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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 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)
Delaware 54-1167173
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(State or other jurisdiction of (I.R.S. employer identification no.)
incorporation or organization)
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:
Title of each class Name of each exchange
Common Stock, $0.01 par value on which registered
New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12 (g) OF THE ACT: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the Registrant's common stock held by non-
affiliates of the Registrant based on the closing price at which stock was
sold on the New York Stock Exchange on March 12, 1999 was $184,570,746.
As of March 12, 1999, 30,599,721 shares of the Registrant's common stock
were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Stockholders of the
registrant to be held on May 20, 1999 are incorporated by reference in Part
III (Items 10, 11, 12 and 13) of this Annual Report on Form 10-K from the date
such document is filed.
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TABLE OF CONTENTS
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Item Page
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PART I
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1.Business............................................................... 3
2.Properties............................................................. 16
3.Legal Proceedings...................................................... 16
4.Submission of Matters to a Vote of Security Holders.................... 16
PART II
5.Market for Registrant's Common Equity and Related Stockholder Matters.. 17
6.Selected Consolidated Financial Data................................... 17
7.Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 19
7A.Quantitative and Qualitative Disclosures About Market Risk............ 29
8.Consolidated Financial Statements and Supplementary Data............... 31
9.Changes in and Disagreements with Accountants on Accounting and Finan-
cial Disclosure......................................................... 54
PART III
10.Directors and Executive Officers of the Registrant.................... 54
11.Executive Compensation................................................ 54
12.Security Ownership of Certain Beneficial Owners and Management........ 54
13.Certain Relationships and Related Transactions........................ 54
PART IV
14.Exhibits, Financial Statement Schedules, and Reports on Form 8-K...... 55
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PART I
ITEM 1. Business
Company Background and General Development of Business
Software AG Systems, Inc., together with its subsidiaries (collectively, the
"Company") is an enterprise solutions company that provides robust software
products and related professional services to large organizations with complex
computing requirements. The Company's products are used to build, enhance and
integrate mission-critical applications that require reliability, scalability
and security, such as customer billing systems, financial accounting systems
and inventory management systems. To complement its products, the Company has
a comprehensive professional services offering. The Company has over 25 years
of experience in addressing the needs of organizations with complex enterprise
level computing environments.
The Company provides enterprise system products and related professional
services used by organizations to develop new mission-critical applications
and enterprise integration ("EI") software products and related professional
services used to extend and integrate business applications. The Company's
enterprise system products include Adabas, a high-performance database
management system designed to operate with a variety of data types and
computer platforms, and Natural, a 4GL programming language that enables the
development of applications that are portable, scaleable and interoperable
across multiple computing platforms. The Company also provides enterprise
enablement software products and professional services that allow
organizations to integrate their mission-critical applications with other
applications and extend them to the Internet and intranets. Products in the EI
area include EntireX, a family of enterprise integration products that
facilitates the communication between application components across
heterogeneous computing environments. The EntireX family includes EntireX
DCOM, a product that uses Microsoft's ActiveX technology to integrate
applications written in a variety of programming languages. Another EI product
is iXpress, a web enablement and deployment platform. In the fourth quarter of
1998, the Company announced Sagavista, its EI product that is currently in
development. The Company believes that Sagavista will help solve EI problems
by providing a plug-and-play solution to link Enterprise Resource Planning
("ERP"), packaged, custom and legacy applications throughout an enterprise
with little or no custom coding. The Company also has a year 2000 program
which offers an internally developed software product, Sagacertify Tool Kit
(formerly Insight 2000 Tool Kit), as well as project management and consulting
services to assist customers in the resolution of their year 2000 problem. The
Company's professional services that complement its products include technical
consulting, application development, application integration, outsourcing and
year 2000 services.
In February 1981, the Company was incorporated as a Delaware corporation and
established as a holding company for SAGA SOFTWARE, Inc. (formerly Software AG
Americas, Inc.). Since 1973, SAGA SOFTWARE, Inc. has primarily licensed and
serviced products of Software AG, a German software company ("SAG"), in the
United States and other countries through a series of licensing agreements
with SAG. In June 1981, the Company sold approximately 30% of its then
outstanding common stock in an initial public offering. In 1988, SAG purchased
all of the outstanding stock of the Company, thereby acquiring control of the
Company. On March 31, 1997, SAG sold approximately 89% of the Company's then
outstanding common stock to Thayer Equity Investors III, L.P. ("Thayer") and
certain senior management of the Company (the "Recapitalization") and on
November 21, 1997, the Company and certain stockholders of the Company
consummated an initial public offering ("IPO").
In May 1998, Thayer, TC Co-Investors, LLC, whose managing member is
controlled by the principal members of Thayer's general partner ("TC Co-
Investors"), and certain senior management of the Company and SAG sold
5,460,212 shares and an over-allotment of 819,031 shares of the Company's
common stock par value $0.01 per share ("Common Stock") in a secondary
offering ("Secondary Offering"). The Company received no proceeds from the
Secondary Offering. After the Secondary Offering, Thayer, TC Co-Investors and
SAG owned approximately 36%, 0.2% and 9%, respectively, of the Company's then
outstanding Common Stock.
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The licensing agreement between the Company and SAG (the "Cooperation
Agreement") among other things (i) provides the Company the exclusive and
perpetual right to license and service in North America, South America, Japan
and Israel (collectively, the "Territory") both existing and future products
developed or acquired by SAG and (ii) provides SAG the exclusive and perpetual
right to license and service outside the Territory both existing and future
products developed or acquired by the Company. Each of the Company and SAG
must pay the other 24% of the net revenues derived from such licenses. This
24% royalty rate is fixed for 20 years. Except under certain circumstances,
the Company's minimum annual royalty payment to SAG through the year 2000 must
equal at least $21.0 million. The Company paid royalty payments of
approximately $29.3 million and $39.6 million to SAG in 1997 and 1998,
respectively. The Company anticipates that the Cooperation Agreement and SAG's
equity interest in the Company will promote close collaboration between the
Company and SAG.
The Cooperation Agreement contains certain safeguards to ensure that the
Company and SAG are able to continue to exercise their respective rights to
license and service each other's products in their respective territories.
These safeguards include rights of first refusal with respect to assignments
of proprietary rights to third parties and restrictions on SAG from competing
against the Company in the Territory and on the Company from competing against
SAG outside the Territory. The Cooperation Agreement also prohibits either
party from consummating a change of control unless such party's successor
agrees to be bound by the terms of the Cooperation Agreement with respect to
all existing products of such party and future products that are materially
derived therefrom. In addition, SAG is precluded from consummating a change of
control unless its successor agrees to continue supporting the research and
development of SAG's then existing and planned products for two years
following the change in control. The Company is precluded from consummating a
change in control in which certain specified entities would be its successor
unless such entities agree to pay the Company's minimum annual royalty
payments to SAG until the later of December 31, 2000 or two years following
the change in control.
The Company's products are distributed in Canada through SAGA SOFTWARE
(CANADA) Inc. (formerly Software AG Systems (Canada) Inc.), an indirect
subsidiary of the Company. On September 30, 1997, the Company acquired R.D.
Nickel and Associates, Inc. ("R.D. Nickel"), a software company that develops,
licenses and supports a family of application development products, including
Construct and Construct Spectrum, with Software AG Systems (Canada) Inc. the
surviving operating company. Before the acquisition, R.D. Nickel served as the
exclusive distributor of the Company's products in Canada since 1973.
Relationship with and Royalty Payments to SAG
The Company has the exclusive and perpetual right to license and service in
the Territory both existing and future products developed or acquired by SAG
and, historically, substantially all of the Company's revenues have been
generated from the licensing and servicing of products developed or acquired
by SAG. As a result, a materially adverse change in the financial condition or
a change in control of SAG could have a material adverse effect on the
business, financial condition and results of operations of the Company. In the
past, SAG has reported operating losses. In addition, the failure of SAG to
develop new products or enhancements to existing products in a timely manner,
to provide ongoing technical support for its products or to adequately protect
its proprietary rights could have a material adverse effect on the business,
financial condition and results of operations of the Company. In the past, the
Company has experienced delays in receiving products from SAG in a timely
manner. The Cooperation Agreement requires SAG to ensure that its products are
year 2000 compliant in accordance with a specified timetable. SAG has provided
the Company with written assurances that the SAG-developed products that the
Company is selling are year 2000 compliant. Both SAG and the Company are
actively cooperating to verify the year 2000 compliance of these products
through the exchange of information relative to the year 2000 test plans and
results for these products. The Company has identified a few products that are
compliant but are not compatible with all other year 2000 compliant products.
At this time, these delays and non-compatibility problems have had no material
financial impact on the Company. There is a risk to future financial
performance and of potential liability to the Company if SAG fails to deliver
the remaining products in a timely manner and resolve the compatibility issues
for these products. Any failure by SAG to deliver these
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remaining products in a timely manner could have a material adverse effect on
the Company's business, financial condition and results of operations. In
addition, to the extent that the Company's aggregate royalty payments to SAG
fall below $21.0 million in any calendar year through the year 2000, the
Company generally is required to pay the differential to SAG, and any such
differential payment could have a material adverse effect on the Company's
business, financial condition and results of operations.
Because SAG has the exclusive and perpetual right to license and service in
all territories other than the Company's Territory both existing and future
products developed or acquired by the Company, the Company is dependent on SAG
for the distribution of these products outside of the Territory. Any failure
by SAG to distribute such products in a timely and effective manner could have
a material adverse effect on the Company's business, financial condition and
results of operations.
Company Strategy
The Company's strategy is to further leverage its current leadership
position in software solutions for the development and integration of
enterprise applications for large organizations by extending its product and
professional services offerings with a particular focus on the EI market. Key
elements of the Company's strategy include developing the Company's own EI
product offerings, offering additional enterprise systems products, leveraging
its customer base, expanding professional service offerings and leveraging
distribution channels.
The Company intends to enhance and extend its product offerings with a
primary focus on EI products. The Company believes that significant
opportunity exists for software solutions which enable the integration of
mainframe legacy applications with commercial ERP systems, applications
developed internally by the Company and other client/server and
Internet/intranet based applications. With EntireX, the Company will continue
to extend Microsoft's ActiveX and DCOM technologies into large enterprise
computing environments enabling its customers to achieve enterprise-wide
application integration. The Company intends to broaden its product offerings
through internal product development, additional product licenses from third
parties and through acquisitions.
