-----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, FETUFivBf/Y/xCaxAvq7t/UAaSKBZ9c7mmPPr1jLwrXMVzqgBt8yNjJo0ooG9lsB wHkyDNhsiGtV7hQDzs0pzA== 0000930661-99-001757.txt : 19990805 0000930661-99-001757.hdr.sgml : 19990805 ACCESSION NUMBER: 0000930661-99-001757 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990804 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: SEC FILE NUMBER: 001-08465 FILM NUMBER: 99677725 BUSINESS ADDRESS: STREET 1: 300 CRESCENT COURT STREET 2: SUITE 1200 CITY: DALLAS STATE: TX ZIP: 75201 BUSINESS PHONE: 2149811000 MAIL ADDRESS: STREET 1: 300 CRESCENT COURT STREET 2: SUITE 1200 CITY: DALLAS STATE: TX ZIP: 75201 10-Q 1 FORM 10-Q 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, 1999 or ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission File 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) 300 Crescent Court, Suite 1200 Dallas, Texas 75201 (Address of principal executive offices, including zip code) Registrant's telephone number, including area code: (214) 981-1000 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 July 30, 1999 ----------------------------- -------------------------------------- Common Stock, $0.10 par value 84,246,875 -1- PART I - FINANCIAL INFORMATION Page ---- Item 1. Financial Statements.............................................. 3 Sterling Software, Inc. Consolidated Balance Sheets at June 30, 1999 and September 30, 1998.................................... 3 Sterling Software, Inc. Consolidated Statements of Operations for the Three and Nine Months Ended June 30, 1999 and 1998.............. 4 Sterling Software, Inc. Consolidated Statement of Stockholders' Equity for the Nine Months Ended June 30, 1999.......................... 5 Sterling Software, Inc. Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 1999 and 1998........................ 6 Sterling Software, Inc. Notes to Consolidated Financial Statements......... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......................................... 17 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K ................................. 27 -2- STERLING SOFTWARE, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share information) A S S E T S
June 30 September 30 1999 1998 ------------- ------------ (unaudited) Current assets: Cash and cash equivalents................................................... $ 425,895 $ 397,312 Marketable securities....................................................... 221,607 310,537 Accounts and notes receivable, net.......................................... 229,763 200,428 Prepaid expenses and other current assets................................... 31,158 32,253 ---------- ---------- Total current assets...................................................... 908,423 940,530 Property and equipment, net of accumulated depreciation of $60,112 at June 30, 1999 and $49,832 at September 30, 1998............................. 76,929 66,726 Computer software, net of accumulated amortization of $121,274 at June 30, 1999 and $112,734 at September 30, 1998............................ 124,145 81,606 Excess cost over net assets of businesses acquired, net of accumulated amortization of $35,079 at June 30, 1999 and $27,316 at September 30, 1998.. 125,580 76.086 Other assets................................................................. 19,887 24,040 ---------- ---------- $1,254,964 $1,188,988 ========== ========== 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: Accounts payable and accrued liabilities.................................... $ 166,656 $ 164,349 Deferred revenue............................................................ 92,125 102,880 ---------- ---------- Total current liabilities................................................. 258,781 267,229 Noncurrent deferred revenue.................................................. 39,288 27,649 Other noncurrent liabilities................................................. 31,311 32,552 Commitments and contingencies Stockholders' equity: Preferred stock, $.10 par value; 10,000,000 shares authorized, no shares issued or outstanding...................................................... Common stock, $.10 par value; 250,000,000 and 125,000,000 shares authorized at June 30, 1999 and September 30, 1998, respectively; 86,371,000 and 84,845,000 shares issued at June 30, 1999 and September 30, 1998, respectively........................................... 8,637 8,485 Additional paid-in capital.................................................. 882,274 858,615 Retained earnings........................................................... 89,078 50,462 Less treasury stock, at cost; 2,525,000 and 2,599,000 shares at June 30, 1999 and September 30, 1998, respectively......................... (54,405) (56,004) ---------- ---------- Total stockholders' equity................................................ 925,584 861,558 ---------- ---------- $1,254,964 $1,188,988 ========== ==========
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 ----------------------------- ----------------------------- 1999 1998 1999 1998 --------- --------- --------- --------- Revenue: Products................................. $ 99,238 $ 71,266 $246,419 $206,167 Product support.......................... 52,163 46,425 154,553 137,991 Services................................. 58,364 63,100 175,638 183,096 --------- --------- --------- --------- 209,765 180,791 576,610 527,254 Costs and expenses: Cost of sales: Products and product support............ 21,034 17,007 58,803 52,070 Services................................ 52,565 54,708 156,449 159,329 --------- --------- --------- --------- 73,599 71,715 215,252 211,399 Product development and enhancement...... 9,250 8,090 28,129 28,108 Selling, general and administrative...... 74,618 66,407 204,067 203,404 Reorganization costs..................... 14,098 33,753 Purchased research and development....... 22,468 32,091 --------- --------- --------- --------- 194,033 146,212 513,292 442,911 --------- --------- --------- --------- Income before other income (expense) and income taxes............................. 15,732 34,579 63,318 84,343 Other income (expense): Interest expense......................... (43) (90) (302) (195) Investment income........................ 7,929 8,652 25,140 25,263 Other.................................... 406 (517) 1,054 (1,082) --------- --------- --------- --------- 8,292 8,045 25,892 23,986 --------- --------- --------- --------- Income before income taxes................ 24,024 42,624 89,210 108,329 Provision for income taxes................ 14,713 15,413 40,533 39,880 --------- --------- --------- --------- Net income................................ $ 9,311 $ 27,211 $ 48,677 $ 68,449 ========= ========= ========= ========= Income per common share: Net income: Basic................................... $.11 $.34 $.59 $.85 ========= ========= ========= ========= Diluted................................. $.11 $.32 $.55 $.81 ========= ========= ========= =========
See accompanying notes. -4- STERLING SOFTWARE, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY Nine Months Ended June 30, 1999 (in thousands) (unaudited)
Common Stock Treasury Stock ------------------ ----------------- Number Additional Number Total of Par Paid-in Retained of Stockholders' Shares Value Capital Earnings Shares Cost Equity ------- ------ --------- -------- -------- -------- ------------ Balance at September 30, 1998.. 84,845 $8,485 $858,615 $ 50,462 2,599 $(56,004) $861,558 Net income.................... 48,677 48,677 Issuance of common stock pursuant to stock options.... 1,228 122 16,849 16,971 Issuance of common stock to 401(k) plan.................. 30 (74) 1,599 1,629 Issuance of common stock pursuant to employee stock purchase plan................ 298 30 6,780 6,810 Other......................... (10,061) (10,061) ------- ------ --------- -------- ------- -------- ------------ Balance at June 30, 1999....... 86,371 $8,637 $882,274 $ 89,078 2,525 $(54,405) $925,584 ======= ====== ========= ======== ======= ======== ============
See accompanying notes. -5- STERLING SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)
