................. 172,851 (21,428) 151,423 Accounts and notes receivable, net..... 170,740 (57,059) 113,681 Prepaid expenses and other current assets................................ 20,860 (18,808) 2,052 ---------- --------- -------- Total current assets.................. 938,397 (119,001) 819,396 Property and equipment, net............. 75,204 (38,315) 36,889 Computer software, net.................. 89,952 (33,415) 56,537 Excess cost over net assets acquired, net.................................... 80,971 (9,939) 71,032 Other assets............................ 13,700 (6,868) 6,832 ---------- --------- -------- Total assets $1,198,224 $(207,538) $990,686 ========== ========= ======== Current liabilities..................... $ 231,786 $ (63,672) $168,114 Long-term debt.......................... 1,093 1,093 Deferred income taxes................... 7,880 (21,191) (13,311) Other noncurrent liabilities............ 32,308 (6,893) 25,415 Minority interest....................... 21,300 (21,300) Stockholders' equity:(2) Common stock........................... 3,835 3,835 Additional paid in capital............. 748,491 (32,736) 715,755 Retained earnings...................... 211,019 (61,746) 149,273 Less: treasury stock.................. (59,488) (59,488) ---------- --------- -------- Total stockholders' equity............ 903,857 (94,482) 809,375 ---------- --------- -------- Total liabilities & stockholders' equity.............................. $1,198,224 $(207,538) $990,686 ========== ========= ========
See accompanying notes. -23- NOTES TO PRO FORMA CONSOLIDATED BALANCE SHEET (1) Adjusted to give effect to the proposed Distribution. (2) In connection with the Offering (as defined in Note 3 to Notes to Consolidated Financial Statements included in Part I of this report), Sterling Software accelerated the vesting of substantially all outstanding options granted under Sterling Software's existing stock option plans. Sterling Software received proceeds of approximately $202,543,000 from the exercise of 6,880,000 warrants and employee stock options for the period from January 1, 1996 to June 30, 1996. Proceeds of approximately $15,852,000 were received from the exercise of approximately 389,000 warrants and employee stock options for the period from July 1, 1996 to August 9, 1996. If all remaining options and warrants to purchase Software Stock at August 9, 1996 were exercised, approximately 1,176,000 additional shares of Software Stock would be issued and outstanding, resulting in additional proceeds to the Company of approximately $42,519,000. The impact of the potential exercise of Sterling Software's remaining options and warrants has not been reflected in the accompanying Pro Forma Consolidated Balance Sheet. -24- STERLING SOFTWARE, INC. PRO FORMA STATEMENTS OF OPERATIONS NINE MONTHS ENDED JUNE 30, 1996 (IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
PRO FORMA HISTORICAL ADJUSTMENTS FOR PRO FORMA STERLING STERLING THE DEBENTURE ADJUSTMENTS FOR SOFTWARE AS SOFTWARE AT REDEMPTION AND THE DISTRIBUTION ADJUSTED AT JUNE 30, 1996 CONVERSION OF COMMERCE(2) JUNE 30, 1996 ------------- --------------- ---------------- ------------- Revenue: Products............................... $191,137 $ (60,206) $130,931 Product support........................ 134,066 (41,354) 92,712 Services............................... 161,756 (72,271) 89,485 Royalties from affiliated companies.... (13,620) 13,620 (4) -------- ------ --------- -------- Total revenue......................... 486,959 (173,831) 313,128 Cost and expenses: Cost of sales: Products and product support.......... 59,315 (22,040) 50,895 13,620 (4) Services.............................. 96,256 (16,907) 79,349 -------- ------ --------- -------- 155,571 (25,327) 130,244 Product development and enhancement.... 27,139 (11,252) 15,887 Selling, general and administrative.... 197,241 (70,844) 128,147 1,750 (3) -------- ------ --------- -------- Total costs and expenses.............. 379,951 (105,673) 274,278 -------- ------ --------- -------- Income from operations................. 107,008 (68,158) 38,850 Interest expense....................... (3,036) 2,581 (1) 110 (345) Investment income...................... 16,815 (797) 16,018 Other.................................. 471 375 846 -------- ------ --------- -------- 14,250 2,581 (312) 16,519 -------- ------ --------- -------- Income before gain on subsidiary public offering, minority interest and income taxes.................................. 121,258 2,581 (68,470) 55,369 Gain on subsidiary public offering..... 239,936 (239,936) (5) Minority interest...................... (3,871) 3,871 (5) -------- ------ --------- -------- Income before income taxes.............. 357,323 2,581 (304,535) 55,369 Provision for income taxes 154,604 877 (27,047) 15,662 (112,772) (5) -------- ------ --------- -------- Income from continuing operations....... $202,719 $1,704 $(164,716) $ 39,707 ======== ====== ========= ======== Pro forma income from continuing operations per share................... $ 5.80 $ 1.13 ======== ========