Most of the Company's customers are large, sophisticated organizations with
complex information systems in dispersed, heterogeneous computing
environments. The Company believes it can expand its share of its customers'
information technology ("IT") budgets through increased and improved product
and professional services offerings.
The Company believes that, due to the strategic nature of its products,
customers require the Company to provide comprehensive professional services
and support. The Company's strategy is to expand its key professional services
offerings, which are centered around enterprise application development and
integration, Web integration, technical consulting and the year 2000 problem.
The Company recognizes that the demand for products and professional services
that address the year 2000 problem will decline significantly following the
year 2000. To compensate for this anticipated decline in revenue, the Company
is focusing on developing two new service practices in the areas of
outsourcing and EI. The Company expects to hire additional employees and
consultants and to develop new professional services offerings to meet its
customers' evolving service needs. The Company intends to expand its efforts
to cross sell its professional services to its product customers.
In addition, the Company places a strong emphasis on developing strategic
business alliances. The Company currently has alliances with International
Business Machines Corporation ("IBM"), Microsoft Corporation ("Microsoft") and
SAP AG ("SAP"). In the future, the Company plans to develop additional
alliances with certain ERP vendors, other packaged application vendors and
service integrators.
The Company directly and indirectly sells its products in over 20 countries
within the Territory through exclusive distributors and wholly owned
subsidiaries. Under its Cooperation Agreement with SAG, the Company has access
to SAG's distribution channels for the Company's products (other than those
licensed from SAG) in approximately 50 additional countries outside the
Territory. The Company intends to leverage this distribution channel by
developing and acquiring additional products for distribution by SAG.
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Products and Services
Enterprise Systems Products and Professional Services
The Company provides a family of enterprise systems products and related
professional services that allow its customers to develop and deploy
enterprise solutions that are integrated with existing data and applications.
. Natural, the Company's 4GL programming language for the enterprise
environment, is designed to increase productivity in application software
design, development and deployment. Natural supports rapid application
development to RDBMS environments with applications that are portable,
scaleable and interoperable across multiple computing platforms.
. Add-on products for the Natural environment include: Predict, for
repository-based development environments; Construct, for model-based rapid
application development; and Construct Spectrum, for automated development
of distributed components.
The Company's family of data management solutions delivers access to data
and is designed to ensure the reliability, integrity, and security of such
data throughout an organization's computing environment.
. Adabas, the Company's flagship high-performance database management
product, is designed to handle large volumes of changing data requiring
high levels of availability. It provides multi-data model support, multi-
platform support, comprehensive SQL support, and a variety of extended
capabilities that take advantage of technological advances in both hardware
and software.
. Add-on products for the Adabas environment include: Adabas SQL Server, an
SQL interface to Adabas data; Adabas Adaplex+, a technology that
distributes and presents a single view of multiple databases; Adabas
Fastpath, which optimizes database and application performance; and Adabas
Delta Save Facility, a product for reducing backup time and database
recovery processing.
. Enterprise Systems Services. These professional services focus on the
deployment and use of the Company's database management and application
development products, including application development and enhancement,
application reengineering, application porting and rightsizing.
EI Products and Professional Services
The Company's EI products and professional services minimize the complexity
of integrating a distributed computing environment that encompasses a variety
of platforms, protocols, programming languages and databases.
. The EntireX product family includes: Broker, a cross-platform messaging
product that links mainframe applications and components to ActiveX- and
Java-enabled desktops; and SAF Gateway, a central security administration
environment. The Company also offers Broker APPC, a product that links
Advanced Program-to-Program Communication and IBM's MQSeries-enabled
mainframe applications to ActiveX- and Java-enabled desktops; Broker SDK, a
set of software products for building and deploying distributed
applications; and EntireX DCOM, a product that allows applications or
pieces of applications to work together transparently on Windows, UNIX and
MVS/VSE mainframe platforms.
. iXpress is an Internet-enablement technology that combines component
technology, such as Java and ActiveX, with enterprise systems, allowing
organizations to deliver and manage business-critical information solutions
via the Web.
. Sagavista is the Company's in-development enterprise integration engine.
Sagavista is a business-centric EI software product that is expected to be
able to intelligently link various systems in order to access desired
enterprise information, integrating disparate operating environments within
an enterprise. With pre-built solutions-ready integration adapters and
message brokering technology from the Company, Sagavista is expected to
permit global and rapidly changing businesses to experience improved
sharing of data among
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connected applications or data sources in the enterprise, including ERP,
custom, legacy packaged and database applications.
. Integration Services. The Company offers its customers a variety of
application integration professional services, such as integrating an
organization's Internet site with an order entry system; integrating
multiple sources of data, applications and services from multiple
platforms; enabling secure access for suppliers to specific data and
applications; and distributing application components across the network.
Year 2000 Products and Services
. Sagacertify Tool Kit is a product that allows developers to analyze and
remediate Natural code by providing a picture of how much code needs to be
fixed and helping project managers break year 2000 projects into segments
and develop a comprehensive work plan for executing remediation.
. Year 2000 Services. The Company's year 2000 professional services offerings
include analysis, remediation, testing and reimplementation to assist
customers in resolving their year 2000 problem. These services are provided
through a professional staff with expertise in managing large projects and
in the methodologies and products that underlie software integration and
systems management. The Company also recently established Millennium
Centers in Colorado, New Jersey and Texas to provide remediation and
testing for its year 2000 program. Year 2000 remediation can be done at one
of the Company's Millennium Centers or at the customer's site.
The Company believes that its future growth depends, in part, on millions of
instructions per second ("MIPS") growth in the Company's customer base,
increased demand for the Company's enterprise systems product and future
demand for the Company's EI product offerings. For the year ended December 31,
1998, the Company had revenues of $29.3 million from its year 2000 program.
The Company anticipates that demand for products and professional services
that address the year 2000 problem to continue in 1999 and decline
significantly following the year 2000. If the demand in 1999 for year 2000
products and professional services is different than anticipated, the
Company's business, financial condition and results of operations could be
materially adversely affected.
The Company's ability to staff and effectively manage any future growth in
this business will require it to continue to improve its operational,
financial and management controls and reporting systems and procedures, and to
hire, train, motivate and manage its professional services employees. There
can be no assurance that the Company will be able to manage these challenges
in an efficient or timely manner. If management of the Company is unable to
manage growth effectively, the Company's business, financial condition and
results of operations could be materially adversely affected.
Other Services
Education Services. The Company provides customers with in-depth training in
the Company's products, with courses available through scheduled and
customized classes. In addition, the Company offers programs to accelerate the
implementation of application development, application integration and year
2000 projects.
Consulting Services. The Company also provides consulting services to
complement all the other professional services offerings.
Product Maintenance and Customer Support
The Company offers a wide range of product maintenance and customer support
services. The Company believes that its future success is dependent in part on
its ability to provide high levels of customer service in order to cultivate
advocacy by the Company's installed customer base. For the year ended December
31, 1998, approximately 93% of the Company's customers who were eligible
renewed at least one of their maintenance
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agreements. There can be no assurance that customers will continue to renew
their maintenance agreements at this rate in the future.
Customers may choose from three levels of service and support offerings:
basic, extended and custom, which are differentiated by service deliverables
and access to support persons. Some of these customer support services include
support during product proof-of-concept/trial, technical support 24 hours a
day, seven days a week, customized support offerings, onsite installation and
implementation, remote analysis automated customer assistance and web-based
electronic services.
Research and Development
Prior to the Recapitalization, the Company was a wholly owned subsidiary of
SAG and the Company's research and development efforts were directed by SAG.
The Company's research and development expenses were $1.4 million in 1996.
Since the Recapitalization, the Company has been building its internal
product development group. The first product resulting from the Company's
recent internal product development efforts is the Sagacertify Tool Kit, which
was released in September 1997. The Company is currently developing Sagavista
which it anticipates shipping in the second half of 1999. The Company intends
to continue expanding its product development group through additional
acquisitions, licensing arrangements and hiring of employees. The Company's
research and development expenses were $1.1 million and $5.5 million in 1997
and 1998, respectively.
Since the Cooperation Agreement provides the Company with an exclusive and
perpetual right to license in the Territory products developed by SAG, the
Company also expects to continue to benefit from SAG's product development
efforts. SAG's product development costs were approximately $56.0 million each
in 1996 and 1997 and are estimated to be at least $56.0 million in 1998.
The process of developing new high-technology products is inherently complex
and uncertain and requires innovative designs anticipating customer demands
and technological trends. Without new products and services, the Company's
products and services are likely to become obsolete and the Company's
operating results are likely to be materially adversely affected. The Company
must quickly develop and deploy its products in a cost effective manner to
meet market needs. There can be no assurance that any potential product,
including Sagavista, will ever be fully developed, shipped, economically
feasible or work as expected.
The Company's success will depend in part on its ability to acquire and/or
develop product enhancements and new products that keep pace with continuing
changes in technology and evolving customer preferences, and the timely
delivery of products and product enhancements from SAG. There can be no
assurance that the Company will be successful in acquiring and/or developing
product enhancements or new products to adequately address changing
technologies, that it can introduce such products or enhancements on a timely
basis, that such products or enhancements will be successful in the
marketplace or that SAG will deliver new products or product enhancements that
will be successful in the marketplace in a timely manner. The Company's
failure to acquire and/or develop technological improvements or to adapt its
products to technological change may have a material, adverse effect on the
Company's business, financial condition and results of operations.
In addition, software products as complex as those offered by the Company
frequently contain errors or defects, especially when first introduced or when
new versions or enhancements are released. Despite product testing, new
products may contain defects or software errors and, as a result, the Company
may experience delayed or lost revenues during the period required to correct
any defects or errors. Any such defects or errors could result in adverse
customer reactions, negative publicity regarding the Company and its products,
harm to the Company's reputation, loss of or delay in market acceptance, or
could require expensive product changes, any of which could have a material
adverse effect upon the Company's business, financial condition and results of
operations. The Company's Cooperation Agreement with SAG provides for only
limited warranties by SAG with respect to the software products licensed by it
to the Company and, therefore, the Company may be primarily liable to its
customers for defects in SAG-supplied software.
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Customers and Markets
The Company's customers consist primarily of major corporations, government
agencies and educational institutions. In 1996, 1997 and 1998, no single
customer accounted for more than 10% of the Company's total revenue.