Nine Months Ended June 30 ------------------------------ 1999 1998 --------- --------- Operating activities: Net income.................................................................. $ 48,677 $ 68,449 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization............................................. 40,333 33,287 Provision for losses on accounts receivable............................... 2,360 2,810 Provision for deferred income taxes....................................... 11,681 27,762 Reorganization costs...................................................... 16,737 Purchased research and development........................................ 32,091 Changes in operating assets and liabilities, net of effects of business acquisitions: Increase in accounts and notes receivable.............................. (17,176) (9,136) Decrease (increase) in prepaid expenses and other assets............... 4,679 (1,791) Decrease in accounts payable and accrued liabilities................... (64,999) (41,819) Decrease in deferred revenue........................................... (18,662) (6,844) Other.................................................................. 4,979 13,346 --------- --------- Net cash provided by operating activities............................. 60,700 86,064 Investing activities: Purchases of property and equipment......................................... (23,127) (22,796) Purchases and capitalized cost of development of computer software.......... (24,292) (20,268) Business acquisitions, net of cash acquired................................. (89,992) (3,626) Purchases of investments.................................................... (287,109) (189,944) Proceeds from sales of investments.......................................... 375,223 145,720 Other....................................................................... (78) 1,798 --------- --------- Net cash used in investing activities................................. (49,375) (89,116) Financing activities: Proceeds from issuance of common stock pursuant to exercise of stock options.................................................................... 16,971 15,339 Proceeds from issuance of common stock pursuant to employee stock purchase plan....................................................................... 6,810 Other....................................................................... (3,278) (3,574) --------- --------- Net cash provided by financing activities............................. 20,503 11,765 Effect of foreign currency exchange rate changes on cash..................... (3,245) (2,181) --------- --------- Increase in cash and cash equivalents........................................ 28,583 6,532 Cash and cash equivalents at beginning of period............................. 397,312 436,955 --------- --------- Cash and cash equivalents at end of period................................... $ 425,895 $ 443,487 ========= ========= Supplemental cash flow information: Income taxes paid, net of refunds received.................................. $ 18,528 $ 2,563 ========= =========
See accompanying notes. -6- STERLING SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 1999 (unaudited) 1. Summary of Significant Accounting Policies The Company Sterling Software, Inc. ("Sterling Software" or the "Company") was founded in 1981 and became a publicly owned corporation in 1983. Sterling Software is a worldwide developer and supplier of application development, information management and systems management software products and services, as well as a supplier of specialized information technology ("IT") services for sectors of the federal government. Basis of Presentation The consolidated financial statements include the accounts of Sterling Software after elimination of all significant intercompany balances and transactions. The financial statements have been prepared in conformity with generally accepted accounting principles which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies at June 30, 1999 and September 30, 1998 and the results of operations for the three and nine months ended June 30, 1999 and 1998. While management has based its estimates and assumptions on the facts and circumstances known to it as of the date of this report, actual amounts may differ from such estimates and assumptions. Revenue Revenue from license fees for software products is recognized when persuasive evidence of a sale arrangement exists, delivery has occurred, the fee is fixed or determinable and collectibility is probable. Services revenue and revenue from products involving installation or other services are recognized as the services are performed. If software product sale transactions include multiple elements, each element of the software sale is separately identified and accounted for based on the relative fair value of such element. Revenue is not recognized on any element of the sale arrangement if undelivered elements are essential to the functionality of the delivered elements. Product support contracts allow customers to receive updated versions of Sterling Software's products when and if they become available, as well as bug fixing, and Internet and telephone access to the Company's technical personnel. 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. -7- When products, product support and services are billed prior to the time the related revenue is recognized, deferred revenue is recorded and any material related costs paid in advance are deferred. Revenue from specialized IT services provided to the federal government under multi-year contracts is recognized as the services are performed. Revenue for services provided under other 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. Returns and allowances and other similar adjustments to revenue involving software products historically have not been material to the Company's results of operations. Cash and Equivalents Cash equivalents consist primarily of highly liquid investments in investment-grade commercial paper of various issuers and repurchase agreements backed by U.S. Treasury securities, with maturities of three months or less when purchased. Cash equivalents are recorded at fair value. Marketable Securities and Other Investments The Company currently invests excess cash in a diversified portfolio of marketable securities consisting of a variety of investment-grade securities, including commercial paper, medium-term notes, U.S. government obligations, municipal obligations and certificates of deposit. 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. 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, if any, on available-for-sale securities are included in investment income. -8- Earnings Per Common Share The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):
Three Months Ended Nine Months Ended June 30 June 30 --------------------------- -------------------------- 1999 1998 1999 1998 --------- --------- --------- --------- Basic: Net income...................................... $ 9,311 $27,211 $48,677 $68,449 ========= ========= ========= ========= Weighted average common shares outstanding .................................. 83,536 80,650 83,087 80,150 ========= ========= ========= ========= Net income per common share..................... $ .11 $ .34 $ .59 $ .85 ========= ========= ========= ========= Diluted: Net income...................................... $ 9,311 $27,211 $48,677 $68,449 ========= ========= ========= ========= Weighted average common shares outstanding .................................. 83,536 80,650 83,087 80,150 Effect of dilutive employee stock options....... 4,200 5,712 4,703 4,695 --------- --------- --------- --------- Adjusted weighted average common shares......... 87,736 86,362 87,790 84,845 ========= ========= ========= ========= Net income per common share..................... $ .11 $ .32 $ .55 $ .81 ========= ========= ========= =========
Recent Developments Effective October 1, 1998, the Company adopted Statement of Position 97-2, "Software Revenue Recognition," as amended by Statement of Position 98-4, "Deferral of the Effective Date of Certain Provisions of SOP 97-2" ("SOP 97-2"). SOP 97-2 requires each element of a software sale arrangement to be separately identified and accounted for based on the relative fair value of such element. Revenue cannot be recognized on any element of the sale arrangement if undelivered elements are essential to the functionality of the delivered elements. Adoption of SOP 97-2 did not significantly affect the Company's results of operations for the three and nine months ended June 30, 1999, nor is it expected to have a significant impact on results for the remainder of the year as the Company's revenue recognition policies have historically been substantially in compliance with the practices required by SOP 97-2. On December 15, 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants released Statement of Position 98-9, "Modification of SOP 97-2, 'Software Revenue Recognition,' with Respect to Certain Transactions" ("SOP 98-9"). SOP 98-9 amends SOP 97-2 to require that an entity recognize revenue for multiple element software product sale arrangements by means of the "residual method" when (1) there is vendor- specific objective evidence ("VSOE") of the fair values of all of the undelivered elements that are not accounted for by means of long-term contract accounting, (2) VSOE of fair value does not exist for one or more of the delivered elements, and (3) all revenue recognition criteria of SOP 97-2 (other than the requirement for VSOE of the fair value of each delivered element) are satisfied. -9- The provisions of SOP 98-9 that extend the deferral of certain passages of SOP 97-2 became effective December 15, 1998. All other provisions of SOP 98-9 will be effective for the Company's fiscal year beginning October 1, 1999. Retroactive application is prohibited. The adoption of SOP 98-9 is not expected to have a material impact on the financial position or results of operations of the Company. Effective October 1, 1998, the Company adopted Statement of Financial Accounting Standards 130, "Reporting Comprehensive Income" ("FAS 130"). FAS 130 requires the presentation of comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. The Company's comprehensive income consists of net income, foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities; however, the adoption of FAS 130 had no impact on the Company's net income for the three and nine months ended June 30, 1999 and 1998. Information concerning the Company's comprehensive income for the three and nine months ended June 30, 1999 and 1998, respectively, is set forth below (in thousands):
