<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_____________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NO. 001-13609
SOFTWARE AG SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 54-1167173
-------- ----------
(State or other jurisdiction of (I.R.S. employer identification no.)
incorporation or organization)
</TABLE>
11190 SUNRISE VALLEY DRIVE
RESTON, VIRGINIA 20191
-----------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: (703) 860-5050
SECURITIES REGISTERED PURSUANT TO SECTION 12 (b) OF THE ACT:
<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- -----------------------
<S> <C>
Common Stock, $0.01 par value New York Stock Exchange
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12 (g) OF THE ACT: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of October 23, 1998, 30,252,989 of shares the registrant's common stock
were outstanding.
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TABLE OF CONTENTS
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<CAPTION>
ITEM PAGE
- ---- ----
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P A R T I
1. Financial Statements:
Condensed Consolidated Balance Sheets as of December 31, 1997 and September 30, 1998......... 3
Condensed Consolidated Statements of Operations for the three and nine months ended
September 30, 1997 and 1998................................................................ 5
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30,
1997 and 1998.............................................................................. 6
Notes to Condensed Consolidated Financial Statements......................................... 7
2. Management's Discussion and Analysis of Financial Condition and Results of Operations........ 11
P A R T II
5. Other Information............................................................................ 18
6. Exhibits and Reports on Form 8-K............................................................. 18
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2
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ITEM 1. FINANCIAL STATEMENTS
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
Dec. 31, Sept. 30,
1997 1998
----------- -----------
(Unaudited)
<S> <C> <C>
Assets
Current:
Cash and cash equivalents.................................... $ 50,429 $ 64,632
Accounts receivable:
Invoiced and currently due................................ 40,212 41,988
Advanced billings on maintenance.......................... 10,287 6,551
Unbilled services......................................... 10,384 13,519
Installment............................................... 24,434 34,984
Other..................................................... 2,858 1,044
Less: allowance for doubtful accounts..................... (9,301) (8,756)
--------- ---------
Total accounts receivable............................... 78,874 89,330
Current portion of deferred income taxes..................... 6,217 6,217
Income taxes receivable...................................... --- 1,095
Prepaid expenses............................................. 1,371 2,174
Other current assets......................................... 2,663 2,968
--------- ---------
Total current assets.................................... 139,554 166,416
Cooperation agreement, net of accumulated amortization......... 21,737 19,975
Installment accounts receivable, net of current portion........ 8,932 12,789
Property, equipment and leasehold improvements, net of
accumulated depreciation and amortization..................... 10,077 8,730
Goodwill, net of accumulated amortization...................... 11,286 9,973
Deferred income taxes.......................................... 2,848 3,222
Other assets................................................... 1,692 763
--------- ---------
Total assets............................................ $ 196,126 $ 221,868
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
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SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS - (CONTINUED)
(In thousands, except per share data)
<TABLE>
<CAPTION>
Dec. 31, Sept. 30,
1997 1998
----------- -----------
(Unaudited)
<S> <C> <C>
Liabilities and Stockholders' Equity
Current:
Accounts payable................................................... $ 8,545 $ 6,097
Accrued payroll and employee benefits.............................. 10,170 12,332
Payable to SAG..................................................... 10,050 7,253
Income taxes payable............................................... 1,752 ---
Other current liabilities.......................................... 4,274 6,147
Current portion of deferred revenues, net of deferred royalties.... 42,711 44,635
---------- ----------
Total current liabilities...................................... 77,502 76,464
Deferred revenues, net of deferred royalties......................... 28,806 29,756
---------- ----------
Total liabilities.............................................. 106,308 106,220
Stockholders' equity
Common stock ($0.01 par value, 75,000,000 shares authorized,
32,677,500 shares issued at December 31, 1997; and
75,000,000 shares authorized, 30,252,714 shares issued and
outstanding at September 30, 1998)................................ 327 303
Additional paid-in capital......................................... 84,185 92,214
Retained earnings.................................................. 5,338 23,696
Treasury stock..................................................... (32) ---
Accumulated translation adjustments................................ --- (565)
---------- ----------
Total stockholders' equity..................................... 89,818 115,648
---------- ----------
Total liabilities and stockholders' equity..................... $ 196,126 $ 221,868
========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
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SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share dollar amounts)
(Unaudited)
<TABLE>
<CAPTION>
Predecessor Successor
------------ -------------------------------------------------------
Three months Three months Six months Three months Nine months
ended ended ended ended ended
Mar. 31, Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1997 1997 1997 1998 1998
------------ ------------ ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Revenues: |
Software license fees.............................. $ 7,341 | $ 18,458 $ 32,712 $ 21,810 $ 68,037
Maintenance fees................................... 17,352 | 17,542 35,936 22,049 62,345
Professional services fees......................... 9,948 | 10,729 21,028 19,064 48,756
----------- | ----------- ----------- ----------- -----------
Total revenues................................ 34,641 | 46,729 89,676 62,923 179,138
----------- | ----------- ----------- ----------- -----------
Cost of revenues: |
Software license.................................. 2,098 | 6,428 10,502 5,531 16,256
Maintenance....................................... 6,205 | 8,062 14,639 7,773 21,869
Professional services............................. 9,211 | 8,491 17,942 14,578 38,126
----------- | ----------- ----------- ----------- -----------
Total cost of revenues........................ 17,514 | 22,981 43,083 27,882 76,251
----------- | ----------- ----------- ----------- -----------