Most of the Company's sales are made to its existing customers. Customers
typically pay a licensing fee for use of the Company's products and generally
pay an annual charge for maintenance services which include software updates
and technical support. There can be no assurance that customers will continue
to purchase the Company's products and services, that the Company's historic
maintenance renewal rates will continue, or that the Company will be able to
maintain its current pricing levels for products and maintenance services.
Customers' decisions not to renew their maintenance agreements or to renew
them on different terms could have a material adverse effect on the Company's
business, financial condition and results of operations.
The majority of the Company's products are purchased by customers using IBM
and IBM-compatible mainframe computing platforms. Worldwide, an increasing
proportion of computing functions are being performed on alternative computing
platforms, including mid-range computers and client/server networks. A
significant shift in the way the Company's customers use computing platforms
may have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, although the Company
believes that any migration away from mainframe computing platforms is
subsiding as a result of more cost effective mainframe technology and other
factors, any further significant reduction in the role of mainframe or other
legacy systems could have a material adverse effect on the Company's business,
financial condition and results of operations.
Sales and Marketing
The Company sells and markets its products through both direct and indirect
channels in the Territory. In North America, the Company sells and markets its
products and services through a direct channel, operating 19 offices as of
December 31, 1998. The Company sells its products in approximately 20
additional countries through six exclusive distributorships in South America,
Japan and Israel. In addition, the Company has access to SAG's distribution
channels for the Company's products (other than those licensed from SAG) in
approximately 50 countries outside the Territory. Because the relationships
with the Company's distributors and SAG are integral to the Company's success,
the Company's continuing relationships with them are important to the
Company's success. The Company's financial results could be materially
adversely affected if the financial condition of these entities weakens or if
the Company's relationships with these entities deteriorate.
The Company's corporate marketing organization supports the Company's sales
and professional services channels through the efforts of professionals with
expertise in product marketing and marketing communications. The Company also
has strategic marketing relationships with certain vendors of computing
products and services including IBM, Microsoft and SAP AG.
Competition
The markets for the Company's software products and professional services
are highly competitive and characterized by continual change and improvement
in technology. The Company provides products and professional services to
several markets within the computer industry and encounters a variety of
competitors within each market. The Company's competitors are numerous in all
business areas ranging from highly specialized small firms to some of the
largest corporations in the world. Many of the Company's competitors have
significantly greater financial, marketing and other competitive resources
than the Company. In addition, in certain markets in which the Company
competes, such as the year 2000 market, there are no significant barriers to
entry by competitors.
In the enterprise systems markets, the Company's competitors with respect to
enterprise and departmental database management products include IBM, Oracle
Corporation ("Oracle"), Informix Corporation
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and Sybase, Inc. In addition, the Company's 4GL applications programming
language, Natural, competes with offerings from both large and small
companies, including Compuware, Inc., Oracle, IBM and Computer Associates,
Inc. In the EI markets, the Company's products compete in both the
component/object and the message oriented segments of the middleware market,
where its competitors include IBM, BEA Systems, Inc., NEON Systems, Inc.,
Active Software, Inc., Vitria, Inc. and Iona, Inc. In the market for year 2000
products and professional services, the Company's competitors include Viasoft,
Inc., BDM, Electronic Data Systems Corporation and IBM. Few of the Company's
competitors compete in all of the same markets as the Company.
The principal competitive factors affecting the markets for the Company's
product and professional services offerings include: (1) product
functionality, performance, reliability and ease of use, (2) quality of
technical support, training and consulting services, (3) responsiveness to
customer needs, (4) reputation, experience and financial stability and (5)
cost of ownership, including initial price and deployment costs as well as
ongoing maintenance costs. Due to the continued increase in new product
licenses and professional services revenues, the Company believes that it has
competed effectively in each of these areas. Nevertheless, current and
potential competitors may introduce new and better products, make strategic
acquisitions, or establish cooperative relationships among themselves or with
third parties, thereby increasing the ability of their products to address the
needs of the Company's current and prospective customers.
There can be no assurance that the Company will be able to compete
successfully against current and future competitors, and its failure to do so
would have a material adverse effect upon the Company's business, financial
condition and results of operations. In addition, no assurance can be given
that the Company will not be required to make substantial additional
investments in connection with its research, development, marketing, sales and
customer service efforts in order to meet any competitive threat, or that such
required investments will not have a material adverse effect on operating
margins. Increased competition could result in reduction in market share,
pressure for price reductions and related reductions in gross margins, any of
which could materially adversely affect the Company's business, financial
condition and results of operations.
Trademarks and Proprietary Rights
The products sold by the Company consist of products developed by SAG (e.g.,
Adabas, Natural and EntireX), products owned by other third parties which are
distributed by the Company (e.g., iXpress) and products developed or acquired
by the Company (i.e., Sagacertify Tool Kit, Construct and Construct Spectrum).
For all of these products, the Company, if not the developer, is contractually
obligated to provide appropriate security measures to protect the proprietary
materials of SAG and other third parties against misappropriation and illegal
copying.
The Company treats all of the products that it distributes as proprietary
trade secrets and confidential information. It relies primarily upon a
combination of trade secret, copyright and trademark laws, its license
agreements with customers, and its internal security systems, confidentiality
procedures and employee agreements to maintain the security of its products.
The Company typically provides its products to users under nonexclusive,
nontransferable perpetual licenses which generally permit use of the licensed
software solely for the user's internal operations on designated computers at
specific sites. Under certain circumstances, the Company makes available the
source code for its products under an escrow arrangement which restricts
access to and use of the source code. Although the Company takes steps to
protect its trade secrets and other proprietary rights, there can be no
assurance that misappropriation will not occur. In addition, the laws of some
foreign countries do not protect proprietary rights to the same extent as the
laws of the United States.
The Company seeks to protect its software, documentation and other written
materials under copyright law, and to assert trademark rights in its product
names. Although the Company has not traditionally sought to protect its
products under patent laws, the Company has filed a patent application with
regard to its new Sagavista product in development. SAG and some third parties
have patented, in the United States, Japan and/or the European Union, certain
of the products which the Company distributes.
10
<PAGE>
The Company is also dependent on SAG and other third parties that license
products to the Company to protect their respective proprietary rights in such
products. There can be no assurance that the legal protections afforded to, or
the precautions taken by, the Company or its third-party licensors will be
adequate to prevent misappropriation of their respective proprietary rights.
In addition, these protections do not prevent independent third-party
development of functionally equivalent or superior technologies, products or
professional services. Any infringement or misappropriation of the Company's
proprietary rights, or those of its third-party licensors, could have a
material adverse effect on the Company's business, financial condition and
results of operations.
In the future, litigation may be necessary to enforce and protect the
Company's trade secrets, copyrights and other intellectual property or
proprietary rights. The Company may also be subject to litigation to defend
against claimed infringement of, or to determine the scope and validity of,
the intellectual property or proprietary rights of others. In the event of
litigation involving the use of technology by the Company, the Company could
be required to expend significant resources to develop non-infringing
technology or to obtain licenses to technology involved in litigation. There
can be no assurance that the Company would be successful in such development
or that any such licenses would be available on commercially reasonable terms,
if at all. Although the Company is not aware of any claims that its products,
trademarks or other proprietary rights infringe on the proprietary rights of
third parties, there can be no assurance that third parties will not assert
infringement claims against the Company in the future with respect to current
and future products or that any such assertion may not require the Company to
enter into royalty arrangements or result in costly litigation. There can be
no assurance that third parties will not assert infringement claims against
the Company and that such claims will not have a material adverse effect on
the Company's business, financial condition and results of operations. Any
litigation involving the use of technology by the Company could result in
substantial cost to the Company and divert management's attention from the
Company's operations, either of which could have a material adverse effect on
the Company's business, financial condition and results of operations. Adverse
determinations in such litigation could result in the loss of the Company's
proprietary rights, subject the Company to significant liabilities, require
the Company to seek licenses from third parties or prevent the Company from
selling its products, any one of which could have a material adverse effect on
the Company's business, financial condition and results of operations.
iXpress(R) is a registered trademark of the Company in the United States
and/or other countries and Construct(TM), Construct Spectrum(TM), Construct
Spectrum SDK(TM), Sagacertify(TM), Sagavista(TM) and Insight 2000(SM) are
trademarks or service marks of the Company in the United States and/or other
countries. Adabas(R), Adaplex+(R) Entire(R), EntireX DCOM(TM), Entire
Broker(TM), Entire Broker SDK(TM), Entire Broker APPC(TM), Entire SAF
Gateway(TM), Natural(R), Natural Lightstorm(TM), Adabas Delta Save
Facility(TM), Adabas Fastpath(TM), and Adabas SQL Server(TM) are developed by
SAG of Darmstadt, Germany and are distributed in the United States, South
America, Latin America, Canada, Israel and Japan exclusively through the
Company and its distributors. Adabas(R) and Natural(R) are registered
trademarks of SAG. Except for Adabas(R) and Natural(R), these products
developed by SAG are either registered trademarks or trademarks of the Company
in the United States and/or other countries. Trade names and trademarks of
other companies appearing in this report are the property of their respective
owners. The duration of each of the registered trademarks is 10 years and the
duration of each of the common law trademarks is perpetual. The trademarks are
an integral part of the Company's product identification.
Employees
As of February 28, 1999, the Company had approximately 900 employees. None
of the Company's employees is represented by a labor union, and the Company
has never experienced any work stoppage. The Company considers its relations
with its employees to be good.
The Company's success will depend in part on its continued ability to
attract and retain highly qualified personnel in a competitive market for
experienced software developers, professional services staff and sales and
marketing personnel. The Company's future performance depends to a significant
degree upon the continued service of the key members of its management, as
well as marketing, sales, consulting and product development
11
<PAGE>
personnel, and its ability to attract and retain new management and other
personnel. The loss of any one or more of the Company's key personnel could
have a material adverse effect on the Company's business, financial condition
and results of operations. Company employees are employed at-will and the
Company has no fixed-term employment agreements with any of its employees.
While historically the Company primarily has relied on SAG for product
development, the Company believes its future success will also depend in part
upon its ability to develop its own technologies and products and,
consequently, upon its ability to attract and retain highly skilled technical
and product development personnel. Competition for such personnel is intense,
and there can be no assurance that the Company will be able to retain its key
employees or that it will be successful in attracting, integrating and
retaining new personnel in the future. Failure to attract, integrate and
retain such personnel could have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, at
December 31, 1998, the Company had approximately 160 independent contractors
working as technical consultants primarily in connection with the Company's
professional service offerings. Competition for such contractors is intense
and the failure to continue to attract, hire and retain such contractors when
they are needed could have a material adverse effect on the Company's
business, financial condition and results of operations.