-25- STERLING SOFTWARE, INC. PRO FORMA STATEMENTS OF OPERATIONS NINE MONTHS ENDED JUNE 30, 1995 (IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
PRO FORMA HISTORICAL ADJUSTMENTS FOR PRO FORMA STERLING STERLING THE DEBENTURE ADJUSTMENTS FOR SOFTWARE AS SOFTWARE AT REDEMPTION AND THE DISTRIBUTION ADJUSTED AT JUNE 30, 1995 CONVERSION OF COMMERCE(2) JUNE 30, 1995 ------------- --------------- ---------------- ------------- Revenue: Products............................... $160,957 $ (44,616) $116,341 Product support........................ 115,550 (33,705) 81,845 Services............................... 139,066 (56,747) 82,319 Royalties from affiliated companies.... (7,940) 7,940 (4) -------- --------- -------- Total revenue......................... 415,573 (135,068) 280,505 Cost and expenses: Cost of sales: Products and product support.......... 48,696 (16,548) 40,088 7,940 (4) Services.............................. 86,547 (12,925) 73,622 -------- ------ --------- -------- 135,243 (21,533) 113,710 Product development and enhancement.... 32,463 (11,337) 21,126 Selling, general and administrative.... 157,383 (53,122) 106,886 2,625 (3) Restructuring charges.................. 19,512 19,512 Purchased research and development..... 62,000 62,000 -------- ------ --------- -------- Total costs and expenses.............. 406,601 (83,367) 323,234 -------- ------ --------- -------- Income (loss) from operations.......... 8,972 (51,701) (42,729) Interest expense....................... (6,389) 4,959 (1) 38 (1,392) Investment income...................... 5,719 (16) 5,703 Other income........................... 776 321 1,097 -------- ------ --------- -------- 106 4,959 343 5,408 -------- ------ --------- -------- Income (loss) before income taxes....... 9,078 4,959 (51,358) (37,321) Provision (benefit) for income taxes.... 28,284 1,984 (20,543) 9,725 -------- ------ --------- -------- Income (loss) from continuing operations $(19,206) $2,975 $ (30,815) $(47,046) ======== ====== ========= ======== Pro forma income (loss) from continuing operations per share................... $ (.84) $ (1.74) ======== ========
-26- NOTES TO PRO FORMA STATEMENTS OF OPERATIONS (1) Adjusted to give effect to the interest savings associated with the conversion of the outstanding Debentures into Software Stock. (2) Adjusted to give effect to the Distribution. (3) Administrative charges incurred by Sterling Software allocated to Commerce were approximately $1,750,000 and $2,625,000 in the nine months ended June 30, 1996 and 1995, respectively. No administrative charges were allocated to Commerce in the third quarter of 1996 as these costs were incurred by Commerce during this period. The historical adjustment reflects the addition of those costs to Sterling Software as if Commerce had been historically distributed to stockholders. (4) As owner of software products distributed by Sterling Software's international operations, Commerce includes royalties received from Sterling Software as revenue. Such revenues are eliminated in the pro forma adjustment and are an expense to Sterling Software. (5) This adjustment is to reflect the reclassification of the gain on the Offering and minority interest to discontinued operations, which is expected to occur if the Distribution occurs. -27- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed as part of this Quarterly Report on Form 10-Q : 2(a) - Amended and Restated Agreement and Plan of Merger dated as of August 31, 1994, among the Company, KnowledgeWare, Inc. and SSI Corporation ("KWI Agreement and Plan of Merger") (1) 2(b) - Agreement dated October 11, 1994 among the Company, KnowledgeWare, Inc. and SSI Corporation (1) 2(c) - First Amendment to KWI Agreement and Plan of Merger (1) 3(a) - Certificate of Incorporation of the