Gross profit........................................... 17,127 | 23,748 46,593 35,041 102,887
----------- | ----------- ----------- ----------- -----------
Operating expenses: |
Software product development...................... --- | 312 595 1,572 3,473
Sales and marketing............................... 7,317 | 9,060 20,537 10,731 35,728
Administrative and general........................ 8,500 | 9,317 18,249 12,368 35,694
Write-off of acquired in-process research and |
development costs.............................. --- | 6,051 6,051 --- ---
----------- | ----------- ----------- ----------- -----------
Total operating expenses..................... 15,817 | 24,740 45,432 24,671 74,895
----------- | ----------- ----------- ----------- -----------
Income (Loss) from operations......................... 1,310 | (992) 1,161 10,370 27,992
Other income and expense, net..................... 978 | (221) 1,376 966 2,825
----------- | ----------- ----------- ----------- -----------
Income (Loss) before income taxes...................... 2,288 | (1,213) 2,537 11,336 30,817
Income tax provision.............................. 915 | 2,014 3,613 4,513 12,459
----------- | ----------- ----------- ----------- -----------
Net income (loss)...................................... $ 1,373 | $ (3,227) $ (1,076) $ 6,823 $ 18,358
=========== | =========== =========== =========== ===========
|
Net income (loss) per common share..................... $ 0.06 | $ (0.13) $ (0.04) $ 0.23 $ 0.62
=========== | =========== =========== =========== ===========
|
|
Net income (loss) per common share-assuming dilution... $ 0.05 | $ (0.13) $ (0.04) $ 0.21 $ 0.58
=========== | =========== =========== =========== ===========
|
Shares used in computing net income (loss) per |
common share: |
Net income (loss) per common share.................. 24,338 | 24,338 24,338 30,111 29,800
Net income (loss) per common share-assuming |
dilution.......................................... 25,894 | 24,338 24,338 32,074 31,849
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
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SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
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<CAPTION>
Predecessor Successor
------------ --------------------------
Three months Six months Nine months
ended ended ended
Mar. 31, Sept. 30, Sept. 30,
1997 1997 1998
---------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities: |
Net income (loss)..................................................... $ 1,373 | $ (1,076) $ 18,358
Adjustments to reconcile net income (loss) to net cash |
provided by operating activities: |
Depreciation and amortization....................................... 941 | 3,429 5,937
(Gain) loss on disposals of property and equipment................. --- | (4) 479
Deferred gain....................................................... (36) | --- ---
Net proceeds from sales of accounts receivable...................... 8,894 | 27,859 18,119
Write-off of acquired in-process research and development |
costs.............................................................. --- | 6,051 ---
Write-off of investment............................................. --- | --- 848
Compensation expense on options granted............................ --- | 129 582
Changes in operating accounts....................................... (746) | (25,860) (28,909)
-------- | --------- ---------
Net cash provided by operating activities....................... 10,426 | 10,528 15,414
-------- | --------- ---------
|
Cash flows from investing activities: |
Additions to property, equipment and leasehold improvements........... (208) | (2,134) (2,472)
Proceeds from sales of property and equipment......................... --- | 2 38
Purchase of Cooperation Agreement..................................... --- | (22,612) ---
Acquisition of subsidiaries, net of cash received..................... --- | (1,260) ---
-------- | --------- ---------
Net cash used in investing activities........................... (208) | (26,004) (2,434)
-------- | --------- ---------
|
Cash flows from financing activities: |
Repurchase of common stock............................................ --- | (33,920) ---
Issuance of common stock.............................................. --- | 31,727 ---
Proceeds from stock options exercised................................. --- | --- 1,596
Expenses relating to public offerings................................. --- | --- (373)
-------- | --------- ---------
Net cash (used for) provided by financing activities............ --- | (2,193) 1,223
-------- | --------- ---------
|
Net increase (decrease) in cash and cash equivalents.................... 10,218 | (17,669) 14,203
Cash and cash equivalents, beginning.................................... 25,773 | 35,991 50,429
-------- | --------- ---------
Cash and cash equivalents, ending....................................... $ 35,991 | $ 18,322 $ 64,632
======== | ========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
6
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SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The condensed consolidated financial statements included herein have been
prepared by management, pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. These condensed consolidated financial statements should be read
in conjunction with the financial statements and notes thereto included in the
Software AG Systems, Inc. Annual Report on Form 10-K for the year ended
December 31, 1997.
In the opinion of management, the accompanying balance sheets and related
statements of operations and cash flows include all adjustments (consisting only
of normal recurring items) necessary for their fair presentation in conformity
with generally accepted accounting principles. The results for the three and
nine month periods ended September 30, 1998 are not necessarily indicative of
the results expected for the full year.
Prior to March 31, 1997, Software AG Systems, Inc. and subsidiaries (the
"Company") was a wholly owned subsidiary of Software AG, Darmstadt, Germany
("SAG"). As is more fully described in Note 3, on March 31, 1997, the Company
consummated a recapitalization agreement under which the Company repurchased
from SAG 24,750,000 shares of its common stock, and certain senior management of
the Company and Thayer Equity Investors III, L.P. ("Thayer") acquired
approximately 89% of the then outstanding common stock of the Company (the
"Recapitalization"). The Company's results of operations for the three months
ended March 31, 1997 are based on operations which occurred prior to the
Recapitalization. Therefore, the results of operations for the nine months
ended September 30, 1997 are not comparative with the results of operations for
the nine months ended September 30, 1998.
(2) ACCOUNTING POLICIES
Revenue Recognition
On January 1, 1998, the Company adopted Statement of Position 97-2,
"Software Revenue Recognition" ("SOP 97-2") which superseded Statement of
Position 91-1, "Software Revenue Recognition." SOP 97-2 focuses on when and in
what amounts revenue should be recognized for licensing, selling, leasing, or
otherwise marketing computer software. The adoption of SOP 97-2 did not have a
material impact on the Company's revenue recognition policies.