Environmental Matters
The Company does not expect compliance with federal, state and local
provisions relating to the protection of the environment to have a material
effect on capital expenditures, earnings or the Company's competitive
position. Presently, there are no material expenditures anticipated for
environmental control facilities for 1999 or the near future.
Backlog
The Company believes that backlog is not a meaningful indicator of future
business prospects due to the relatively short period of time between
acceptance of an order and delivery and the portion of revenue related to its
service and support business. As of December 31, 1998, the Company does not
have a material backlog and the majority of the backlog will be filled by
December 31, 1999.
Other Conditions Related to the Business
In addition to other risk factors herein, the Company may be subject to the
following risks and uncertainties.
Dependence on Third-Party Technology. The Company's products are currently
designed, and may in the future be designed, to work on or in conjunction with
certain third-party hardware and/or software products. In addition, the
Company relies on the timely delivery of competitive products and enhancements
from SAG for a material part of its revenue. If any of these current or future
third-party vendors or SAG were to discontinue making their products available
to the Company or to licensees of the Company's products on a timely basis, or
to increase materially the cost to the Company or its licensees to acquire,
license or purchase such third-party vendor's products, or if a material
problem were to arise in connection with the ability of the Company's products
to properly use or operate with third-party hardware and/or software products,
the Company's products would have to be redesigned by the Company, or the
licensor of the product to the Company, to function with or on alternative
third-party products, or the Company or its licensees may not be able to sell
the product at all. There can be no assurance that an alternative source of
suitable technology would be available or that the Company, or the licensor of
the product to the Company, would be able to develop an alternative product on
a timely basis or at a reasonable cost. The failure of the Company to license,
acquire or develop alternative technologies or products on a timely basis and
at a reasonable cost could have a material adverse effect on the Company's
business, financial condition and results of operations.
Potential Fluctuations in Quarterly Performance/Seasonality of the
Business. The Company has experienced significant quarterly and other
fluctuations in revenues and results of operations and, although future
12
<PAGE>
results may vary, the Company expects these fluctuations to continue in the
future. The Company believes that these fluctuations have been primarily
attributable to the budgeting and purchasing practices of its customers, and,
to a lesser extent, the Company's sales commission practices, which are based
partly on annual quotas, and other factors. The Company's revenues and results
of operations may also be affected by seasonal trends which have resulted in
higher revenues in the Company's third and fourth quarters and lower revenues
in its first and second quarters. The Company's professional services fees
tend to fluctuate due to the completion or commencement of significant
projects, the number of working days in a quarter and the Company's ability to
attract, retain and efficiently utilize professional services personnel. The
Company's future revenues and operating results may fluctuate as a result of
these and other factors, including the demand for the Company's products and
services, the timing and cost of new product and service introductions and
product enhancements by the Company or its competitors, changes in the mix of
products and services sold by the Company and in the mix of sales by
distribution channels, commencement or conclusion of significant service
contracts, timing of any acquisitions and associated costs, the size, timing
and terms of customer orders, including delays in significant orders, changes
in pricing policies by the Company or its competitors, the timing of
collection of accounts receivable, changes in foreign currency exchange rates,
competitive conditions in the industry and general economic conditions.
The Company's expense levels are based, in part, on its expectation of
future revenues, and expense levels are, to a large extent, fixed in the short
term. The Company may be unable to adjust spending in a timely manner to
compensate for any unexpected revenue shortfall. If revenue levels are below
expectations for any reason, the Company's results of operations are likely to
be materially and adversely affected. The Company's net income may be
disproportionately affected by a reduction in revenue because a large portion
of the Company's expenses cannot be easily reduced. In addition, the Company
intends to increase its operating expenses by expanding its software product
development staff, increasing its professional services and sales and
marketing operations, expanding its distribution channels and hiring personnel
in other operating areas. The Company expects to experience a significant time
lag between the date professional services, sales and technical personnel are
hired and the date such personnel become fully productive. The timing of such
expansion and the rate at which new technical, professional services and sales
personnel become productive as well as the timing of the introduction and the
productivity of new distribution channels could cause material fluctuations in
quarterly results of operations. Furthermore, to the extent such increased
operating expenses precede or are not subsequently followed by increased
revenues, the Company's business, financial condition and results of
operations could be materially and adversely affected.
Due to all of the foregoing factors, it is likely that in some future
periods the Company's revenues or results of operations will be below the
expectations of securities analysts or investors, in which case the market
price of the Common Stock would likely be materially and adversely affected.
The Company offers its customers installment payment plans as a vehicle for
financing license fees. Customers have expressed a desire to finance large
purchases, therefore, the Company acts competitively in allowing them to do
so. The Company maintains its own financing plans rather than utilizing banks
or other third parties to arrange client financing, although historically
certain installment accounts receivable have been sold to third parties. See
Note 7 of Notes to Consolidated Financial Statements.
Reliance on Acquisitions. The Company believes that its future growth may
depend, in part, on its ability to successfully identify, acquire and then
develop promising technologies and products. In addition, the Company intends
to build its product development staff in part through acquisitions. The
integration of R.D. Nickel or any other future acquisitions into the Company's
existing business could result in certain unanticipated difficulties that
could require a disproportionate amount of management's attention and the
Company's resources. Furthermore, there can be no assurance that the
anticipated benefits of acquiring R.D. Nickel or any other future acquisition
will be realized. The Company has limited experience in completing
acquisitions and integrating acquired technologies or products into its
operations. The Company may compete for future acquisition opportunities with
other companies that have significantly greater financial and management
resources and there
13
<PAGE>
can be no assurance that the Company will be successful in identifying,
acquiring and developing products and technology. Acquisitions could also have
adverse short-term effects on the Company's operating results, and could
result in dilutive issuances of equity securities and the incurrence of debt
and contingent liabilities. In addition, many business acquisitions must be
accounted for as purchases and, because most software-related acquisitions
involve the purchase of significant intangible assets, these acquisitions
typically result in substantial amortization charges and may also involve
charges for acquired research and development projects, which could have a
material adverse effect on the Company's operating results. The Company has
incurred significant charges of this nature in connection with its acquisition
of R.D. Nickel.
Risk Associated with International Sales and Operations. The Company holds
the exclusive and perpetual right to license SAG products in North America,
South America, Japan and Israel. In South America, Japan and Israel, the
Company has entered into exclusive distributorship arrangements with local
firms. There can be no assurance that such distributors will continue to
perform as they have historically and that they will not offer products that
compete with the Company's products. Additionally, the distributorships
generally may be terminated by either party at any time upon compliance with
applicable notice provisions. In the event that any of the distributorships
were terminated or expired, there can be no assurance that the Company could
find an adequate replacement, and such a termination or expiration could have
a material adverse effect on the Company's business, financial condition and
results of operations.
Royalty revenues from international distributors represented 17%, 15% and
10% of the Company's total revenues in 1996, 1997 and 1998, respectively. This
decline in percentage was primarily due to the acquisition in September 1997
of R.D. Nickel, a former international distributor of the Company, and a
higher growth rate in total revenues compared to the revenue growth rate from
international distributors. Excluding the revenue from R.D. Nickel prior to
the acquisition, the revenue from international distributors would have
increased each year from 1996 to 1998. The Company anticipates that royalty
revenues from international sales and services will continue to account for a
material portion of its total revenues in the foreseeable future. As a result,
the Company may be subject to certain risks associated with international
operations, foreign currency exchange rate fluctuations and the application
and imposition of protective legislation and regulations relating to import or
export activities (including export of high technology products) or otherwise
resulting from foreign policy or the variability of foreign economic
conditions.
The Company's international distributors report and pay royalties 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 less than 3% of total revenues in
each 1996, 1997 and 1998. With the acquisition of R.D. Nickel, the Company
began direct sales in Canada effective October 1, 1997. Revenues from this
source were approximately 4% of total revenues in the fourth quarter of 1997
and 5% of the total revenues in 1998. The Company, therefore, has not, to
date, engaged in foreign currency hedging transactions. The Company may enter
into hedging transactions in the future.
Additional risks associated with international operations include costs of
localizing products for foreign countries, lack of acceptance of localized
products in foreign countries, difficulties in enforcing intellectual
property, proprietary and contract rights, the burdens of complying with a
wide variety of foreign laws, potentially adverse tax consequences, tariffs,
quotas and other barriers, and potential difficulties in collecting accounts
receivable. There can be no assurance that these and other factors will not
have a material adverse effect on the Company's business, financial condition
and results of operations.
See Note 16 of Notes to Consolidated Financial Statements for financial data
pertaining to the geographic distribution of the Company's operations.
Potential for Contract Liability. The Company markets its products and
professional services to customers for, among other things, developing,
building, deploying, maintaining and managing mission-critical computer
software applications and for addressing the year 2000 problem. The Company's
license and other agreements with its customers typically contain provisions
designed to limit the Company's exposure to potential
14
<PAGE>
liability claims relating to the Company's products or professional services.
Despite this precaution, there can be no assurance that the limitations of
liability set forth in the Company's agreements would be enforceable or would
otherwise protect the Company from liability for damages. Although the Company
has not experienced any material liability claims to date, the sale and
support of the Company's products and professional services may entail the
risk of such claims, which could be substantial in light of the use of such
products in mission-critical applications. A material liability claim against
the Company, regardless of its outcome, could result in substantial cost to
the Company and divert management's attention from the Company's operations.
Therefore, any material liability claim could have a material adverse effect
on the Company's business, financial condition and results of operations.
Dependence on State, Local and Other Government Contracts. The Company
derived 24%, 30% and 20% of its total revenues in 1996, 1997 and 1998,
respectively, from selling its products and professional services directly or
indirectly to state and local government agencies. In addition, the Company
derived 9%, 11% and 8% of its total revenues in 1996, 1997 and 1998,
respectively, from selling its products and professional services directly or
indirectly to federal government agencies. Any failure to obtain a contract
award, or a delay on the part of a government agency in making the award or in
ordering products and professional services under an awarded contract, could
have a material adverse effect on the Company's business, financial condition
and results of operations. Other risks generally involved in government sales
include the larger discounts (and thus lower margins) typically involved in
government sales, the dependence of the Company on the ability of a prime
contractor, if any, to obtain the award and perform the contract, the
unpredictability of funding for various government programs, the ability of
the government agency to unilaterally terminate the contract, and the
dependence on the creditworthiness of any prime contractor (some of which are
relatively small organizations without substantial funds). The Company
anticipates that state, local and other government sales will continue to
represent a significant but fluctuating portion of its revenues in the future.