Company (2) 3(b) - Certificate of Amendment of Certificate of Incorporation of the Company (3) 3(c) - Certificate of Amendment of Certificate of Incorporation of the Company (4) 3(d) - Certificate of Amendment of Certificate of Incorporation of the Company (5) 3(e) - Restated Bylaws of the Company (6) 4(a) - Indenture dated February 2, 1993 between the Company and Bank of America Texas, National Association, as Trustee, including the form of 5.75% Convertible Subordinated Debenture attached as Exhibit A thereto (7) 4(b) - Warrant Agreement dated June 9, 1994 between KnowledgeWare, Inc. and Trust Company Bank (8) 4(c) - Supplemental Warrant Agreement dated as of November 30, 1994 between KnowledgeWare, Inc. and Trust Company Bank (8) 10(a) - Form of Amendment to Change in Control Severance Agreement dated as of June 18, 1996, between the Company and each of its executive officers (9) 11(a) - Computation of Earnings Per Share, Three Months Ended June 30, 1996 (9) 11(b) - Computation of Earnings Per Share, Three Months Ended June 30, 1995 (9) 11(c) - Computation of Earnings Per Share, Nine Months Ended June 30, 1996 (9) 27 - Financial Data Schedule (9) ------------------- (1) Previously filed as an exhibit to the Company's Registration Statement No. 33-56185 on Form S-4 and incorporated herein by reference. -28- (2) Previously filed as an exhibit to the Company's Registration Statement No. 2-82506 on Form S-1 and incorporated herein by reference. (3) Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1993 and incorporated herein by reference. (4) Previously filed as an exhibit to the Company's Registration Statement No. 33-69926 on Form S-8 and incorporated herein by reference. (5) Previously filed as an exhibit to the Company's Quarterly Report on Form 10- Q for the quarter ended March 31, 1995 and incorporated herein by reference. (6) Previously filed as an exhibit to the Company's Registration Statement No. 33-47131 on Form S-8 and incorporated herein by reference. (7) Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1995 and incorporated herein by reference. (8) Previously filed as an exhibit to the Company's Registration Statement No. 33-56679 on Form S-3 and incorporated herein by reference. (9) Filed herewith. (b) Reports on Form 8-K. During the three months ended June 30, 1996, the Company filed a Current Report on Form 8-K dated May 29, 1996 reporting information under Item 5. -29- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. STERLING SOFTWARE, INC. Date: August 13, 1996 /s/ Sterling L. Williams ------------------------------- Sterling L. Williams President, Chief Executive Officer and Director (Principal Executive Officer) Date: August 13, 1996 /s/ Jeannette P. Meier --------------------------------- Jeannette P. Meier Executive Vice President, Chief Financial Officer and General Counsel (Principal Financial and Accounting Officer) -30- EXHIBIT INDEX ------------- EXHIBIT NO. DESCRIPTION - ------- -------------------------------------------- 2(a) - Amended and Restated Agreement and Plan of Merger dated as of August 31, 1994, among the Company, KnowledgeWare, Inc. and SSI Corporation ("KWI Agreement and Plan of Merger") (1) 2(b) - Agreement dated October 11, 1994 among the Company, KnowledgeWare, Inc. and SSI Corporation (1) 2(c) - First Amendment to KWI Agreement and Plan of Merger (1) 3(a) - Certificate of Incorporation of the Company (2) 3(b) - Certificate of Amendment of Certificate of Incorporation of the Company (3) 3(c) - Certificate of Amendment of Certificate of Incorporation of the Company (4) 3(d) - Certificate of Amendment of Certificate of Incorporation of the Company (5) 3(e) - Restated Bylaws of the Company (6) 4(a) - Indenture dated February 2, 1993 between the Company and Bank of America Texas, National Association, as Trustee, including the form of 5.75% Convertible Subordinated Debenture attached as Exhibit A thereto (7) 4(b) - Warrant Agreement dated June 9, 1994 between KnowledgeWare, Inc. and Trust Company Bank (8) 4(c) - Supplemental Warrant Agreement dated as of November 30, 1994 between KnowledgeWare, Inc. and Trust Company Bank (8) 10(a) - Form of Amendment to Change in Control Severance Agreement dated as of June 18, 1996, between the Company and each of its executive officers (9) 11(a) - Computation of Earnings Per Share, Three Months Ended June 30, 1996 (9) -31- 11(b) - Computation of Earnings Per Share, Three Months