Software license revenues for an arrangement to deliver software that does
not require significant production, modification or customization of software is
recognized when there is an executed license agreement, the software and
authorization code, where applicable, have been delivered, the fee is fixed or
determinable and collectibility is probable.
Maintenance revenues, which include unspecified when-and-if deliverable
software upgrades, user documentation, and technical support for software
products, are deferred and recognized on a straight-line basis over the term of
the maintenance agreement, generally one year.
Customer training revenues and revenues from time and material type
professional consulting and custom application contracts are recognized as the
services are provided and the work is performed. Revenues from long-term fixed
price professional consulting and custom application contracts are accounted for
under the percentage of completion method. When estimates of costs, on long-
term fixed price contracts, indicate a loss, such a loss is provided for
currently.
7
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SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
Sales of enterprise license agreements generally bundle a combination of
products, technical services and professional consulting services. In
accordance with SOP 97-2, these elements are unbundled for revenue recognition
purposes, and are accounted for according to their component parts using the
criteria described above.
Research and Development
Research and development expenditures are charged to operations as
incurred. Statement of Financial Accounting Standards ("SFAS") No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed", requires certain costs to be capitalized once the product has reached
technological feasibility and prior to general availability. Based on the
Company's development cycle, technological feasibility is established upon the
completion of a working model. To date, technology feasibility, as defined by
SFAS No. 86, has not been met on any internally developed products.
Net Income per Common Share
The Company reports earnings per share under SFAS No. 128, "Earnings Per
Share" ("SFAS No. 128"). In accordance with SFAS No. 128 requirements, the
Company presents basic and diluted earnings per share. Basic earnings per share
is based on income available to common stockholders divided by the weighted
average number of common shares outstanding. Diluted earnings per share is based
on income available to common stockholders divided by the sum of the weighted
average number of common shares outstanding and all potential common shares
which are dilutive. The following information is a reconciliation of the amounts
used in these calculations:
<TABLE>
<CAPTION>
Predecessor Successor
------------ ---------------------------------------------------------
Three months Three months Six months Three months Nine months
ended ended ended ended ended
Mar. 31, Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1997 1997 1997 1998 1998
------------ ------------ ------------ ------------ ------------
(In thousands, except for per share dollar amounts)
(Unaudited)
<S> <C> <C> <C> <C> <C>
Numerator: |
Net income (loss)....................... $ 1,373 | $ (3,227) $ (1,076) $ 6,823 $ 18,358
======== | ======== ======== ======== ========
Denominator: |
Basic: |
Weighted average shares outstanding..... 24,338 | 24,338 24,338 30,111 29,800
Effect of dilutive securities: |
Stock options........................... 1,556 | --- --- 1,963 2,049
-------- | -------- -------- -------- --------
Diluted: |
Weighted average shares outstanding-- |
assuming dilution...................... 25,894 | 24,338 24,338 32,074 31,849
======== | ======== ======== ======== ========
EPS: |
Net income (loss) per common share...... $ 0.06 | $ (0.13) $ (0.04) $ 0.23 $ 0.62
======== | ======== ======== ======== ========
Net income (loss) per common share-- |
assuming dilution...................... $ 0.05 | $ (0.13) $ (0.04) $ 0.21 $ 0.58
======== | ======== ======== ======== ========
</TABLE>
For the three months and the six months ended September 30, 1997, the assumed
exercise of stock options has not been included in the calculation as they would
be anti-dilutive.
8
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SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
Comprehensive Income
In June 1997, FASB issued SFAS No. 130, "Reporting Comprehensive Income"
which is effective for the fiscal years beginning after December 15, 1997. SFAS
No. 130 establishes standards for the reporting of comprehensive income and its
components in the financial statements. The Company adopted SFAS No. 130
effective as of January 1, 1998.
<TABLE>
<CAPTION>
Predecessor Successor
------------ ---------------------------------------------------------
Three months Three months Six months Three months Nine months
ended ended ended ended ended
Mar. 31, Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1997 1997 1997 1998 1998
------------ ------------ ------------ ------------ ------------
(In thousands)
(Unaudited)
<S> <C> <C> <C> <C> <C>
Net income (loss)..................... $ 1,373 $ (3,227) $ (1,076) $ 6,823 $ 18,358
======= ======== ======== ======= ========
Other comprehensive income (loss):
Foreign currency translation
adjustment......................... --- --- --- (833) (939)
Less income tax benefit............. --- --- --- 332 374
------- -------- -------- ------- --------
Comprehensive income (loss)........... $ 1,373 $ (3,227) $ (1,076) $ 6,322 $ 17,793
======= ======== ======== ======= ========
</TABLE>
Reclassifications
Certain amounts in 1997 have been reclassified to conform to the 1998
presentation.
(3) RECAPITALIZATION OF THE COMPANY
On March 31, 1997, the Company consummated the Recapitalization under which
the Company repurchased from its former parent, SAG, 24,750,000 shares of its
common stock and sold 21,450,000 shares of its common stock to Thayer and
certain of the Company's senior managers. As a result of this change in control,
the acquisition by Thayer and such managers was accounted for as a purchase
business combination, and as such the fair value of the Company's assets and
liabilities was recorded as of April 1, 1997.
Prior to the consummation of the Recapitalization, the Company entered into
a perpetual and exclusive (unless otherwise terminated by the written agreement
of the parties) cooperation agreement ("Cooperation Agreement") with SAG that
terminated and superseded the license agreement dated January 1, 1995. As
consideration for the Cooperation Agreement, the Company paid SAG approximately
$22,600,000. Under the Cooperation Agreement, each of the Company and SAG are
required to pay the other royalties of 24% of net revenues from sales of
licenses of, and technical services on, each other's products for the initial 20
years of the perpetual term of the agreement.