Three Months Nine Months Ended June 30 Ended June 30 --------------------------- ---------------------------- 1999 1998 1999 1998 -------- --------- --------- -------- Net income................................. $ 9,311 $27,211 $48,677 $68,449 Foreign currency translation adjustments... (5,373) 31 (9,473) (7,493) Unrealized gains (losses) on available-for-sale securities, net of taxes..................................... 257 (23) (588) 36 -------- -------- -------- -------- Comprehensive income....................... $ 4,195 $27,219 $38,616 $60,992 ======== ======== ======== ========
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 and are necessary for a fair presentation of the financial position and results of operations for the periods presented. Certain amounts for periods ended prior to June 30, 1999 have been reclassified to conform to the current period presentation. Results of operations for the periods presented herein are not necessarily indicative of results of operations for the entire fiscal year. The information included in this report should be read in conjunction with the information presented under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1998. -10- 3. Business Acquisitions and Reorganizations Acquisition of Spectra Logic's Alexandria Business and Interlink Computer Sciences, Inc. On April 15, 1999, Sterling Software acquired the distributed systems storage software business (the "Alexandria Business") of Spectra Logic Corporation in a cash asset acquisition transaction valued at approximately $33,000,000. On April 30, 1999, Sterling Software acquired Interlink Computer Sciences, Inc. ("Interlink"), a global supplier of high-performance solutions for enterprise systems networking, in a two-step cash tender offer/merger transaction valued at approximately $63,907,000, net of proceeds from outstanding Interlink stock options and warrants. The total cost of both acquisitions was approximately $115,128,000, including costs directly related to the acquisitions of approximately $18,221,000, consisting of employee termination costs, transaction costs, costs associated with the elimination of duplicate facilities and other direct costs. At June 30, 1999, of the $18,221,000 of direct costs, the remaining balance to be paid was $10,128,000. Both acquisitions were accounted for in accordance with the purchase method of accounting and, accordingly, the results of operations of the Alexandria Business and Interlink were included in the Company's results of operations from the respective dates of the acquisitions as part of the Company's systems management business segment. Results of operations for the third quarter of 1999 and the first nine months of 1999 include $22,468,000 of purchased research and development costs, which is the portion of the purchase price from both acquisitions attributed to in-process research and development, and which was charged to expense in accordance with the purchase method of accounting. The components of the aggregate cost of the Alexandria and Interlink acquisitions were as follows (in thousands): Cash transaction consideration................................ $ 96,907 Interlink and Alexandria employee severance and benefits...... 11,364 Elimination of duplicate facilities and leases................ 2,725 Transaction costs............................................. 3,445 Other costs................................................... 687 -------- $115,128 ======== The aggregate cost of the Alexandria and Interlink acquisitions was allocated to the respective assets and liabilities acquired and to purchased research and development, with the remainder recorded as excess cost over net assets acquired, based on estimates of fair values (in thousands): Working capital............................................... $ 15,266 Property and equipment........................................ 1,037 Developed software and core technology........................ 37,244 Purchased research and development costs charged to expense... 22,468 Other assets and liabilities (net)............................ 735 Excess cost over net assets acquired.......................... 38,378 -------- $115,128 ======== -11- The estimates of fair value were determined by the Company's management based on information furnished by management of Spectra Logic Corporation and Interlink and a preliminary independent valuation of developed software, core technology and purchased research and development. Amounts allocated to purchased research and development were expensed at the time of the acquisitions as the Company determined that the purchased research and development had not reached technological feasibility based on the status of design and development activities that required further refinement and testing. The Company is using the purchased research and development to create new products that are expected to become part of the products offered by the systems management business segment. The Company expects that products developed from the purchased research and development will generally be released during the remainder of 1999 and 2000. The development activities required to complete the purchased research and development technologies include additional coding, cross-platform porting and validation, quality assurance procedures and beta testing. The Company's management expects that the purchased research and development will be successfully developed; however, there can be no assurance that commercial viability or timely release of these products will be achieved. Acquisition of Cayenne Software, Inc. On October 26, 1998, Sterling Software acquired Cayenne Software, Inc. ("Cayenne"), a global supplier of analysis and design solutions for application and database development, in an $11,400,000 cash-for-stock merger transaction (the "Cayenne Acquisition"). The total cost of the Cayenne Acquisition was approximately $33,184,000, including costs directly related to the acquisition of approximately $21,784,000, consisting of employee termination costs, transaction costs, costs associated with the elimination of duplicate facilities and other direct costs. At June 30, 1999, of the $21,784,000 of direct costs, the remaining balance to be paid was $8,533,000. The Cayenne Acquisition was accounted for in accordance with the purchase method of accounting and, accordingly, the results of operations of Cayenne were included in the Company's results of operations from the date of the acquisition as part of the Company's application management business segment. Results of operations for the first nine months of 1999 include $9,623,000 of purchased research and development costs, which is the portion of the purchase price attributed to in-process research and development, and which was charged to expense in accordance with the purchase method of accounting. The components of the aggregate cost of the Cayenne Acquisition were as follows (in thousands): Cash merger consideration..................................... $11,400 Cayenne employee severance and benefits....................... 11,912 Elimination of duplicate facilities and leases................ 5,510 Transaction costs............................................. 2,773 Other costs................................................... 1,589 ------- $33,184 ======= -12- The aggregate cost of the Cayenne Acquisition was allocated to the assets and liabilities acquired and to purchased research and development, with the remainder recorded as excess cost over net assets acquired, based on estimates of fair values (in thousands): Working capital (deficit)...................................... $(3,921) Property and equipment......................................... 383 Developed software and core technology......................... 11,434 Purchased research and development costs charged to expense.... 9,623 Other assets and liabilities (net)............................. (89) Excess cost over net assets acquired........................... 