Ended June 30, 1995 (9) 11(c) - Computation of Earnings Per Share, Nine Months Ended June 30, 1996 (9) 27 - Financial Data Schedule (9) - --------- (1) Previously filed as an exhibit to the Company's Registration Statement No. 33-56185 on Form S-4 and incorporated herein by reference. (2) Previously filed as an exhibit to the Company's Registration Statement No. 2-82506 on Form S-1 and incorporated herein by reference. (3) Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1993 and incorporated herein by reference. (4) Previously filed as an exhibit to the Company's Registration Statement No. 33-69926 on Form S-8 and incorporated herein by reference. (5) Previously filed as an exhibit to the Company's Quarterly Report on Form 10- Q for the quarter ended March 31, 1995 and incorporated herein by reference. (6) Previously filed as an exhibit to the Company's Registration Statement No. 33-47131 on Form S-8 and incorporated herein by reference. (7) Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1995 and incorporated herein by reference. (8) Previously filed as an exhibit to the Company's Registration Statement No. 33-56679 on Form S-3 and incorporated herein by reference. (9) Filed herewith. -32- EX-10.A 2 CHANGE IN CONTROL SEVERANCE AGREEMENT EXHIBIT 10(a) FORM OF AMENDMENT TO CHANGE IN CONTROL SEVERANCE AGREEMENT THIS AMENDMENT TO CHANGE IN CONTROL SEVERANCE AGREEMENT (this "Amendment"), dated as of June __, 1996, by and between Sterling Software, Inc., a Delaware corporation (the "Company"), and ______________________________ (the "Executive"). WITNESSETH: WHEREAS, the Company and the Executive are parties to a Change in Control Severance Agreement, dated as of February 12, 1996 (the "Agreement"); and WHEREAS, the Company and the Executive desire to amend the Agreement as set forth in this Amendment; NOW, THEREFORE, the Company and the Executive agree as follows: 1. Amendment: The last paragraph of Section 1(b) of the Agreement is --------- hereby amended in its entirety to read as follows: "Notwithstanding the foregoing provisions of Sections 1(b)(iii) or 1(b)(iv), unless otherwise determined in a specific case by majority vote of the Board, a "Change in Control" shall not be deemed to have occurred for purposes of Section 1(b)(iii) or 1(b)(iv) solely because (A) the Company, (B) an entity in which the Company directly or indirectly beneficially owns 50% or more of the outstanding Voting Stock (a "Subsidiary"), or (C) any Company-sponsored employee stock ownership plan or any other employee benefit plan of the Company or any Subsidiary either files or becomes obligated to file a report or a proxy statement under or in response to Schedule 13D, Schedule 14D-1, Form 8-K or Schedule 14A (or any successor schedule, form or report or item therein) under the Exchange Act disclosing beneficial ownership by it of shares of Voting Stock of the Company, whether in excess of 20% or otherwise, or because the Company reports that a change in control of the Company has occurred or will occur in the future by reason of such beneficial ownership or any increase or decrease thereof." Section 14 of the Agreement is hereby amended in its entirety to read as follows: "14. Termination of Prior Agreements. Upon the effectiveness of this ------------------------------- Agreement pursuant to Section 1(f) of this Agreement, the Employment Agreement between Executive and Sterling Software, dated _______________, as amended to the date hereof (the "Employment Agreement") shall terminate automatically and shall thereafter be of no further force or effect; provided, however, that if this Agreement is held wholly invalid, unenforceable or otherwise illegal, the preceding clause shall have no effect and the Employment Agreement shall be deemed to have continued at all times in force and effect. Subject to the foregoing proviso, this Agreement, upon its effectiveness pursuant to such Section 1(f), supersedes all prior agreements, arrangements and understandings with respect to the subject matter hereof." 2. Defined Terms: Terms used in this Amendment with initial capital ------------- letters are used herein as defined in the Agreement. 3. References to and Continuation of Agreement: (a) On and after the ------------------------------------------- date hereof, each reference in the Agreement to "this Agreement," "hereunder," "hereof," "herein" or words of like import referring to the Agreement will be a reference to the Agreement as amended by this Amendment. (b) Except as specifically amended by this Amendment, the Agreement will remain in full force and effect and is hereby ratified and confirmed. 