For calendar years 1997 through 2000, the Company is required to pay SAG
minimum annual royalties of $21,000,000, provided that SAG's worldwide product
and technical services revenues for each of those years are at least equal to
SAG's 1996 worldwide revenues. In the event of a decrease in SAG's worldwide
revenues, the minimum annual royalty requirement will be reduced
proportionately.
Pursuant to the Recapitalization, Thayer and certain of the Company's
senior managers acquired approximately 89% of the then outstanding common stock
of the Company for approximately $31,500,000. The determination of fair value
allocated to the identifiable assets and liabilities of the Company has been
made by management based on the nature of the assets and liabilities acquired,
and general economic factors. Based on this allocation, the fair value of the
Company's Cooperation Agreement has been recorded at $23,500,000, based on an
independent appraisal.
9
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SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
The amortization period for the Cooperation Agreement is ten years. The
fair value of the Company's remaining assets and liabilities has been presumed
to be equal to the book value as of the date of the acquisition. Based on
allocation of the purchase price to the net assets and liabilities, an excess of
purchase price over net assets acquired (goodwill) of $6,402,000 was recorded.
Such goodwill is being amortized on a straight-line basis over 10 years. At
September 30, 1998, accumulated amortization on the Cooperation Agreement and
the goodwill was approximately $3,525,000 and approximately $960,000,
respectively.
(4) ACQUISITION
On September 30, 1997, the Company acquired 100% of the issued and
outstanding shares of the common stock of R.D. Nickel and Associates, Inc. (R.D.
Nickel) by merging R.D. Nickel with and into Software AG Systems (Canada) Inc.,
a wholly owned subsidiary of SAG Systems (Canada) Holdings Ltd. (a 90% owned
subsidiary of the Company and a 10% owned subsidiary of Software AG Americas,
Inc.) ("Software AG (Canada)"), with Software AG (Canada) as the surviving
entity. Software AG (Canada) is a software company that develops, licenses and
supports a family of application development products. Additionally, R.D. Nickel
served as the exclusive distributor of the Company's products in Canada since
1973. The transaction was accounted for using the purchase method of accounting
for a business combination. The aggregate purchase price of Cdn$14,000,000
(US$10,130,000) was funded through a cash payment of Cdn$7,000,000
(US$5,065,000) and a note payable of Cdn$7,000,000 (US$5,065,000). The note
payable was paid in November 1997 with the proceeds from the Company's initial
public offering consummated in November 1997.
In connection with the transaction, the Company recorded a $6,051,000 non-
recurring charge against earnings for in-process research and development costs
in September 1997. The remaining excess purchase price of $4,960,000 represents
goodwill. The related amortization period for the goodwill is ten years. At
September 30, 1998, accumulated amortization on the goodwill was approximately
$448,000.
As of October 1, 1997, the operating results of Software AG (Canada) have
been consolidated with the Company's operating results.
(5) NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which is
effective for the years beginning after December 15, 1997. SFAS No. 131 requires
companies to present certain information about operating segments and related
information, including geographic and major customer data, in its annual
financial statements and in condensed financial statements for interim periods.
The Company will adopt the annual disclosure requirements in the preparation of
its Annual Report on Form 10-K for the year ending 1998 while the quarterly
disclosure requirements will be adopted in 1999. The Company does not believe
that the adoption of SFAS No. 131 will have a material impact on its financial
statements.
10
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
REVENUES
Total Revenues. The Company's revenues are currently derived from fees
from licensing the Company's software products, fees for providing maintenance
to customers which have licensed the Company's software products and fees from
professional services. The Company's total revenues were $179.1 million and
$124.3 million for the nine months ended September 30, 1998 and 1997,
respectively, representing an increase of 44%.
Software License Fees. The Company's software license fees are derived
primarily from the licensing of the Company's enterprise development and
enterprise enablement products. Software license fees were $68.0 million and
$40.1 million for the nine months ended September 30, 1998 and 1997,
respectively, representing an increase of 70%. This increase was primarily due
to the reorganization of the direct sales force at the beginning of 1997. As a
result of this reorganization, the Company has experienced increased volume and
acceptance of Enterprise License Agreements ("ELAs") by its customer base. For
the nine months ended September 30, 1998, the Company entered into 41 ELAs with
a total product value of $33.3 million, compared to 30 ELAs with a total product
value of $17.6 million for the nine months ended September 30, 1997. The
increase in software license fees was also attributable to the incremental
revenue recorded by Software AG (Canada) since the acquisition of R.D. Nickel in
September 1997.
Maintenance Fees. The Company's maintenance fees are derived primarily
from providing technical support to customers that have licensed the Company's
enterprise development and enterprise enablement products. Maintenance is
available in various levels of support and priced as a percentage of the
software license fees. The most commonly contracted level is priced at 18% of
the applicable license fee at the time of renewal. Software customers are not
required to renew their maintenance agreements and renewals can be expected only
if the customer continues to use the licensed product. Maintenance fees were
$62.3 million and $53.3 million for the nine months ended September 30, 1998 and
1997, respectively, representing an increase of 17%. This increase was primarily
attributable to an expansion of the installed base due to strong software
license sales combined with the incremental revenue recorded by Software AG
(Canada) since the acquisition of R.D. Nickel in September 1997.
Professional Services Fees. The Company's professional service fees are
derived primarily from work performed by the Company on behalf of customers who
have licensed the Company's software products. Professional services fees were
$48.8 million and $31.0 million for the nine months ended September 30, 1998 and
1997, respectively, representing an increase of 57%. This increase was primarily
attributable to the increases in the revenue generated from the Company's year
2000 professional services compared to the prior year.