15,754 ------- $33,184 ======= The estimates of fair value were determined by the Company's management based on information furnished by management of Cayenne and an independent valuation of developed software, core technology and purchased research and development. Amounts allocated to purchased research and development were expensed at the time of the Cayenne Acquisition as the Company determined that the purchased research and development had not reached technological feasibility based on the status of design and development activities that required further refinement and testing. The Company is using the purchased research and development to create new products that are expected to become part of the products offered by the application management business segment. Products developed from the purchased research and development are generally being released during calendar 1999. The Company's management expects that the purchased research and development will be successfully developed; however, there can be no assurance that commercial viability or timely release of these products will be achieved. Methodology for Valuing Purchased Research and Development The value of the purchased research and development attributable to each acquisition was determined by discounting the estimated projected net cash flows related to the applicable products, including costs to complete the development of the technology and the future revenues to be earned upon release of the products. The projected net cash flows from such products were based on estimates of revenues and operating profits related to such products. Acquisition of Synon Corporation On July 31, 1998, Sterling Software acquired Synon Corporation ("Synon"), a provider of application development software and services, in a stock-for-stock merger transaction (the "Synon Merger") accounted for as a pooling of interests, valued at approximately $79,000,000. As a result of the transaction, Sterling Software issued approximately 2,603,000 shares of the Company's common stock, par value $.10 per share ("Common Stock"), in exchange for the previously outstanding shares of Synon capital stock and reserved approximately 375,000 shares of Common Stock for issuance upon exercise of assumed Synon stock options. The Company's financial statements for periods prior to the Synon Merger, including the results of the application management business segment, have been restated to represent the combined financial statements of the previously separate entities. -13- Reorganization Costs The Company's results of operations for the third quarter of 1999 and the first nine months of 1999 include reorganization costs of $14,098,000 related to the reorganization of the Company's operations in connection with the Alexandria and Interlink acquisitions. Of the total reorganization costs, approximately $8,730,000 consisted of non-cash costs and the remaining $5,368,000 required cash outlays. At June 30, 1999, the remaining balance to be paid was $4,818.000. The Company does not expect to incur costs related to this reorganization in excess of the amounts charged to operations in the third quarter of 1999. The components of the reorganization costs associated with the Alexandria and Interlink acquisitions were as follows (in thousands): Employee termination costs..........................................$ 1,760 Write-down of software products that will not be actively marketed.. 8,488 Elimination of duplicate facilities, equipment and other assets..... 885 Out of pocket costs related to the reorganization................... 2,965 ------- $14,098 ======= The Company's results of operations for the first nine months of 1999 also include reorganization costs of $19,655,000 related to the reorganization of the Company's operations in connection with the Cayenne Acquisition. Of the total reorganization costs, approximately $8,007,000 consisted of non-cash costs and the remaining $11,648,000 required cash outlays. At June 30, 1999, the remaining balance to be paid was $3,379,000, which consisted primarily of commitments under lease arrangements for office space and equipment. The Company does not expect to incur costs related to this reorganization in excess of the amounts charged to operations in the first quarter of 1999. The Company's results of operations for the year ended September 30, 1998 include reorganization costs of $45,162,000 primarily related to the reorganization of the Company's operations in the fourth quarter of 1998 in connection with the Synon Merger. Of the total reorganization costs, approximately $9,552,000 consisted of non-cash costs and the remaining $35,610,000 required cash outlays. At June 30, 1999, the remaining balance to be paid was $6,754,000, which consisted primarily of commitments under lease arrangements for office space and equipment. The Company does not expect to incur costs related to this reorganization in excess of the amounts charged to operations in the fourth quarter of 1998. 4. Legal Proceedings and Claims The Company is subject to various legal proceedings and claims that arise in the normal course of its business. While many of these matters involve inherent uncertainty, the Company's management believes that the amount of the liability, if any, ultimately incurred by Sterling Software with respect to any such existing proceedings and claims, net of applicable reserves and available insurance, will not materially affect the business, financial condition or results of operations of the Company. -14- 5. Segment Information Sterling Software is a worldwide developer and supplier of application development, information management and systems management software products and services, as well as a supplier of specialized IT services for sectors of the federal government. The Company addresses these major markets through three business segments. The application management business segment provides solutions for both enterprise-scale application development and information management. Application development solutions include products and services for business modeling through code generation. Information management solutions include products and services that enable customers to facilitate enterprise information access and to extend the life and usefulness of legacy applications. The systems management business segment provides solutions that enable customers to simplify the use of multiple computing environments and to increase the productivity of information systems, ultimately ensuring that the systems meet the business needs of the organization. The federal systems business segment provides specialized IT services for sectors of the federal government, as well as state and local governments. Financial information concerning the Company's operations, by business segment, for the three and nine months ended June 30, 1999 and 1998, is summarized as follows (in thousands):
Three Months Nine Months Ended June 30 Ended June 30 --------------------------------------------------------------------- 1999 1998 1999 1998 --------- --------- --------- ---------- Revenue: Application Management.................... $ 93,106 $ 93,649 $273,821 $277,539 Systems Management........................ 76,120 49,983 184,640 142,358 Federal Systems........................... 40,539 37,159 118,149 106,729 Corporate and other....................... 628 --------- --------- --------- --------- Consolidated totals..................... $209,765 $180,791 $576,610 $527,254 ========= ========= ========= ========= Operating Profit (Loss): Application Management.................... $ 27,514 $ 20,418 $ 75,842 $ 48,818 Systems Management........................ 29,479 19,524 68,288 52,042 Federal Systems........................... 3,136 2,412 9,044 7,119 Reorganization costs...................... (14,098) (33,753) Purchased research and development........ (22,468) (32,091) Corporate and other....................... (7,831) (7,775) (24,012) (23,636) --------- --------- --------- --------- Consolidated totals...................... $ 15,732 $ 34,579 $ 63,318 $ 84,343 ========= ========= ========= =========
6. Subsequent Events On July 15, 1999, Sterling Software entered into a definitive merger agreement to acquire Information Advantage, Inc. ("Information Advantage"), a provider of web-based and enterprise business intelligence software, in a two- step cash tender offer/merger transaction. The transaction is valued at approximately $165,000,000 and is expected to close during the second half of August 1999. On July 26, 1999, Sterling Software acquired CoreData, Inc., ("CoreData"), a developer and supplier of backup software for remote and mobile PCs in a cash merger transaction valued at approximately $14,000,000. -15- Both acquisitions will be accounted for in accordance with the purchase method of accounting and, accordingly, the results of operations of CoreData and Information Advantage will be included in the Company's results of operations from the respective dates of the acquisitions. -16- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Business Combinations and Reorganizations Acquisition of Spectra Logic's Alexandria Business and Interlink Computer Sciences, Inc. On April 15, 1999, Sterling Software acquired the distributed systems storage software business (the "Alexandria Business") of Spectra Logic Corporation in a cash asset acquisition transaction valued at approximately $33,000,000. On April 30, 1999, Sterling Software acquired Interlink Computer Sciences, Inc. ("Interlink"), a global supplier of high-performance solutions for enterprise systems networking, in a two-step cash tender offer/merger transaction valued at approximately $63,907,000, net of proceeds from outstanding Interlink stock options and warrants. The total cost of both acquisitions was approximately $115,128,000, including costs directly related to the acquisitions of approximately $18,221,000, consisting of employee termination costs, transaction costs, costs associated with the elimination of duplicate facilities and other direct costs. At June 30, 1999, of the $18,221,000 of direct costs, the remaining balance to be paid was $10,128,000. Both acquisitions were accounted for in accordance with