4. Governing Law: The validity, interpretation, construction and ------------- performance of this Amendment will be governed by and construed in accordance with the substantive laws of the State of Delaware, without giving effect to the principles of conflict of laws of such State. 5. Counterparts: This Amendment may be executed in one or more ------------ counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same agreement. IN WITNESS WHEREOF, the parties have caused this Amendment to be duly executed and delivered as of the date first above written. STERLING SOFTWARE, INC. By__________________________ [Name and Title] __________________________ [Executive] EX-11.A 3 THREE MONTH COMPUTATION 1996 EXHIBIT 11(A) COMPUTATION OF EARNINGS PER SHARE, THREE MONTHS ENDED JUNE 30, 1996 STERLING SOFTWARE, INC. EXHIBIT 11(A) COMPUTATION OF EARNINGS PER SHARE THREE MONTHS ENDED JUNE 30, 1996 (IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
FULLY PRIMARY DILUTED ------- ------- Earnings: Earnings applicable to common stockholders....................... $29,394 $29,394 ======= ======= Shares: Weighted average of shares outstanding.. 35,758 35,758 Add common shares issued on assumed exercise of options and warrants...... 2,771 2,775 Less common shares assumed repurchased.. (1,565) (1,560) ------- ------- 36,964 36,973 ======= ======= Earnings per common share: Primary................................ $ .80 Fully diluted.......................... ======= $ .80 =======
EX-11.B 4 THREE MONTH COMPUTATION 1995 EXHIBIT 11(B) COMPUTATION OF EARNINGS PER SHARE, THREE MONTHS ENDED JUNE 30, 1995 EXHIBIT 11(B) STERLING SOFTWARE, INC. COMPUTATION OF EARNINGS PER SHARE THREE MONTHS ENDED JUNE 30, 1995 (IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
FULLY PRIMARY DILUTED ------- ------- Earnings: Earnings applicable to common stockholders............................. $22,240 $22,240 Add: Interest expense on amounts outstanding for the 5-3/4% Convertible Subordinated Debentures (net of applicable income taxes).................... 391 1,053 Interest income on investment of proceeds from assumed conversion of options and warrants (net of applicable income taxes)......... 377 ------- ------- $22,631 $23,670 ======= ======= Shares: Weighted average of shares outstanding... 24,118 24,118 Add common shares issued on assumed exercise of options and warrants...... 9,379 9,379 Less common shares assumed repurchased... (4,952) (4,952) ------- ------- 28,545 28,545 ======= ======= Common shares issued on assumed conversion of 5-3/4% Convertible Subordinated Debentures.................. 4,056 ------- 32,601 ======= Earnings per common share: Primary................................ $ .79 Fully diluted.......................... ======= $ .73 =======
EX-11.C 5 NINE MONTH COMPUTATION 1996 EXHIBIT 11(C) COMPUTATION OF EARNINGS PER SHARE, NINE MONTHS ENDED JUNE 30, 1996 STERLING SOFTWARE, INC. EXHIBIT 11(C) COMPUTATION OF EARNINGS PER SHARE NINE MONTHS ENDED JUNE 30, 1996 (IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
FULLY PRIMARY DILUTED ------- ------- Earnings: Earnings applicable to common stockholders.......................... $202,719 $202,719 Add: Interest expense on amounts outstanding for the 5-3/4% Convertible Subordinated Debentures (net of applicable income taxes)...... 1,685 -------- -------- $202,719 $204,404 ======== ======== Shares: Weighted average of shares outstanding. 30,598 30,598 Add common shares issued on assumed exercise of options and warrants.... 6,191 6,222 Less common shares assumed repurchased. (4,308) (3,565) -------- -------- 32,481 ======== Common shares issued on assumed conversion of 5-3/4% Convertible Subordinated Debentures.............. 1,998 -------- 35,253 ======== Earnings per common share: Primary................................ $ 6.24 Fully diluted.......................... ======== $ 5.80 ========
EX-27 6 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS SEP-30-1996 OCT-01-1995 JUN-30-1996 573,946 172,851 170,740 0 0 938,397 143,510 68,306 1,198,224 231,786 0 0 0 3,835 900,022 1,198,224 486,959 486,959 155,571 379,951 0 0 3,036 357,323 154,604 202,719 0 0 0 202,719 6.24 5.80
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