COST OF REVENUES
Software License. Software license costs consist primarily of royalties
paid to third parties. Software license costs were $16.3 million and $12.6
million for the nine months ended September 30, 1998 and 1997, respectively,
representing 24% and 31% of software license fees for each respective period.
The increase in dollar amount was primarily due to an increase in sales volume.
The percentage decrease was attributable to a shift in the mix of third party
products sold. Royalty rates on third-party products range from 24% to 40%. In
addition, there was an increase in sales of Company owned products.
Maintenance. Maintenance costs consist of royalties paid to third parties,
the costs of providing customer support and the distribution costs of new
releases. Maintenance costs were $21.9 million and $20.8 million for the nine
months ended September 30, 1998 and 1997, respectively, representing 35% and 39%
of maintenance fees for each respective period. The increase in dollar amount
was primarily attributable to the increase in sales of software
11
<PAGE>
licenses and related maintenance. The percentage decreased due to improved
utilization of resources and an increase in sales of Company owned products
compared to the prior year.
Professional Services. Professional services costs consist of labor and
related overhead costs for the people performing the services. Such costs
include costs for project management, quality control and project review.
Professional services costs were $38.1 million and $27.2 million for the nine
months ended September 30, 1998 and 1997, respectively, representing 78% and 88%
of professional services fees for each respective period. The increase in the
dollar amount was primarily due to an increase in sales volume. The improvement
in margin was primarily attributable to improved performance on fixed price
contracts combined with improved utilization of resources.
OPERATING EXPENSES
Software Product Development. Software product development expenses
include all labor and overhead costs related to the development of software
products owned by the Company. Software product development costs were
$3.5 million and $0.6 million for the nine months ended September 30, 1998 and
1997 representing 5% and 1% of software license fees for each respective period.
Prior to the Recapitalization in March 1997, the Company's ability to invest
in software product development was constrained. However, since the
Recapitalization, the Company has been building its internal product development
group. To date, the total number of developers has increased to 46 from 3 in the
comparable prior period. The Company expects software product development
expenses to increase in the future as a percentage of software license fees.
Sales and Marketing. Sales and marketing expenses consist primarily of
employee salaries, benefits, commissions, marketing programs, public relations,
trade shows, seminars, advertising and related communications and associated
overhead costs. Sales and marketing expenses were $35.7 million and
$27.9 million for the nine months ended September 30, 1998 and 1997,
respectively, representing 20% and 22% of total revenues for each respective
period. The increase in dollar amount was attributable to several new marketing
programs implemented in 1998 combined with the increased commissions associated
with higher revenues compared to the prior year. Additionally, the increase in
the dollar amount was due to the incremental sales and marketing expenses
recorded by Software AG (Canada) since the R.D. Nickel acquisition.
Administrative and General. Administrative and general expenses include
employee salaries and benefits for administration, executive, finance, legal,
human resources, data center, distribution and internal systems personnel and
associated overhead costs, as well as bad debt, accounting and legal expenses.
Administrative and general expenses were $35.7 million and $26.7 million for the
nine months ended September 30, 1998 and 1997, respectively, representing 20%
and 22% of total revenues for each respective period. The increased dollar
amount was primarily attributable to increases in personnel related expenses and
infrastructure required to support an independent and growing company (prior to
the Recapitalization, the Company's ability to market and grow its business was
limited by the business of its then parent company, SAG), amortization expenses
relating to the goodwill and the Cooperation Agreement resulting from the
Recapitalization on March 31, 1997 and amortization expenses relating to the
goodwill associated with the R.D. Nickel acquisition completed in September
1997.
Write-off of Acquired In-Process Research and Development Costs. The
write-off acquired in-process research and development costs in the amount of
$6.1 million in 1997 was attributable to certain products acquired in the
acquisition of R.D. Nickel. See Note 4 of Notes to Condensed Consolidated
Financial Statements.
OTHER
Other Income and Expense, Net. Other income and expense, net, consists
primarily of interest earned on cash, cash equivalents, short term investments
and long term customer contracts carried by the Company and other miscellaneous
income and expenses. Other income and expense, net, was $2.8 million and
$2.4 million for the nine months ended September 30, 1998 and 1997,
respectively. The increase in other income and expense, net, was primarily due
to the increase in the interest income from cash, cash equivalent and short term
investments in 1998 compared to 1997.
12
<PAGE>
Income Tax Provision. The income tax provision was $12.5 million and
$4.5 million for the nine months ended September 30, 1998 and 1997,
respectively, resulting in effective tax rates of 40.4% and 41.6% (exclusive of
the write-off of acquired in-process research and development costs in 1997),
respectively. The higher effective tax rate in 1997 was primarily due to the
non-deductible expenses incurred as a result of the Recapitalization.
THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
REVENUES
Total Revenues. The Company's total revenues were $62.9 million and
$46.7 million for the three months ended September 30, 1998 and 1997,
respectively, representing an increase of 35%.
Software License Fees. Software license fees were $21.8 million and
$18.5 million for the three months ended September 30, 1998 and 1997,
respectively, representing an increase of 18%. This increase was primarily
attributable to an increase in the sales of the Company owned products coupled
with the incremental revenue recorded by Software AG (Canada) in the current
period.
Maintenance Fees. Maintenance fees were $22.0 million and $17.5 million
for the three months ended September 30, 1998 and 1997, respectively,
representing an increase of 26%. This increase was primarily attributable to an
increase in the maintenance base from the sale of new software licenses and the
incremental revenue recorded by Software AG (Canada) in the current period.
Professional Services Fees. Professional services fees were $19.1 million
and $10.7 million for the three months ended September 30, 1998 and 1997,
respectively, representing an increase of 78%. This increase was primarily
attributable to the increases in the revenue generated from the Company's year
2000 professional services in the current year, combined with growth in the
Company's traditional services.