the purchase method of accounting and, accordingly, the results of operations of the Alexandria Business and Interlink were included in the Company's results of operations from the respective dates of the acquisitions as part of the Company's systems management business segment. Results of operations for the third quarter of 1999 and the first nine months of 1999 include $22,468,000 of purchased research and development costs, which is the portion of the purchase price from both acquisitions attributed to in-process research and development, and which was charged to expense in accordance with the purchase method of accounting. Acquisition of Cayenne Software, Inc. On October 26, 1998, Sterling Software acquired Cayenne Software, Inc. ("Cayenne"), a global supplier of analysis and design solutions for application and database development, in an $11,400,000 cash-for-stock merger transaction (the "Cayenne Acquisition"). The total cost of the Cayenne Acquisition was approximately $33,184,000, including costs directly related to the acquisition of approximately $21,784,000, consisting of employee termination costs, transaction costs, costs associated with the elimination of duplicate facilities and other direct costs. At June 30, 1999, of the $21,784,000 of direct costs, the remaining balance to be paid was $8,533,000. The Cayenne Acquisition was accounted for in accordance with the purchase method of accounting and, accordingly, the results of operations of Cayenne were included in the Company's results of operations from the date of the acquisition as part of the Company's application management business segment. Results of operations for the first nine months of 1999 include $9,623,000 of purchased research and development costs, which is the portion of the purchase price attributed to in-process research and development, and which was charged to expense in accordance with the purchase method of accounting. -17- Acquisition of Synon Corporation On July 31, 1998, Sterling Software acquired Synon Corporation ("Synon"), a provider of application development software and services, in a stock-for-stock merger transaction (the "Synon Merger") accounted for as a pooling of interests, valued at approximately $79,000,000. As a result of the transaction, Sterling Software issued approximately 2,603,000 shares of the Company's common stock, par value $.10 per share ("Common Stock"), in exchange for the previously outstanding shares of Synon capital stock and reserved approximately 375,000 shares of Common Stock for issuance upon exercise of assumed Synon stock options. The Company's financial statements for periods prior to the Synon Merger, including the results of the application management business segment, have been restated to represent the combined financial statements of the previously separate entities. Reorganization Costs The Company's results of operations for the third quarter of 1999 and the first nine months of 1999 include reorganization costs of $14,098,000 related to the reorganization of the Company's operations in connection with the Alexandria and Interlink acquisitions. Of the total reorganization costs, approximately $8,730,000 consisted of non-cash costs and the remaining $5,368,000 required cash outlays. At June 30, 1999, the remaining balance to be paid was $4,818,000. The Company does not expect to incur costs related to this reorganization in excess of the amounts charged to operations in the third quarter of 1999. The Company's results of operations for the first nine months of 1999 also include reorganization costs of $19,655,000 related to the reorganization of the Company's operations in connection with the Cayenne Acquisition. Of the total reorganization costs, approximately $8,007,000 consisted of non-cash costs and the remaining $11,648,000 required cash outlays. At June 30, 1999, the remaining balance was $3,379,000, which consisted primarily of commitments under lease arrangements for office space and equipment. The Company does not expect to incur costs related to this reorganization in excess of the amounts charged to operations in the first quarter of 1999. The Company's results of operations for the year ended September 30, 1998 include reorganization costs of $45,162,000 primarily related to the reorganization of the Company's operations in the fourth quarter of 1998 in connection with the Synon Merger. Of the total reorganization costs, approximately $9,552,000 consisted of non-cash costs and the remaining $35,610,000 required cash outlays. At June 30, 1999, the remaining balance to be paid was $6,754,000, which consisted primarily of commitments under lease arrangements for office space and equipment. The Company does not expect to incur costs related to this reorganization in excess of the amounts charged to operations in the fourth quarter of 1998. -18- Results of Operations Three Months Ended June 30, 1999 and 1998 Total revenue increased $28,974,000, or 16%, in the third quarter of 1999 over the same period of 1998 due to revenue increases in the Company's systems management and federal systems business segments. Revenue from the systems management and federal systems business segments increased by 52% and 9%, respectively, in the third quarter of 1999 over the same period in 1998. Revenue increases in the systems management and federal systems business segments were partially offset by a 1% decline in total revenue from the application management business segment for the same period. Without the effect of the Synon restatement, total application management revenue would have increased 25% and total revenue would have increased 30% in the third quarter of 1999 over the same period of 1998. Revenue generated from the Company's international operations was $79,972,000 and $70,125,000 in the third quarter of 1999 and 1998, respectively, representing an increase of $9,847,000, or 14%. This was due to a 53% quarter over quarter increase in international revenue generated by the systems management business segment, partially offset by a 6% quarter over quarter decline in international revenue generated by the application management business segment. Revenue from the Company's international operations represented 38% and 39% of total revenue in the third quarter of 1999 and 1998, respectively. Without the effect of the Synon restatement, revenue from the Company's international operations would have increased 32% in the third quarter of 1999 over the same period of 1998. The Company's recurring revenue includes revenue from product support agreements generally having terms ranging from one to three years and federal contracts generally having terms ranging from one to five years. Like most federal contracts, Sterling Software's federal contracts permit termination by the government for convenience or for failure to obtain funding. Recurring revenue decreased to 44% of total revenue in the third quarter of 1999 compared to 45% in the same period of 1998. Revenue from the application management business segment decreased $543,000 in the third quarter of 1999 compared to the same period of 1998 due to a 35% decline in services revenue, partially offset by a 16% increase in products revenue and an 8% increase in product support revenue. Without the effect of the Synon restatement, total application management revenue would have increased 25% in the third quarter of 1999 over the same period of 1998 with 30%, 33% and 3% increases in products, product support and services revenue, respectively. The reported decline in services revenue is due primarily to the Company's execution of its strategy of transitioning application development consulting services opportunities to partners and third-party consulting firms in order to focus the Company's efforts primarily on software product sales. Additionally, the Company believes that the execution of this strategy has enabled it to enhance its relationships with third party service providers, namely systems integrators and independent software vendors, who are also buyers of its application development tools. Approximately 47% of the application management business segment's total revenue in the third -19- quarter of 1999 was derived from the Company's international operations, compared to 49% in the same period of 1998. Revenue from the systems management business segment increased $26,137,000, or 52%, in the third quarter of 1999 over the same period of 1998 primarily due to a 67% increase in products revenue and a 20% increase in product support revenue. The increase in products revenue was mainly attributable to strong product sales in the storage management and network management product lines, including revenue added as a result of the Company's acquisitions of the Alexandria Business and Interlink. Approximately 48% of the systems management business segment's total revenue was derived from the Company's international operations in both the third quarters of 1999 and 1998. Revenue from the federal systems business segment increased $3,380,000, or 9%, in the third quarter of 1999 over the same period of 1998 primarily due to higher contract billings in the segment's defense business as well as revenue added as a result of the Company's acquisition of Mystech Associates, Inc. in the