Fixed Price Contracts. Revenues from fixed price contracts represented
approximately 8%, 12% and 11% of the Company's total revenues for 1996, 1997
and 1998, respectively. In making proposals for fixed price contracts, the
Company relies on its estimated costs for completing the project. These
estimates reflect, among other factors, judgments as to the efficiencies of
the Company's technology and services as applied to the project. Any increased
or unexpected costs or unanticipated delays in connection with the performance
of fixed price contracts could have a material adverse effect on the Company's
business, financial condition and results of operations. In the past, the
Company has suffered material losses on fixed price contracts.
Control By Officers, Directors and Thayer. As of March 12, 1999, the
Company's officers and directors, and their affiliates, in the aggregate, have
voting control of approximately 47% of the Company's outstanding Common Stock.
In particular, Thayer and its affiliates have voting control of approximately
35% of the Company's outstanding Common Stock. As a result, these stockholders
will be able to control all matters requiring stockholder approval, including
the election of directors and approval of significant corporate transactions.
The voting power of Thayer and the Company's officers and directors under
certain circumstances could have the effect of preventing or delaying a change
in control of the Company.
Anti-Takeover Effect of Certain Provisions. The Company's Second Amended and
Restated Certificate of Incorporation and Third Amended and Restated Bylaws
contain certain provisions that may have the effect of discouraging a third
party from making an acquisition proposal for the Company. Such provisions
could limit the price that investors might be willing to pay in the future for
shares of the Company's Common Stock. In addition, the Company's Board of
Directors is divided into three classes, the members of each of which will
serve for a staggered three-year term, which may make it more difficult for a
third party to gain control of the Company's Board of Directors. Certain
provisions of the Cooperation Agreement with SAG may also have the effect of
discouraging a third party from making an acquisition proposal for the
Company.
15
<PAGE>
ITEM 2. Properties.
The Company's executive offices, principal marketing and data center
facilities are located in approximately 173,000 square feet of space in a
three building campus that the Company leases in Reston, Virginia. The Company
also leases approximately 11,000 square feet of space for use as a print shop
and materials distribution center in Dulles, Virginia. The Company's Customer
Service and Support Center is located in approximately 86,000 square feet that
the Company leases in Highlands Ranch, Colorado. The Company currently sublets
approximately 18,000 and 25,000 square feet of the Reston and Highlands Ranch
locations, respectively.
The Company's subsidiary in Mexico leases offices of approximately 15,000
square feet in Mexico City and Monterrey, Mexico. In addition, the Company
leases product sales and professional services branch offices of approximately
43,000 square feet in the following cities in Canada: Calgary, Cambridge,
Edmonton, Montreal, Ottawa and Toronto.
The Company leases product sales and professional services branch offices
in: Irvine and Sacramento, California; Atlanta, Georgia; Chicago, Illinois;
Braintree, Massachusetts; Bloomington, Minnesota; Fort Lee, New Jersey;
Plymouth Meeting, Pennsylvania; Dallas, Texas; Bellevue, Washington and
Reston, Virginia in the United States.
The Company believes that its facilities are adequate for its current needs
and that suitable space will be available as needed to accommodate the
expansion of the Company's operations.
ITEM 3. Legal Proceedings.
From time to time, the Company is involved in legal proceedings and
litigation arising in the ordinary course of business. As of the date of this
report, the Company is not a party to any litigation or other legal proceeding
that, in the opinion of management, could have a material adverse effect on
the Company's business, financial condition or results of operations.
ITEM 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of security holders during the
fourth quarter of the year covered by this report.
16
<PAGE>
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder
Matters.
Price Range of Common Stock
The Company's Common Stock trades on the New York Stock Exchange ("NYSE")
under the symbol AGS. The following table sets forth the quarterly high and
low prices as reported by the NYSE composite transactions for 1997 and 1998.
As the Company's IPO went effective on November 17, 1997 and trading began in
the Company's Common Stock on November 18, 1997, the quarterly high and low
prices reported by the NYSE composite transactions are only available
beginning with the fourth quarter in 1997.
<TABLE>
<CAPTION>
1997 1998
---------- -----------
Quarters ended, High Low High Low
--------------- ------ --- ---- ---
<S> <C> <C> <C> <C>
March 31,........................................... n/a n/a 27 1/4 11 1/8
June 30,............................................ n/a n/a 33 22 1/2
September 30,....................................... n/a n/a 32 15 7/8
December 31,........................................ 14 1/2 10 20 3/4 11 7/8
</TABLE>
Dividends
The Company did not pay any cash dividends in 1997 or 1998 and does not
anticipate paying any cash dividends on its Common Stock in the foreseeable
future.
Holders of Record
The Company had approximately 3,945 stockholders of record of its Common
Stock at March 26, 1999.
ITEM 6. Selected Consolidated Financial Data.
The consolidated statement of operations data set forth below for each of
the years ended December 31, 1994, 1995, 1996, 1997 and 1998 and the
consolidated balance sheet data as of December 31, 1994, 1995, 1996, 1997 and
1998 have been derived from the Company's consolidated financial statements,
which statements have been audited by KPMG LLP, independent certified public
accountants. The selected consolidated financial data set forth below should
be read in conjunction with the Consolidated Financial Statements and Notes
thereto and with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" appearing elsewhere in this Form 10-K. The
historical financial data set forth below for the periods ended, or as of the
dates prior to, March 31, 1997 reflect the results of operations and balance
sheet data of the Company prior to the Recapitalization when the Company was a
wholly owned subsidiary of SAG and is captioned as "Predecessor". The
historical financial information subsequent to March 31, 1997 reflects the
results of operations and balance sheet data subsequent to the
Recapitalization and is captioned as "Successor".
17
<PAGE>
<TABLE>
<CAPTION>
Predecessor Combined(1) Predecessor Successor
-------------------------- ----------- ----------- -----------------
Three Nine
months months Year
Years ended December 31, ended ended ended
-------------------------------------- Mar. 31, Dec. 31, Dec. 31,
1994 1995 1996 1997 1997 1997 1998
-------- -------- -------- ----------- ----------- -------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Consolidated Statement
of Operations Data:
Software license fees... $ 51,832 $ 52,061 $ 52,163 $ 64,137 $ 7,341 | $ 56,796 $ 94,899
Maintenance fees........ 65,871 65,307 69,702 72,689 17,352 | 55,337 83,817
Professional service |
fees................... 29,552 35,194 34,975 44,398 9,948 | 34,450 70,273
-------- -------- -------- -------- ------- | -------- --------
Total revenues........ 147,255 152,562 156,840 181,224 34,641 | 146,583 248,989
Gross profit............ 77,429 81,239 83,869 94,984 17,127 | 77,857 142,771
Operating expenses |
before write-off....... 76,534 78,051 78,588 75,171 15,817 | 59,354 100,690
Write-off of acquired |
in-process research and |
development costs(2)... -- -- -- 6,051 -- | 6,051 --
Income from operations.. 895 3,188 5,281 13,762 1,310 | 12,452 42,081
Net income.............. $ 1,382 $ 3,326 $ 6,209 $ 6,711 $ 1,373 | $ 5,338 $ 27,710
======== ======== ======== ======== ======= | ======== ========
Net income per common |
share(3)............... $ 0.05 $ 0.12 $ 0.23 $ 0.27 $ 0.06 | $ 0.21 $ 0.93
======== ======== ======== ======== ======= | ======== ========
Net income per common |
share--assuming |
dilution(3)............ $ 0.05 $ 0.11 $ 0.21 $ 0.25 $ 0.05 | $ 0.20 $ 0.87
======== ======== ======== ======== ======= | ======== ========
Dividends............... $ 600 $ 1,700 $ 9,000 $ -- $ -- | $ -- $ --
======== ======== ======== ======== ======= | ======== ========
</TABLE>
<TABLE>
<CAPTION>
Predecessor Successor
-------------------------- -----------------
December 31,
--------------------------------------------
1994 1995 1996 1997 1998
------- -------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
Consolidated Balance Sheet Data:
Working capital (deficit)........ $ 5,167 $ (2,465) $ 30,421|$ 62,052 $ 85,946
Total assets..................... 86,466 125,612 158,088| 201,737 253,765
Long-term debt, less current |
maturities...................... 431 -- -- | -- 635
Total stockholders' equity....... 30,972 32,599 29,808| 89,818 127,908
</TABLE>
- --------
(1) Reflects combined data for the three months ended March 31, 1997 (prior to
the Recapitalization) and for the nine months ended December 31, 1997
(subsequent to the Recapitalization).
(2) The write-off of acquired in-process research and development costs for
the year ended December 31, 1997 relates to the Company's acquisition of
R.D. Nickel. Before deducting the nonrecurring write-off for this period,
income from operations was $19.8 million, net income was $12.8 million and
basic and diluted earnings per share for net income was $0.51 and $0.48,
respectively.
(3) In accordance with the Statement of Financial Accounting Standards No. 128
"Earnings Per Share" ("SFAS No. 128") issued by the Financial Accounting
Standards Board, the Company adopted the SFAS No. 128 during 1997. For all
periods presented prior to 1997, the Company retroactively adopted SFAS
No. 128 for calculating and presenting the earnings per share. See Note 1
of Notes to Consolidated Financial Statements.
18
<PAGE>
ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Overview
In February 1981, the Company was incorporated as a holding company for SAGA
SOFTWARE, Inc. (formerly Software AG of North America, Inc.). In June 1981,
the Company sold approximately 30% of its then outstanding common stock in an
initial public offering. In 1988, SAG purchased all of the outstanding stock
of the Company, thereby acquiring control over the Company. On March 31, 1997,
the Company consummated the Recapitalization, whereby SAG sold approximately
89% of the Company's then outstanding common stock to Thayer and certain
senior management of the Company (See Note 2 of the Notes to Consolidated
Financial Statements). On November 21, 1997, the Company and certain
stockholders of the Company consummated the IPO which resulted in net proceeds
to the Company of $42.8 million (See Note 3 of the Notes to Consolidated
Financial Statements).