COST OF REVENUES
Software License. Software license costs were $5.5 million and
$6.4 million for the three months ended September 30, 1998 and 1997,
respectively, representing 25% and 35% of software license fees for each
respective period. The decreases in both the dollar amount and the percentage
were attributable to a shift in the mix of third party products sold and an
increase in sale of Company owned products.
Maintenance. Maintenance costs were $7.8 million and $8.1 million for the
three months ended September 30, 1998 and 1997, respectively, representing 35%
and 46% of maintenance fees for each respective period. The decreases in both
the dollar amount and the percentage were attributable to a shift in the mix of
third party products sold and improved utilization of existing resources.
Professional Services. Professional services costs were $14.6 million and
$8.5 million for the three months ended September 30, 1998 and 1997,
respectively, representing 76% and 79% of professional services fees for each
respective period. The improvement in margin was primarily attributable to
improved performance on fixed price contracts combined with improved utilization
of resources.
OPERATING EXPENSES
Software Product Development. Software product development costs were
$1.6 million and $0.3 million for the three months ended September 30, 1998 and
1997, respectively, representing 7% and 2% of software license fees for each
respective period. Prior to the Recapitalization in March 1997, the Company's
ability to invest in software product development was constrained. However,
since the Recapitalization, the Company has been building its internal product
development group. To date, the total number of developers has increased to 46
from 3 in the comparable prior period. The Company expects software product
development expenses to increase in the future as a percentage of software
license fees.
13
<PAGE>
Sales and Marketing. Sales and marketing expenses were $10.7 million and
$9.1 million for the three months ended September 30, 1998 and 1997,
respectively, representing 17% and 19%, of total revenues for each respective
period. The increase in dollar amount was primarily due to the increased
commissions associated with higher revenues compared to the prior period
combined with incremental sales and marketing expenses recorded by Software AG
(Canada) in the current period. The decrease in percentage was primarily a
result of the increase in sales compared to the prior period.
Administrative and General. Administrative and general expenses were
$12.4 million and $9.3 million for the three months ended September 30, 1998 and
1997, respectively, representing 20% of total revenues for both respective
periods. The increased dollar amount was primarily attributable to increases in
personnel related expenses and infrastructure required to support an independent
and growing company and amortization expenses relating to the goodwill resulting
from the R.D. Nickel acquisition completed in September 1997.
Write-off of Acquired In-Process Research and Development Costs. The
write-off acquired in-process research and development costs in the amount of
$6.1 million in 1997 was attributable to certain products acquired in the
acquisition of R.D. Nickel. See Note 4 of Notes to Condensed Consolidated
Financial Statements.
OTHER
Other Income and Expense, Net. Interest and investment income, net of
expenses, was income of $1.0 million and expenses of $0.2 million for the three
months ended September 30, 1998 and 1997, respectively. This increase was
primarily attributable to the increase in the interest income from cash, cash
equivalent and short term investments in 1998 compared to 1997.
Income Tax Provision. The income tax provision was $4.5 million and
$2.0 million for the three months ended September 30, 1998 and 1997,
respectively, resulting in effective tax rates of 39.8% and 41.6% (exclusive of
the write-off of acquired in-process research and development costs in 1997).
The higher effective tax rate in 1997 was primarily due to the non-deductible
expenses incurred as a result of the Recapitalization.
LIQUIDITY AND CAPITAL RESOURCES
The Company finances its operations principally through cash flows from
operating activities. However, the Company periodically sells long term
customer receivable contracts in order to meet its short term cash needs. Sales
of long term customer receivable contracts increased in recent years in order to
meet SAG's directives prior to the Recapitalization, in connection with the
Recapitalization and to fund the acquisition of R.D. Nickel. Net cash provided
by operating activities was $15.4 million and $21.0 million for the nine months
ended September 30, 1998 and 1997, respectively. This decrease is primarily
attributable to the higher net proceeds from sales of accounts receivable in the
prior year compared to the current year.
Investing activities used net cash of $2.4 million and $26.2 million for
the nine months ended September 30, 1998 and 1997, respectively, primarily to
fund capital expenditures needed to support expansion of the Company's business
and to purchase the Cooperation Agreement from SAG in 1997.
Financing activities provided net cash of $1.2 million for the nine months
September 30, 1998 primarily from the proceeds received from stock options
exercised. Financing activities used net cash of $2.2 million for the nine
months ended September 30, 1997 primarily to fund the Recapitalization.
The Company has no long term debt, and as of September 30, 1998 and
December 31, 1997, had $64.6 million and $50.4 million in cash and cash
equivalents, respectively. The Company currently has relationships with two
third parties whereby the Company may sell long term receivable contracts in
which control over and the economic interest in the contract is transferred to
the buyer. As of September 30, 1998 and December 31, 1997, the Company remained
contingently liable under the recourse provisions associated with these sales in
the amount of $46.1 million and $47.9 million, respectively.
14
<PAGE>
The Company's international distributors report to and pay the Company in
U.S. dollars. In addition, royalties reported and paid by the Company to SAG
under the Cooperation Agreement are in U.S. dollars. The Company's Mexican
operations commenced in 1996 and represented approximately 2% of total revenues
since that time. With the acquisition of R.D. Nickel, the Company began direct
sales in Canada effective October 1, 1997. Revenues from this source were
approximately 7% of total revenues since the acquisition. The Company,
therefore, has not to date engaged in foreign currency hedging transactions.
The Company may enter into hedging transactions in the future.
The Company traditionally leases all major equipment, and has no investment
in inventory or facilities other than leasehold improvements.