fourth quarter of 1998 (the "Mystech Merger"). Total costs and expenses increased $47,821,000, or 33%, in the third quarter of 1999 over the same period of 1998. However, excluding the Alexandria- and Interlink-related reorganization costs of $14,098,000 and the write-off of Alexandria- and Interlink-related purchased research and development costs of $22,468,000 in the third quarter of 1999, total costs and expenses increased $11,255,000, or 8%. A 10% decrease in total costs in the application management business segment was offset by increases in total costs in the systems management and federal systems business segments of 53% and 8%, respectively. The decrease in total costs in the application management business segment is primarily a result of the Company's lower cost structure in that business segment, compared to the cost structure of the former Synon operation. The increase in total costs in the systems management and federal systems business segments is consistent with the revenue growth generated in these segments. Total cost of sales increased $1,884,000, or 3%, in the third quarter of 1999 compared to the same period of 1998, and represented 35% and 40% of total revenue in the third quarter of 1999 and 1998, respectively. Cost of sales for products and product support represented 14% of products and product support revenue in both the third quarters of 1999 and 1998. Cost of sales for services represented 90% of services revenue in the third quarter of 1999 compared to 87% for the same period in 1998. Product development expense for the third quarter of 1999 grew 14% to $9,250,000, as compared to product development expense in the third quarter of 1998 of $8,090,000. Gross product development expense, before capitalization of software, was 11% of non-federal revenue in the third quarter of 1999 compared with 10% for the same period of 1998. In the third quarter of 1999, the Company capitalized $9,811,000 of development costs, a 51% capitalization rate, and amortized $7,181,000 of software. This compares to $6,869,000 of capitalized development costs, or a 46% capitalization rate, and $5,455,000 of software amortization in the third quarter of 1998. Product development expenses and the capitalization rate historically have fluctuated, and may in the future continue to fluctuate, from period to period depending in part upon the number and status of software development projects that are in process. -20- Selling, general and administrative expenses increased $8,211,000, or 12%, in the third quarter of 1999 compared to the same period of 1998, primarily due to an increase in selling, general and administrative expenses in the systems management business segment, partially offset by a decrease in selling, general and administrative expenses in the application management business segment. The decrease in selling, general and administrative expenses in the application management business segment is primarily a result of the Company's lower cost structure in that business segment, compared to the cost structure of the former Synon operation. The increase in selling, general and administrative expenses in the systems management business segment is consistent with the revenue growth generated in this segment. Selling, general and administrative expenses represented 36% and 37% of total revenue in the third quarter of 1999 and 1998, respectively. Income before income taxes in the third quarter of 1999 was $24,024,000 compared to $42,624,000 for the same period of 1998. However, excluding the Alexandria- and Interlink-related reorganization costs of $14,098,000 and the write-off of Alexandria- and Interlink-related purchased research and development costs of $22,468,000 in the third quarter of 1999, income before income taxes was $60,590,000, representing an increase of $17,966,000, or 42%, primarily due to higher profits in all three of the Company's business segments. The Company's effective tax rate for the third quarter of 1999 was 61% compared to 36% for the same period of 1998. The effective tax rate for the third quarter of 1999 was adversely impacted by the write-off of purchased research and development costs related to the Interlink acquisition and certain acquisition and reorganization costs related to the Alexandria and Interlink acquisitions. Neither of these items will provide a tax benefit to the Company. Before the net tax benefit related to the Alexandria- and Interlink-related reorganization costs and the write-off of purchased research and development costs, the Company's effective tax rate for the third quarter of 1999 was 34%. The effective tax rate for the third quarter of 1998 was adversely impacted by unbenefited losses incurred by Synon prior to the Synon Merger. Nine Months Ended June 30, 1999 and 1998 Total revenue increased $49,356,000, or 9%, in the first nine months of 1999 over the same period of 1998 due to revenue increases in the Company's systems management and federal systems business segments. Revenue from the systems management and federal systems business segments increased by 30% and 11%, respectively, in the first nine months of 1999 over the same period in 1998. Revenue increases in the systems management and federal systems business segments were partially offset by a 1% decline in total revenue from the application management business segment for the same period. Without the effect of the Synon restatement, total application management revenue would have increased 24% and total revenue would have increased 23% in the first nine months of 1999 over the same period of 1998. Revenue generated from the Company's international operations was $223,665,000 and $209,264,000 in the nine months ended June 30, 1999 and 1998, respectively, representing an increase of $14,401,000, or 7%. This was due to a 28% period over period increase in international revenue generated by the systems management business segment, partially offset by -21- a 3% period over period decline in international revenue generated by the application management business segment. Revenue from the Company's international operations represented 39% and 40% of total revenue in the first nine months of 1999 and 1998, respectively. Without the effect of the Synon restatement, revenue from the Company's international operations would have increased 25% in the first nine months of 1999 over the same period of 1998. The Company's recurring revenue includes revenue from product support agreements generally having terms ranging from one to three years and federal contracts generally having terms ranging from one to five years. Like most federal contracts, Sterling Software's federal contracts permit termination by the government for convenience or for failure to obtain funding. Recurring revenue increased to 47% of total revenue in the first nine months of 1999 compared to 46% in the same period of 1998. Revenue from the application management business segment declined $3,718,000, or 1%, in the first nine months of 1999 compared to the same period of 1998 due to a 27% decline in services revenue, partially offset by a 5% increase in products revenue and a 13% increase in product support revenue. Without the effect of the Synon restatement, total application management revenue would have increased 24% in the nine months ended June 30, 1999 over the same period of 1998 with 23%, 40% and 7% increases in products, product support and services revenue, respectively. The reported decline in services revenue is due primarily to the Company's execution of its strategy of transitioning application development consulting services opportunities to partners and third- party consulting firms in order to focus the Company's efforts primarily on software product sales. Additionally, the Company believes that the execution of this strategy has enabled it to enhance its relationships with third party service providers, namely systems integrators and independent software vendors, who are also buyers of its application development tools. Approximately 50% of the application management business segment's total revenue in the first nine months of 1999 was derived from the Company's international operations, compared to 51% in the same period of 1998. Revenue from the systems management business segment increased $42,282,000, or 30%, in the nine months ended June 30, 1999 over the same period of 1998, primarily due to a 39% increase in products revenue and a 10% increase in product support revenue. The increase in products revenue was mainly attributable to higher product sales in the storage management and network management product lines, including revenue added as a result of the Company's acquisitions of the Alexandria Business and Interlink. Approximately 47% of the systems management business segment's total revenue in the first nine months of 1999 was derived from the Company's international operations, compared to 48% in the same period of 1998. Revenue from the federal systems business segment increased $11,420,000, or 11%, in the first nine months of 1999 over the same period of 1998 primarily due to higher contract billings in the segment's defense business as well as revenue added as a result of the Mystech Merger. -22- Total costs and expenses increased $70,381,000, or 