In May 1998, Thayer and certain senior management of the Company and SAG
sold 5,460,212 shares and an over-allotment of 819,031 shares of the Company's
Common Stock in the Secondary Offering. The Company received no proceeds from
the Secondary Offering. After the Secondary Offering, Thayer and SAG owned
approximately 36% and 9%, respectively, of the Company's then outstanding
Common Stock.
Immediately prior to the consummation of the Recapitalization, the Company
entered into a perpetual Cooperation Agreement with SAG. As consideration for
the Cooperation Agreement, the Company paid SAG approximately $22.6 million.
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 will be required to pay SAG minimum annual royalties of $21.0 million,
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. The Company's Cooperation
Agreement has been recorded at $23.5 million, its fair value, determined at
the time of the Recapitalization through an independent appraisal. The Company
recorded remaining assets and liabilities at book value which approximates the
fair value at the date of 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 $6.4 million was recorded. The Cooperation
Agreement and the goodwill are being amortized on a straight-line basis over
10 years. See Note 2 of the Notes to Consolidated Financial Statements.
On September 30, 1997, the Company acquired R.D. Nickel, a software company
that develops, licenses and supports a family of application development
products. R.D. Nickel is located in Ontario, Canada. The transaction was
accounted for using the purchase method of accounting for a business
combination. As a result of this acquisition, the Company recorded an
approximately $6.1 million non-recurring charge against earnings for in-
process research and development costs in September 1997. The Company also
recorded goodwill (excess purchase price) in the amount of approximately $5.0
million, which is being amortized over ten years. As of October 1, 1997, the
operating results of R.D. Nickel have been consolidated with the Company's
operating results. See Note 4 of the Notes to Consolidated Financial
Statements.
The Company is an enterprise solutions company that provides robust software
products and related professional services to large organizations with complex
computing requirements. The Company's revenues are primarily derived from
license fees for the use of software products, fees for maintenance related to
those products and fees for professional services.
The Company's software license fees are derived primarily from the licensing
of the Company's enterprise systems and enterprise integration products.
Enterprise systems products include Adabas, a high-performance data management
system, and Natural, a 4GL programming language. Enterprise integration
products include EntireX, a family of integration products, and Sagacertify
Tool Kit (formerly Insight 2000 Tool Kit), a software product that addresses
the year 2000 problem.
19
<PAGE>
The Company's maintenance fees are derived primarily from providing
technical support services to customers who have licensed the Company's
enterprise systems and enterprise integration 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 products.
The Company's professional services fees are derived primarily from services
provided with the implementation and deployment of the Company's enterprise
systems and enterprise integration products, and through educational services.
The Company's professional services offerings include consulting, software
integration, system implementation, large project management and year 2000
analysis and remediation. The services are delivered on either a time and
material basis or a fixed price basis.
The Company markets and sells its software products and maintenance
services, as well as third-party products, through direct and indirect
channels in its Territory. In North America, a direct sales and support
structure is utilized through the Company's wholly owned subsidiaries. In the
remainder of the Territory, exclusive distributors sell the Company's products
and provide maintenance support and pay the Company a royalty on the revenues
derived therefrom. The Company has historically generated the majority of its
revenues from sales within the United States. Royalty revenues from
international distributors represented approximately 17%, 15% and 10% of the
Company's total revenues in 1996, 1997 and 1998, respectively.
The Company offers its products and professional services to certain
customers under Enterprise License Agreements ("ELAs"). ELAs are typically
long-term contracts of three to five years which include software products,
maintenance support and professional services. Revenues from software licenses
sold as part of an ELA are recognized as revenue when such products are
shipped. Revenue from maintenance support and professional services are
recognized as provided.
On January 1, 1998, the Company adopted Statement of Position 97-2,
"Software Revenue Recognition" ("SOP 97-2"), as amended by SOP 98-4 and SOP
98-9. SOP 97-2 focuses on when and in what amount revenue should be recognized
for licensing, selling, leasing, or otherwise marketing computer software. SOP
98-4 and SOP 98-9 defer certain portions of SOP 97-2 until the Company's
fiscal year 2000. Management of the Company is currently evaluating what
impact, if any, SOP 97-2 will have on the Company's revenue recognition
policies once the portions of SOP 97-2, which have been deferred become
effective (see Note 1 of the Notes to Consolidated Financial Statements).
Results of Operations
Years ended December 31, 1998 and 1997
Revenues
Total Revenues. The Company's total revenues were $249.0 million and $181.2
million in 1998 and 1997, respectively, representing an increase of 37%.
Software License Fees. Software license fees were $94.9 million and $64.1
million in 1998 and 1997, respectively, representing an increase of 48%. This
increase was primarily attributable to the expanded deployment of the
Company's products within the current customer base, combined with the
increased number of new ELAs entered into in 1998 compared to 1997. There were
54 new ELAs with software license fees of $41.3 million compared to 47 ELAs
with software license fees of $27.7 million in 1997.
Maintenance Fees. Maintenance fees were $83.8 million and $72.7 million in
1998 and 1997, respectively, representing an increase of 15%. This increase
was primarily attributable to expansion of the installed base due to strong
license sales. The increase was also attributable to the incremental revenue
recorded since the R.D. Nickel acquisition in September 1997.
20
<PAGE>
Professional Services Fees. Professional services fees were $70.3 million
and $44.4 million in 1998 and 1997, respectively, representing an increase of
58%. This increase was primarily attributable to the increase in the revenue
generated from the Company's year 2000 program which began in 1997. The year
2000 program revenue increased to $29.3 million in 1998 from $6.6 million in
1997. The Company anticipates demand for product and professional services
that address the year 2000 problem to continue in 1999 and decline
significantly following the year 2000. If the demand in 1999 for year 2000
products and professional services is different than anticipated, the
Company's business, financial condition and results of operations could be
materially adversely affected.
Cost of Revenues
Software License. Software license costs consist primarily of royalties paid
to third parties. Software license costs were $23.3 million and $19.9 million
in 1998 and 1997, respectively, representing 25% 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 primarily due
to the shift in the mix of third party products sold, including those
developed by SAG. The royalty rates on third party products vary from 24% to
40%. The decrease in the percentage was also attributable to an increase in
the sale of the Company owned products compared to the prior year.
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 $30.0 million and $28.8 million in 1998 and
1997, respectively, representing 36% and 40% of maintenance fees for each
respective period. The increase in dollar amount was primarily attributable to
the increase in sale of software license and maintenance fees. The percentage
decrease was primarily attributable to the shift in the mix of third party
products sold, including those developed by SAG, and improved utilization of
existing resources.
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 $52.8 million and $37.6 million in 1998 and
1997, respectively, representing 75% and 85% of professional services fees for
each respective period. The increase in the dollar amount was primarily due to
an increase in sales volume. The decrease in percentage 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 $5.5 million and
$1.1 million in 1998 and 1997, respectively, representing 6% and 2% of
software license fees for each respective period. The increases in both the
dollar amount and the percentage were primarily due to expenses incurred in
support of the Company's current product in development, Sagavista. The total
number of developers has increased to 54 in 1998 from 8 in 1997. The Company
expects software product development expenses to increase in the future as a
percentage of software license fees as the management of the Company has
undertaken several strategic initiatives since the Recapitalization to
increase revenue growth and profitability.
Sales and Marketing. Sales and marketing expenses consist primarily of
employee salaries, benefits, commissions, marketing programs, public
relations, proposal writing, trade shows, seminars, advertising and related
communications and associated overhead costs. Sales and marketing expenses
were $47.6 million and $38.3 million in 1998 and 1997, respectively,
representing 19% and 21% of total revenues for each respective period. The
increased dollar amount was mainly attributable to several new marketing
programs implemented in 1998 combined with 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
21
<PAGE>
since the R.D. Nickel acquisition in September 1997. The decrease in
percentage was primarily due to a higher percentage increase in revenue than
the percentage increase in sales and marketing expenses over the prior year.
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, amortization expenses,
accounting and legal expenses. Administrative and general expenses were $47.6
million and $35.8 million in 1998 and 1997, respectively, representing 19% and
20% 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 of acquired in-process research and development costs in 1997 was
attributable to certain of the products acquired in the acquisition of R.D.
Nickel. See Note 4 of Notes to 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, long term customer contracts carried by the Company and
miscellaneous income, offset by miscellaneous expenses. Other income and
expense, net, was $4.0 million and $2.0 million in 1998 and 1997,
respectively. This increase was primarily attributable to the increase in the
interest income from cash, cash equivalents and the short-term investments in
1998.
Income Tax Provision. The income tax provision was $18.4 million and $9.0
million in 1998 and 1997, respectively, resulting in effective tax rates of
39.9% and 41.5% (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.
Years ended December 31, 1997 and 1996
Revenues
Total Revenues. The Company's total revenues were $181.2 million and $156.8
million in 1997 and 1996, respectively, representing an increase of 16%.
Software License Fees. Software license fees were $64.1 million and $52.2
million in 1997 and 1996, respectively, representing an increase of 23%. This
increase was primarily attributable to the reorganization of the direct sales
force at the beginning of 1997 into three groups, with one group focused on
software products, another on professional services and a third on the year
2000 program. As a result of this reorganization, the Company has experienced
increased acceptance of ELAs by its customer base. In 1997, the Company
entered into 47 ELAs, compared to 30 ELAs in 1996. The increase in revenue was
also impacted by the incremental revenue recorded since the acquisition of
R.D. Nickel in September 1997.
Maintenance Fees. Maintenance fees were $72.7 million and $69.7 million in
1997 and 1996, respectively, representing an increase of 4%. This increase was
primarily attributable to the effect of price increases, combined with an
increase in the maintenance base from the sale of new software licenses and
incremental maintenance fees recorded since the R.D. Nickel acquisition.
22
<PAGE>
Professional Services Fees. Professional services fees were $44.4 million
and $35.0 million in 1997 and 1996, respectively, representing an increase of
27%. This increase was primarily attributable to the Company's year 2000
program, which began in 1997 and contributed $6.6 million of professional
services fees in 1997.
Cost of Revenues
Software License. Software license costs were $19.9 million and $14.1
million in 1997 and 1996, respectively, representing 31% and 27% of software
license fees for each respective period. The increase in dollar amount was
primarily due to an increase in sales volume. The percentage increase was
primarily due to a shift in product mix since royalty rates on third-party
products varied from 24% to 40%.