The Company believes that its existing cash balances, funds generated from
operations and funds received from the sale of receivables will be sufficient to
finance the Company's operations for at least the next twelve months. Although
operating activities may provide cash in certain periods, to the extent the
Company grows in the future, its operating and investing activities may use such
cash. To the extent sufficient cash is not available from operations, the
Company may need additional financing. There can be no assurances that any
necessary additional financing will be available to the Company on commercially
reasonable terms. The Company had no material capital commitments or planned
expenditures as of September 30, 1998.
YEAR 2000
The year 2000 poses certain issues for business and consumer computing,
particularly the functionality of software for two-digit storage of dates and
special meanings of certain dates such as 9/9/99. The year 2000 is also a leap
year, which may also lead to incorrect calculations, functions, or system
failure. The problem exists for many kinds of software, including software for
mainframe, PCs, and embedded systems. The Company is aware of and is addressing
the issues associated with the programming code existing in computer systems as
the year 2000 approaches.
Substantially all of the Company's revenues have been derived from the
licensing and servicing of products developed or acquired by SAG. Under the
terms of the Cooperation Agreement, SAG is contractually required to ensure that
its products are year 2000 compliant in accordance with a specified timetable.
Although SAG has delayed the timetable set forth in the Cooperation Agreement
for certain products, SAG has subsequently delivered most of the year 2000
compliant products set forth in the Cooperation Agreement in a timely manner.
As of October 27, 1998, there is one product that is not year 2000 compliant and
the Company is awaiting delivery of this product from SAG. This product is not
significant to the Company, as there was no license or maintenance revenue
generated from this product in 1998 as of September 30, 1998. In addition, the
Company has identified a few products that are year 2000 compliant but are not
compatible with all other year 2000 compliant products. These delays and non-
compatibility problems have had no material impact on the Company to date and
the Company does not expect these problems to have a material impact to the
Company's business, financial condition or results of operations. There can be
no assurance, however, that compliant products will be delivered by SAG in a
timely manner. In addition, there can be no assurances that the year 2000
compliant products will not contain undetected errors or defects associated with
year 2000 date functions that may result in material costs to the Company. Some
commentators have stated that a significant amount of litigation will arise out
of year 2000 compliance issues, and the Company is aware of a growing number of
lawsuits against other software vendors. Because of the unprecedented nature of
such litigation, it is uncertain to what extent the Company may be affected by
it.
All other third party products, which are not developed or acquired by SAG,
are expected to be year 2000 compliant by the end of 1999. The Company has
sought written assurances from its principal third party vendors that their
products are or will be year 2000 compliant. To date, the Company has received
no indication from these vendors that their products will not be year 2000
compliant, therefore, the year 2000 risk associated with these products are not
currently anticipated to have a material effect on the Company's business,
financial condition or results of operations. There can be no assurance,
however, that compliant products will be delivered by third parties in a timely
manner.
All products developed or acquired by the Company are year 2000 compliant.
15
<PAGE>
With respect to its internal information technology systems (including
information technology-based office facilities such as data voice
communications, and building management and security systems), the Company has
established a rigorous internal readiness program which when completed should
minimize any potential issues that may arise from the year 2000 date problem.
The program includes the following major components: (i) a complete analysis,
assessment and remediation of all internal software applications, (ii) a
complete inventory of all computer hardware, communication equipment and third
party software used by the Company in support of its internal operations,
(iii) a formal survey to all third party suppliers identified above requesting
them to insure that the products that the Company is using are and will be year
2000 compliant, and (iv) the upgrade of all significant hardware and software to
year 2000 compliant versions where needed. The Company expects to substantially
complete its year 2000 readiness program for all hardware systems and its
internal software applications by the end of the calendar year 1998 and the
Company will continue to test and re-implement back into production its systems
and internal applications in 1999.
Although the Company has initiated formal communications with all of its
significant suppliers and large customers to determine the extent to which the
Company's interface systems are vulnerable to those third parties failure to
remediate their own year 2000 issues, there is no guarantee that the systems of
other companies on which the Company's systems rely will be timely converted and
that they will not have an adverse effect on the Company's systems. The Company
does not believe that the cost of such actions will have a material effect on
the Company's results of operations or financial conditions.
Although the Company believes that its products will be year 2000
compliant, there can be no assurance that its customers' applications or
databases will be year 2000 compliant, resulting in a failure of the customer's
system. Therefore, the Company has provided year 2000 remediation services under
standard services agreements with limits placed on liability and in some
instances, the execution of performance bonds. For the nine months ended
September 30, 1998, year 2000 remediation services revenues have been
approximately $13.6 million. The Company does not believe that potential
liability from these services will materially impact the Company's financial
condition or results of operations, however, a certain amount of inaccuracy is
inherent in all remediation. As a result of this inherent risk in remediation,
the Company cannot guarantee that errors resulting from the year 2000
remediation services performed for customers will not materially adversely
impact the Company's business, financial condition or results of operations.
To date, the costs associated with preparing the Company's products and
internal information technology systems to be year 2000 compliant have not been
material to the Company's business, financial condition or results of operations
and the Company does not expect these costs to materially impact the Company's
business, financial condition or results of operations in the future. These
costs are expensed as incurred. There can be no assurances, however, that the
Company will not experience delay in, or increased cost associated with, the
implementation of such changes, and the Company's inability to implement such
changes could have an adverse effect on future results of operations. In
addition, there can be no assurance that the Company will not experience serious
unanticipated negative consequences and/or material costs caused by undetected
errors or defects in the technology used in its internal systems, which are
composed of third party software, third party hardware that contains embedded
software and the Company's own software products.
The most reasonably likely worst case scenarios would include:
(i) corruption of data contained in the Company's internal information systems,
(ii) hardware failure, and (iii) the failure of infrastructure services provided
by government agencies and other third parties (e.g., electricity, phone
service, water transport, internet services, etc.).