16%, in the first nine months of 1999 over the same period of 1998. However, excluding the Alexandria- and Interlink-related reorganization costs of $14,098,000 and the write-off of Alexandria- and Interlink-related purchased research and development costs of $22,468,000 in the third quarter of 1999, and the Cayenne-related reorganization costs of $19,655,000 and the write-off of Cayenne-related purchased research and development costs of $9,623,000 in the first quarter of 1999, total costs and expenses increased $4,537,000, or 1%. A 13% decrease in total costs in the application management business segment was offset by increases in total costs in the systems management and federal systems business segments of 29% and 10%, respectively. The decrease in total costs in the application management business segment is primarily a result of the Company's lower cost structure in that business segment, compared to the cost structure of the former Synon operation. The increase in total costs in the systems management and federal systems business segments is consistent with the revenue growth generated in these segments. Total cost of sales increased $3,853,000, or 2%, in the first nine months of 1999 compared to the same period of 1998, and represented 37% and 40% of total revenue in the first nine months of 1999 and 1998, respectively. Cost of sales for products and product support represented 15% of products and product support revenue in both the first nine months of 1999 and 1998. Cost of sales for services represented 89% of services revenue in the first nine months of 1999 compared to 87% for the same period in 1998. Product development expense for the first nine months of 1999 remained constant at $28,129,000 as compared to product development expense in the first nine months of 1998 of $28,108,000. Gross product development expense, before capitalization of software, was 11% of non-federal revenue in both the nine months ended June 30, 1999 and 1998. In the first nine months of 1999, the Company capitalized $23,903,000 of development costs, a 46% capitalization rate, and amortized $18,609,000 of software. This compares to $20,026,000 of capitalized development costs, or a 42% capitalization rate, and $15,559,000 of software amortization in the first nine months of 1998. Product development expenses and the capitalization rate historically have fluctuated, and may in the future continue to fluctuate, from period to period depending in part upon the number and status of software development projects that are in process. Selling, general and administrative expenses increased $663,000 in the nine months ended June 30, 1999 compared to the same period of 1998, primarily due to an increase in selling, general and administrative expenses in the systems management business segment offset by decreased selling, general and administrative expenses in the application management business segment. The decrease in selling, general and administrative expenses in the application management business segment is primarily a result of the Company's lower cost structure in that business segment, compared to the cost structure of the former Synon operation. The increase in selling, general and administrative expenses in the systems management business segment is consistent with the revenue growth generated in this segment. Selling, general and administrative expenses represented 35% and 39% of total revenue in the first nine months of 1999 and 1998, respectively. -23- Income before income taxes in the first nine months of 1999 was $89,210,000 compared to $108,329,000 for the same period of 1998. However, excluding the Alexandria- and Interlink-related reorganization costs of $14,098,000 and the write-off of Alexandria- and Interlink-related purchased research and development costs of $22,468,000 in the third quarter of 1999, and Cayenne- related reorganization costs of $19,655,000 and the write-off of Cayenne-related purchased research and development costs of $9,623,000 in the first quarter of 1999, income before income taxes was $155,054,000, representing an increase of $46,725,000, or 43%, primarily due to higher profits in all three of the Company's business segments. The Company's effective tax rate for the first nine months of 1999 was 45% compared to 37% for the same period of 1998. The effective tax rate for the first nine months of 1999 was adversely impacted by the write-off of purchased research and development costs related to the Cayenne and Interlink acquisitions and certain acquisition and reorganization costs related to the Cayenne, Alexandria and Interlink acquisitions. None of these items will provide a tax benefit to the Company. Before the net tax benefit related to the Cayenne-, Alexandria- and Interlink-related reorganization costs and the write-off of purchased research and development costs, the Company's effective tax rate for the first nine months of 1999 was 34%. The effective tax rate for the first nine months of 1998 was adversely impacted by unbenefited losses incurred by Synon prior to the Synon Merger. Liquidity and Capital Resources The Company maintained a strong liquidity and financial position with $649,642,000 of working capital at June 30, 1999, which included $425,895,000 of cash and cash equivalents and $221,607,000 of marketable securities. Net cash provided by operating activities was $60,700,000 in the first nine months of 1999 as compared to $86,064,000 in the first nine months of 1998. Net cash provided by operating activities in the first nine months of 1999 was reduced by payments made during the period of approximately $52,806,000 related to the Company's acquisitions and related reorganizations that have occurred in the preceding twelve months. Net cash provided by operating activities in the first nine months of 1998 was reduced by payments of approximately $25,227,000 related to the acquisition of substantially all of the assets of the Software Division of Texas Instruments Incorporated and the related reorganizations that occurred in the third quarter of 1997. Investing activities used $49,375,000 of cash in the first nine months of 1999 as compared to $89,116,000 in the first nine months of 1998. Capital expenditures in the first nine months of 1999 were $23,127,000 compared to $22,796,000 in the first nine months of 1998. Purchases and capitalized costs of computer software were $24,292,000 and $20,268,000 in the first nine months of 1999 and 1998, respectively. Cash provided by operating activities, together with other available cash, was used to fund capital expenditures and additions to computer software, as well as the Cayenne, Alexandria and Interlink acquisitions. -24- Financing activities provided $20,503,000 of cash in the first nine months of 1999 compared to $11,765,000 in the first nine months of 1998. The Company received proceeds of approximately $16,971,000 and $15,339,000 from the exercise of employee stock options in the first nine months of 1999 and 1998, respectively. Also, the Company received proceeds of $6,810,000 in the first nine months of 1999 from the issuance of Common Stock pursuant to the Company's employee stock purchase plan. The Company is party to a bank credit agreement (the "Credit Agreement") which provides for unsecured revolving credit loans of up to $35,000,000. Borrowings under the Credit Agreement, which expires on June 30, 2000, bear interest at the lower of the lender's base rate or a Eurodollar lending rate plus one-half percent. No amounts were borrowed under the Credit Agreement during the first nine months of 1999 or 1998. At June 30, 1999, the Company's short- and long-term cash commitments, including remaining costs related to the Company's acquisitions and related reorganizations that have occurred in the preceding twelve months, consisted primarily of commitments under lease arrangements for office space and equipment. The Company intends to meet such obligations primarily from cash provided by operating activities. The Company believes that available cash balances, cash equivalents and short-term investments combined with cash provided by operating activities and amounts available under existing credit agreements are sufficient to meet the Company's cash requirements for the foreseeable future. Other Matters Foreign Currency Matters The assets and liabilities of the Company's non-U.S. operations are translated into U.S. dollars at exchange rates in effect as of the applicable 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 exposure to foreign currency exchange rate fluctuations through decentralized sales, marketing and support operations, and through international development facilities, in which substantially all costs are local-currency based. The Company has entered, and may in the future enter, into hedging transactions in an effort to reduce its exposure to currency exchange risks. Year 2000 Issues The following discussion regarding year 2000 matters constitutes a "Year 2000 Readiness Disclosure" within the meaning of the Year 2000 Information and Readiness Disclosure Act. -25- Like most companies in the IT industry, the Company has been and is continuing to address the impact of the so-called "year 2000" issue. A more detailed discussion of certain risks associated