Maintenance. Maintenance costs were $28.8 million and $25.9 million in 1997
and 1996, respectively, representing 40% and 37% of maintenance fees for each
respective period. This increase was primarily attributable to the hiring of
additional staff to support new enterprise integration products.
Professional Services. Professional services costs were $37.6 million and
$33.0 million in 1997 and 1996, respectively, representing 85% and 94% 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. Both of these
improvements were derived from process changes initiated in late 1995 that
included enhanced infrastructure and tools for project management, improved
estimating and bidding processes and expanded quality control procedures.
Operating Expenses
Software Product Development. Software product development costs were $1.1
million and $1.4 million in 1997 and 1996, respectively, representing 2% and
3% of software license fees for each respective period. This decrease was the
result of a sale, with transfer of the applicable software product development
costs, of one of the Company's products in 1996 to a third party. This
decrease was partially offset by the incremental product development costs
recorded since the acquisition of R.D. Nickel. Prior to the Recapitalization,
the Company's ability to invest in software product development was
constrained. 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 were $38.3 million and
$48.7 million in 1997 and 1996, respectively, representing 21% and 31% of
total revenues for each respective period. This decrease was primarily
attributable to reductions in the direct sales force and related support
personnel, combined with reductions in marketing staff and programs. These
reductions, which were undertaken to reduce the Company's cost of sales
relative to software license fees and were part of an overall cost reduction
program, began in 1995 and were substantially implemented by June 1997. The
overall decrease in the sales and marketing expenses was slightly offset by
the incremental expenses recorded since the acquisition of R.D. Nickel.
Administrative and General. Administrative and general expenses were $35.8
million and $28.5 million in 1997 and 1996, respectively, representing 20% and
18% 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 company. The increase was
also attributable to amortization expenses relating to 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 in September 1997.
Write-off of Acquired In-Process Research and Development Costs. The write-
off of acquired in-process research and development costs in 1997 was
attributable to certain of the products acquired in the acquisition of R.D.
Nickel. See Note 4 of Notes to Consolidated Financial Statements.
Other
Other Income and Expense, Net. Other income and expense, net, was $2.0
million and $5.2 million in 1997 and 1996, respectively. This decrease was
primarily attributable to the interest income recorded on $30.0
23
<PAGE>
million in loans made to SAG combined with income received for the sale of the
rights to one of the Company's products in 1996. The loans to SAG were offset
against payables due SAG in March 1997 prior to the Recapitalization.
Income Tax Provision. The income tax provision was $9.0 million and $4.3
million in 1997 and 1996, respectively, resulting in effective tax rates of
41.5% (exclusive of the write-off of acquired in-process research and
development costs), and 40.9%, respectively. This increase in rate was
primarily attributable to the non-deductible expenses incurred as a result of
the Recapitalization.
Selected Unaudited Quarterly Information
The following table sets forth certain unaudited quarterly statement of
operations data for each of the eight most recent quarters. In the opinion of
management, this information has been prepared on the same basis as the
audited financial statements, and all necessary adjustments, consisting only
of normal recurring adjustments, have been included in the amounts stated
below to present fairly the unaudited quarterly results when read in
conjunction with the audited Consolidated Financial Statements and Notes
thereto. The operating results for any quarters are not necessarily indicative
of results for any future periods.
<TABLE>
<CAPTION>
Predecessor Successor
----------- ---------------------------
Three
months Three months ended,
ended, ---------------------------
Mar. 31, June 30, Sept. 30, Dec. 31,
1997 1997 1997 1997
----------- -------- --------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Revenue............................... $34,641 | $42,947 $46,729 $56,907
Gross profit.......................... 17,127 | 22,845 23,748 31,264
Net income (loss)..................... 1,373 | 2,151 (3,227) 6,414
Net income (loss) per share........... 0.06 | 0.09 (0.13) 0.24
Net income (loss) per share-assuming |
dilution............................. $ 0.05 | $ 0.08 $ (0.13) $ 0.23
<CAPTION>
Successor
---------------------------------------
Three months ended,
---------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31,
1998 1998 1998 1998
----------- -------- --------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Revenue............................... $55,863 $60,352 $62,923 $69,851
Gross profit.......................... 31,635 36,211 35,041 39,884
Net income............................ 5,390 6,145 6,823 9,352
Net income per share.................. 0.18 0.21 0.23 0.31
Net income per share-assuming dilu-
tion................................. $ 0.17 $ 0.19 $ 0.21 $ 0.29
</TABLE>
Net loss for the quarter ended September 30, 1997 includes the write-off of
acquired in-process research and development costs of $6.1 million which
relates to the Company's acquisition of R.D. Nickel. Before deducting the
nonrecurring write-off for this period, net income was $2.8 million, net
income per share was $0.12 and net income per share--assuming dilution was
$0.11.
As a result of the Recapitalization on March 31, 1997, the Company is no
longer a wholly owned subsidiary of SAG. Management has undertaken several
strategic initiatives since the Recapitalization to increase revenue growth
and profitability including building a product development organization,
developing products and professional services offerings that address the year
2000 problem and acquiring R.D. Nickel. The revenue and profit improvements
since March 31, 1997 may be partially attributable to these changes, but there
can be no assurance that this trend will continue in future quarters. Due in
part to these initiatives, the Company expects that product development costs
as a percentage of software license fees will increase and that administrative
and general expenses as a percentage of total revenues will decrease.
24
<PAGE>
The Company's results of operations have historically fluctuated on a
quarterly basis and although future results are uncertain, they are expected
to be subject to quarterly fluctuations in the future. The Company's software
license fees have tended to increase through each successive quarter of the
year, with software license fees in the first quarter of a year being lower
than those in the immediately preceding fourth quarter of the prior year.
Third quarter results have been favorably affected by increased end of the
year spending by the Company's government customers. Fourth quarter results
benefit from those customers who operate on a calendar year basis, combined
with the Company's sales compensation plans which include incentives for
achieving annual targets. In addition, due to the reorganization of the sales
force and the increase in the number of ELAs, the Company's historic trend of
third and fourth quarter revenues that are higher than previous first and
second quarter revenues may not continue.
Software license costs have varied from period to period and can be expected
to fluctuate in the future primarily due to shifts in product mix since
royalty rates on third party products vary from 24% to 40% and due to an
increase in the sale of the Company owned products.
Although past results may not be indicative of future results, maintenance
fees generally have not fluctuated on a quarterly basis to the same degree as
software license fees due to the large percentage of maintenance fees
generated from renewals of annual maintenance contracts which are recognized
ratably over the contract period.
Revenues from professional services are influenced by the number of
personnel providing such services, the utilization rates of such personnel and
the number of billable days in a quarter. Other factors being equal, a quarter
ending December 31 will generally reflect lower professional services fees
than other quarters due to the relatively large number of holidays falling in
that quarter. In addition, the completion or commencement of significant
professional services projects may affect the revenues from professional
services in a particular quarter.
Historically, sales and marketing expenses have varied from quarter to
quarter in absolute dollar terms and as a percentage of revenues, as a result
of the size and timing of marketing programs. A significant portion of
marketing program costs are variable in nature and subject to management
discretion as to their timing and amount.
The Company's quarterly operating results may continue to fluctuate due to
numerous factors, including the demand for the Company's products and
services, the timing and cost of new product and service introductions and
product enhancements by the Company or its competitors, changes in the mix of
products and services sold by the Company and in the mix of sales by
distribution channels, commencement or conclusion of significant service
contracts, timing of any acquisitions and associated costs, the size, timing
and terms of customer orders, including delays in significant orders, changes
in pricing policies by the Company or its competitors, the timing of
collection of accounts receivable, changes in foreign currency exchange rates,
competitive conditions in the industry and general economic conditions. The
Company's expenses are generally fixed and do not vary significantly in the
short term with revenues. As a result, operating and net income in a given
quarter may be disproportionately affected by a reduction in revenues.
Liquidity and Capital Resources
The Company has financed its operations principally through cash flow 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, in connection with the Recapitalization and to
fund the R.D. Nickel acquisition. Net cash provided by operating activities
was $21.8 million, $13.3 million and $37.5 million for 1998, 1997 and 1996,
respectively, primarily from the net proceeds from sales of accounts
receivable in the amount of $18.1 million, $24.3 million and $28.4 million,
respectively.
25
<PAGE>
Investing activities used net cash of $14.4 million, $33.2 million, and $4.3
million during 1998, 1997, and 1996, respectively, primarily to fund capital
expenditures needed to support expansion of the Company's business, to
purchase short-term investments, to provide loans to SAG, to purchase the
Cooperation Agreement from SAG and the acquisition of R.D. Nickel.
Financing activities provided net cash of $2.7 million and $44.6 million for
1998 and 1997, respectively, primarily from the proceeds from stock options
exercised, stock purchased from the Employee Stock Purchase Plan and the sale
of Common Stock from the IPO. During 1996, financing activities used net cash
of $9.0 million primarily for the payment of dividends.
The Company had $70.9 million and $50.4 million in cash, cash equivalents
and short-term investments as of December 31, 1998 and 1997, 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 December 31, 1998
and 1997, the Company remained contingently liable under the recourse
provisions associated with the sales made prior to 1998 in the amount of $24.7
million and $47.9 million, respectively. The sale of accounts receivable which
occurred in 1998 do not carry the recourse provision. The Company's accounts
receivable days sales outstanding at December 31, 1998 and 1997 were 64 and
62, respectively.
The Company's international distributors report and pay 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 less than 3% of total revenues each in 1998,
1997 and 1996, respectively. With the acquisition of R.D. Nickel, the Company
began direct sales in Canada effective October 1, 1997. Revenues from this
source were approximately 4% of total revenues in the fourth quarter of 1997
and 5% of the total revenues in 1998. The Company, therefore, has not to date
engaged in foreign currency hedging transactions. The Company may enter into
hedging transactions in the future.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 is effective for all
fiscal quarters of all fiscal years beginning after June 15, 1999. SFAS No.
133 establishes accounting and reporting standards for derivative instruments
embedded in other contracts and for hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measures those instruments at fair value.
If certain conditions are met, a derivative may be designated as a hedge. As
stated previously, the Company does not currently enter into any derivative or
hedging transactions. If the Company enters into any of these transactions in
the future, the adoption of this statement may impact the accounting for those
transactions.