The Company is currently in an initial stage in preparing its contingency
planning, which will include among other things, manual "work-arounds" for
software and hardware failures, as well as substitution of systems, if
necessary. The Company anticipates the contingency planning to be completed by
the second quarter of 1999.
16
<PAGE>
SAFE HARBOR PROVISION FOR FORWARD-LOOKING STATEMENTS
The statements contained in this report include forward-looking statements
subject to the safe harbor created by the Private Securities Litigation Reform
Act of 1995. These forward-looking statements include projections of financial
results, expenditures and investment including but not limited to product
development, financing of the Company's operations, capital commitments and
expenditures and hedging transactions, and are based on the Company's current
knowledge, beliefs, expectations and specific assumptions with respect to future
business decisions. Accordingly, the statements are subject to significant
risks, contingencies and uncertainties that could cause actual operating
results, performance or business prospects to differ materially from those
expressed in, or implied by, these statements. These risks, contingencies and
uncertainties include, but are not limited to, the timely development,
production, marketing and delivery of new products and services; significant
quarterly and other fluctuations in revenues and results of operations; reliance
on Software AG, Darmstadt, Germany for development and timely delivery of
products; reliance on acquisitions; increased demand for year 2000 products and
services; risks associated with conducting a professional services business;
reliance on the mainframe computing environment and demand for the Company's
products; changes in the Company's product and service mix and product and
service pricing; interoperability of the Company's products with leading
software application products; competition from other software companies; risks
of protecting intellectual property rights and litigation; dependence on third-
party technology; risks associated with international sales, distributors and
operations; dependence on government contracts; control of the Company by
affiliates; the Company's ability to implement its acquisition strategy,
successfully integrate any acquired products, services and businesses, adjust to
changes in technology, customer preferences, enhanced competition and new
competitors in software and professional services markets, maintain and enhance
its relationships with vendors, and attract and retain key employees; general
economic and business conditions; and other risks detailed from time to time in
the Company's Securities and Exchange Commission reports and filings.
17
<PAGE>
PART II
ITEM 5. OTHER INFORMATION
The SEC has promulgated new Rules 14a-4(c) and 14a-5(e) with respect to
when a Company may exercise discretionary voting authority at an annual meeting
over a stockholder proposal when the stockholder has not requested that the
proposal be included in the proxy statement, i.e., the stockholder will make the
proposal at the meeting. Pursuant to the new rules and the Company's Bylaws, a
stockholder's notice of a proposal to be brought before an annual meeting
generally must be delivered to the principal executive offices of the Company
not less than 120 days prior to the date the Company's proxy statement for the
previous year's annual stockholder meeting was released to stockholder in order
to eliminate the Company's ability to exercise discretionary voting authority
with respect to a proposal not discussed in the proxy statement.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
11 Computation of Earnings per Share
27 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on July 24, 1998 to report
the resignation of Alan M. Teicher, Vice President-Sales of the Company.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SOFTWARE AG SYSTEMS, INC.
BY: /s/ Harry K. McCreery
-------------------------------------
Harry K. McCreery
Date: November 12, 1998 Vice President, Treasurer and
Chief Financial Officer
(Principal Financial and
Accounting Officer and
Duly Authorized Officer)
19
<PAGE>
EXHIBIT 11
Software AG Systems, Inc.
Computation of Earnings Per Share
(In thousands, except for per share dollar amounts)
(Unaudited)
<TABLE>
<CAPTION>
Predecessor Successor
------------ ---------------------------------------------------------
Three months Three months Six months Three months Nine months
ended ended ended ended ended
Mar. 31, Sept. 30, Sept. 30, Sept. 30, Sept. 30,
1997 1997 1997 1998 1998
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Weighted average common shares outstanding... 24,338 | 24,338 24,338 30,111 29,800
Effect of dilutive securities................ 1,556 | --- --- 1,963 2,049
-------- | -------- -------- -------- --------
Weighted average common shares outstanding |
assuming dilution........................... 25,894 | 24,338 24,338 32,074 31,849
======== | ======== ======== ======== ========
|
Calculation of net income per share: |
Net (loss) income.......................... $ 1,373 | $ (3,227) $ (1,076) $ 6,823 $ 18,358
======== | ======== ======== ======== ========
Net (loss) income per share................ $ 0.06 | $ (0.13) $ (0.04) $ 0.23 $ 0.62
======== | ======== ======== ======== ========
Net (loss)income per share -- assuming |
dilution.................................. $ 0.05 | $ (0.13) $ (0.04) $ 0.21 $ 0.58
======== | ======== ======== ======== ========
</TABLE>
Note: For the three months and the six months ended September 30, 1997, the
assumed exercise of stock options has not been included in the
calculation as they would be anti-dilutive.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 64,632
<SECURITIES> 0
<RECEIVABLES> 98,086
<ALLOWANCES> 8,756
<INVENTORY> 0
<CURRENT-ASSETS> 166,416
<PP&E> 34,167
<DEPRECIATION> 25,437
<TOTAL-ASSETS> 221,868
<CURRENT-LIABILITIES> 76,464
<BONDS> 0
0
0
<COMMON> 303
<OTHER-SE> 115,345
<TOTAL-LIABILITY-AND-EQUITY> 221,868
<SALES> 179,138
<TOTAL-REVENUES> 179,138
<CGS> 76,251
<TOTAL-COSTS> 76,251
<OTHER-EXPENSES> 74,895
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 30,817
<INCOME-TAX> 12,459
<INCOME-CONTINUING> 18,358
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 18,358
<EPS-PRIMARY> 0.62
<EPS-DILUTED> 0.58
</TABLE>