with the year 2000 issue and the Company's actions and plans to address this issue is set forth in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1998. Among other risks associated with the year 2000 issue, some commentators have predicted that it may affect historical purchasing patterns and trends in the software industry. For example, certain industry analysts believe that many customers and potential customers are heavily engaged in testing and correcting year 2000 problems in their systems, and therefore, may choose to defer system investments during calendar 1999, negatively impacting the revenues of enterprise software vendors like the Company. Other analysts have indicated that many enterprises that have completed their year 2000 corrective measures intend to make no changes to their existing computing environments during the latter part of calendar 1999 and the early part of 2000, also resulting in the potential deferral of system investments. Because of the unprecedented nature of the year 2000 issue and the general uncertainty that surrounds it, there can be no assurance that it will not affect customer purchasing patterns, lengthen the Company's sales cycles or otherwise negatively affect demand for the Company's products. As the turn of the century approaches, the Company is continuing to assess the need for, implement and refine contingency plans associated with the year 2000 issue. Among other things, the Company's product support and internal MIS organizations are developing and refining plans to ensure the ready availability of adequate customer and product support resources, and the Company's critical business systems, in late December of 1999 and early January of 2000. 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. Such statements are based upon the beliefs and assumptions of, and on information available to, the Company's management. The following statements are or may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995: (i) statements preceded by, followed by or that include the words "may", "will", "could", "should", "believe", "expect", "future", "potential", "anticipate", "intend", "plan", "estimate" or "continue" or the negative or other variations thereof and (ii) other statements regarding matters that are not historical facts. Such forward-looking statements are subject to various risks and uncertainties, including (i) risks and uncertainties relating to the possible invalidity of the underlying beliefs and assumptions, (ii) possible changes or developments in social, economic, business, industry, market, legal and regulatory circumstances and conditions, and (iii) actions taken or omitted to be taken by third parties, including customers, suppliers, business partners, competitors and legislative, regulatory, judicial and other governmental authorities and officials. In addition to any risks and uncertainties specifically identified in the text surrounding such forward-looking statements, the statements in the immediately preceding sentence and the statements under captions such as "Risk Factors", "Certain Considerations Relative to the Company" and "Special Considerations" in the SEC Filings constitute cautionary statements identifying important factors that could cause actual amounts, results, events and circumstances to differ materially from those reflected in such forward-looking statements. -26- 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: 2.1 Agreement and Plan of Merger, dated as of June 20, 1998, among the Company, Sterling Software (Southern), Inc. and Synon Corporation (1), (2) 2.2 Agreement and Plan of Merger, dated as of August 27, 1998, among the Company, Sterling Software (Southern), Inc. and Cayenne Software, Inc. (2), (3) 2.3 Asset Purchase Agreement, dated as of March 6, 1999, between the Company, Spectra Logic Corporation, Sterling Software (U.S.A.), Inc., Nathan C. Thompson and Michael J. Sausa (2), (4) 2.4 Agreement and Plan of Merger, dated as of March 23, 1999, among the Company, Sterling Software (Southwest), Inc. and Interlink Computer Sciences, Inc. (2), (5) 2.5 Agreement and Plan of Merger, dated as of July 15, 1999, among the Company, Sterling Software Acquisition Corp. and Information Advantage, Inc. (2), (6) 3.1 Certificate of Incorporation, as amended, of the Company (4) 3.2 Bylaws, as amended, of the Company (7) 27 Financial Data Schedule (8) _____________ (1) Previously filed as an exhibit to the Company's Current Report on Form 8-K dated June 21, 1998 and incorporated herein by reference (SEC File No. 98652676). (2) In accordance with Item 601 of Regulation S-K, the schedules and exhibits relating to the agreement have been omitted. The Company will furnish supplementally to the Securities and Exchange Commission such schedules or exhibits upon request. (3) Previously filed as an exhibit to the Current Report on Form 8-K dated August 27, 1998 filed by Cayenne Software, Inc. and incorporated herein by reference (File ID #000-19682, SEC File No. 98700698). (4) Previously filed as an exhibit to the Company's Quarterly Report on Form 10- Q for the quarter ended March 31, 1999 and incorporated herein by reference (SEC File No. 99617213). (5) Previously filed as an exhibit to the Company's Tender Offer Statement on Schedule 14D-1 dated March 30, 1999 and incorporated herein by reference (SEC File No. 99579124). (6) Previously filed as an exhibit to the Company's Tender Offer Statement on Schedule 14D-1 dated July 21, 1999 and incorporated herein by reference (SEC File No. 99667898). (7) Previously filed as an exhibit to the Company's Registration Statement on Form 8-A/A filed on May 27, 1998 and incorporated herein by reference (SEC File No. 98632257). (8) Filed herewith. -27- (b) Reports on Form 8-K. The Company did not file any Current Reports on Form 8-K during the three month period ended June 30, 1999. -28- 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 4, 1999 By: /s/ Sterling L. Williams ------------------------------------ Sterling L. Williams President, Chief Executive Officer and Director (Principal Executive Officer) Date: August 4, 1999 /s/ R. Logan Wray ------------------------------------ R. Logan Wray Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) -29- EXHIBIT INDEX ------------- Exhibit No. Description - ------- ----------- 2.1 Agreement and Plan of Merger, dated as of June 20, 1998, among the Company, Sterling Software (Southern), Inc. and Synon Corporation (1), (2) 2.2 Agreement and Plan of Merger, dated as of August 27, 1998, among the Company, Sterling Software (Southern), Inc. and Cayenne Software, Inc. (2), (3) 2.3 Asset Purchase Agreement, dated as of March 6, 1999, between the Company, Spectra Logic Corporation, Sterling Software (U.S.A.), Inc., Nathan C. Thompson and Michael J. Sausa (2), (4) 2.4 Agreement and Plan of Merger, dated as of March 23, 1999, among the Company, Sterling Software (Southwest), Inc. and Interlink Computer Sciences, Inc. (2), (5) 2.5 Agreement and Plan of Merger, dated as of July 15, 1999, among the Company, Sterling Software Acquisition Corp. and Information Advantage, Inc. (2), (6) 3.1 Certificate of Incorporation, as amended, of the Company (4) 3.2 Bylaws, as amended, of the Company (7) 27 Financial Data Schedule (8) _____________ (1) Previously filed as an exhibit to the Company's Current Report on Form 8-K dated June 21, 1998 and incorporated herein by reference (SEC File No. 98652676). (2) In accordance with Item 601 of Regulation S-K, the schedules and exhibits relating to the agreement have been omitted. The Company will furnish supplementally to the Securities and Exchange Commission such schedules or exhibits upon request. (3) Previously filed as an exhibit to the Current Report on Form 8-K dated August 27, 1998 filed by Cayenne Software, Inc. and incorporated herein by reference (File ID #000-19682, SEC File No. 98700698). (4) Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1999 and incorporated herein by reference (SEC File No. 99617213). (5) Previously filed as an exhibit to the Company's Tender Offer Statement on Schedule 14D-1 dated March 30, 1999 and incorporated herein by reference (SEC File No. 99579124). (6) Previously filed as an exhibit to the Company's Tender Offer Statement on Schedule 14D-1 dated July 21, 1999 and incorporated herein by reference (SEC File No. 99667898). (7) Previously filed as an exhibit to the Company's Registration Statement on Form 8-A/A filed on May 27, 1998 and incorporated herein by reference (SEC File No. 98632257). (8) Filed herewith. -30- EX-27 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS INCLUDED IN THE STERLING SOFTWARE, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER AND NINE MONTHS ENDED JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS 9-MOS SEP-30-1999 SEP-30-1999 APR-01-1999 OCT-01-1998 JUN-30-1999 JUN-30-1999 425,895 425,895 221,607 221,607 229,763 229,763 0 0 0 0 908,423 908,423 76,929 76,929 60,112 60,112 1,254,964 1,254,964 258,781 258,781 0 0 0 0 0 0 8,637 8,637 916,947 916,947 1,254,964 1,254,964 209,765 576,610 209,765 576,610 73,599 215,252 157,467 447,448 36,566 65,844 0 0 43 302 24,024 89,210 14,713 40,533 9,311 48,677 0 0 0 0 0 0 9,311 48,677 .11 .59 .11 .55
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