The Company traditionally leases all major equipment, and has no investment
in inventory or facilities other than leasehold improvements.
The Company believes that with its existing cash balances, short-term
investments, funds generated from operations and funds received from the sale
of receivables, if any, 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. 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 December 31, 1998.
Year 2000 Compliance
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
26
<PAGE>
for many kinds of software, including software for mainframe, PCs, and
embedded systems. The Company is aware of and is addressing 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, as defined in the Cooperation
Agreement, in accordance with a specified timetable. SAG has provided the
Company with written assurances that the SAG-developed products that the
Company is selling are year 2000 compliant. Both SAG and the Company are
actively cooperating to verify the year 2000 compliance of these products
through the exchange of information relative to the year 2000 test plans and
results for these products. The Company has identified a few SAG 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 delivered by
SAG 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 sold by the Company, 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. In 1998,
total product revenues from the sale of other third party products, excluding
products developed or acquired by SAG, were approximately $3.2 million which
represents less than 2% of total revenues. There can be no assurance, however,
that year 2000 compliant products will be delivered by third parties in a
timely manner.
All products developed or acquired by the Company are or will be year 2000
compliant. The Company considers a product to be "year 2000 compliant" when
the product in question is capable of accurately processing, providing and
receiving data from, into and between the twentieth and twenty-first
centuries, and will correctly create, store, process and output information
related to or including dates on or after January 1, 2000, provided that the
product in question is used in accordance with any applicable documentation
and, provided further that all other products, including hardware and
software, used in combination with the product in question properly exchange
date data with such product.
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
substantially completed its year 2000 readiness program for all hardware
systems and its internal software applications as of December 31, 1998 and the
Company will continue to test and re-implement back into production its
systems and internal applications in 1999.
27
<PAGE>
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 any such failure to timely convert will not have an adverse
effect on the Company's systems. The Company does not believe that the cost
associated with a third party's failure to timely convert its systems will
have a material effect on the Company's results of operations or financial
condition but because of the unprecedented nature of the year 2000 problem, it
is not certain to what extent the Company may ultimately be affected by any
such failure by a third party.
Although the Company believes that its products are or 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. In 1998, year 2000
remediation services revenues were $24.2 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. As of December 31, 1998, the Company incurred less than $400,000 of
costs associated with preparing the Company's products and internal
information technology system to be year 2000 compliant and the remaining
costs are expected to be less than $50,000. 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 continuing to prepare 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.
28
<PAGE>
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company has no material holdings of market risk sensitive instruments.
Safe Harbor Provision for Forward-Looking Statements
The statements contained in this report and in documents incorporating this
report by reference include forward-looking statements subject to the safe
harbor created by the Private Securities Litigation Reform Act of 1995. These
forward-looking statements include, but are not limited to, (1) references to
the Company's business, financial condition, results of operations, products,
competition and markets in which the Company competes, (2) 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 (3)
other statements regarding matters that are not historical facts, 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;
significant quarterly and other fluctuations in revenues and results of
operations; reliance on SAG for development and timely delivery of products;
reliance on acquisitions and the timely development, production, marketing and
delivery of new products and services; 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; 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.
29
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
30
<PAGE>
ITEM 8. Consolidated Financial Statements and Supplementary Data
INDEPENDENT AUDITORS' REPORT
Board of Directors
Software AG Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Software AG
Systems, Inc. and subsidiaries (Successor) as of December 31, 1998 and 1997,
and the related consolidated statements of operations, stockholders' equity
and cash flows for the year ended December 31, 1998 and the period from April
1, 1997 to December 31, 1997 (Successor periods), and the consolidated
statements of operations, stockholders' equity and cash flows of Software AG
Systems, Inc. and subsidiaries (a wholly owned subsidiary of Software AG, a
German software company) (Predecessor), for the periods from January 1, 1997
to March 31, 1997 and for the year ended December 31, 1996 (Predecessor
periods). In connection with our audits of the consolidated financial
statements, we have also audited the accompanying financial statement Schedule
II--Valuation and Qualifying Accounts. These consolidated financial statements
and financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the aforementioned Successor consolidated financial
statements present fairly, in all material respects, the financial position of
Software AG Systems, Inc. and subsidiaries as of December 31, 1998 and 1997
and the results of their operations and their cash flows for the Successor
periods, in conformity with generally accepted accounting principles. Further,
in our opinion, the aforementioned Predecessor consolidated financial
statements present fairly, in all material respects, the results of operations
and cash flows of Software AG Systems, Inc. and subsidiaries (a wholly owned
subsidiary of Software AG, a German software company) for the Predecessor
periods, in conformity with generally accepted accounting principles. Also in
our opinion, the related financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, effective
April 1, 1997, Software AG Systems, Inc. consummated a Recapitalization under
which a majority of the Company's common stock changed control. The change in
control of the Company's common stock was accounted for as a purchase business
combination. As a result of the Recapitalization, the consolidated financial
information for the periods after the Recapitalization is presented on a
different cost basis than that for the periods before the Recapitalization
and, therefore, is not comparable.
KPMG LLP
Washington, D.C.
March 5, 1999
31
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1997 1998
-------- --------
(in thousands)
<S> <C> <C>
Assets
Current:
Cash and cash equivalents............................... $ 50,429 $ 60,298
Short-term investments.................................. -- 10,600
Accounts receivable:
Invoiced and currently due............................. 40,212 50,110
Advanced billings on maintenance....................... 10,287 11,899
Unbilled services...................................... 10,384 8,771
Installment............................................ 24,434 32,016
Other.................................................. 2,858 1,231
Less: allowance for doubtful accounts.................. (3,690) (5,042)
-------- --------
Total accounts receivable............................. 84,485 98,985
Current portion of deferred income taxes................ 6,217 5,392
Prepaid expenses........................................ 1,371 2,265
Other current assets.................................... 2,663 1,855
-------- --------
Total current assets.................................. 145,165 179,395
Cooperation agreement, net of accumulated amortization.... 21,737 19,387
Installment accounts receivable, net of current portion... 8,932 30,248
Property, equipment and leasehold improvements, net of ac-
cumulated depreciation and amortization.................. 10,077 10,176
Goodwill, net of accumulated amortization................. 11,286 9,720
Deferred income taxes..................................... 2,848 4,136
Other assets.............................................. 1,692 703
-------- --------
Total assets.......................................... $201,737 $253,765
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
32
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1997 1998
---------- ----------
(in thousands, except
share data)
<S> <C> <C>
Liabilities and Stockholders' Equity
Current:
Current portion of long-term obligations............. $ -- $ 478
Accounts payable..................................... 8,545 9,675
Accrued payroll and employee benefits................ 10,170 12,181
Payable to SAG....................................... 10,050 10,884
Income taxes payable................................. 1,752 3,991
Other current liabilities............................ 9,885 7,912
Current portion of deferred revenues, net of deferred
royalties of $11,245 in 1997 and $12,683 in 1998.. 42,711 48,328
---------- ----------
Total current liabilities.......................... 83,113 93,449
Long-term obligations, net of current portion.......... -- 635
Deferred revenues, net of deferred royalties of $8,880
in 1997 and $9,966 in 1998............................ 28,806 31,773
---------- ----------
Total liabilities.................................. 111,919 125,857
Commitments and contingencies
Stockholders' equity:
Common stock ($.01 par value; 75,000,000 shares au-
thorized; 32,677,500 shares issued in 1997:
30,516,946 shares issued and outstanding in
1998)............................................. 327 305
Additional paid-in capital........................... 84,185 95,474
Retained earnings.................................... 5,338 33,048
Accumulated other comprehensive income............... -- (919)
Treasury stock, at cost, 3,162,500 shares in 1997 and
no shares in 1998................................. (32) --
---------- ----------
Total stockholders' equity......................... 89,818 127,908
---------- ----------
Total liabilities and stockholders' equity......... $ 201,737 $ 253,765
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
33
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Predecessor Successor
---------------------------- ---------------------------
Year Three months Nine months Year
ended ended ended ended
Dec. 31, Mar. 31, Dec. 31, Dec. 31,
1996 1997 1997 1998
------------ -------------- ------------- ------------
(in thousands, except per share dollar amounts)
<S> <C> <C> <C> <C>
Revenues:
Software license fees.......... $ 52,163 $ 7,341 | $ 56,796 $ 94,899
Maintenance fees............... 69,702 17,352 | 55,337 83,817
Professional services fees..... 34,975 9,948 | 34,450 70,273
------------ ----------- | ------------ ------------
Total revenues............... 156,840 34,641 | 146,583 248,989
------------ ----------- | ------------ ------------
Cost of revenues: |
Software license............... 14,120 2,098 | 17,811 23,329
Maintenance.................... 25,885 6,205 | 22,559 30,042
Professional services.......... 32,966 9,211 | 28,356 52,847
------------ ----------- | ------------ ------------
Total cost of revenues....... 72,971 17,514 | 68,726 106,218
------------ ----------- | ------------ ------------
Gross profit..................... 83,869 17,127 | 77,857 142,771
------------ ----------- | ------------ ------------
Operating expenses: |
Software product development... 1,372 -- | 1,093 5,492
Sales and marketing............ 48,677 7,317 | 31,003 47,635
Administrative and general..... 28,539 8,500 | 27,258 47,563
Write-off of acquired |
in-process R&D costs.......... -- -- | 6,051 --
------------ ----------- | ------------ ------------
Total operating expenses..... 78,588 15,817 | 65,405 100,690
------------ ----------- | ------------ ------------
Income from operations........... 5,281 1,310 | 12,452 42,081
Other income and expense, net.. 5,230 978 | 1,017 4,003
------------ ----------- | ------------ ------------
Income before income taxes....... 10,511 2,288 | 13,469 46,084
Income tax provision........... 4,302 915 | 8,131 18,374
------------ ----------- | ------------ ------------
Net income....................... 6,209 1,373 | 5,338 27,710
Other comprehensive income: |
Foreign currency |
translation adjustments....... -- -- | -- (919)
------------ ----------- | ------------ ------------
Comprehensive income............. $ 6,209 $ 1,373 | $ 5,338 $ 26,791
============ =========== | ============ ============
Dividends........................ $ 9,000 $ -- | $ -- $ --
============ =========== | ============ ============
Net income per common share...... $ 0.23 $ 0.06 | $ 0.21 $ 0.93
============ =========== | ============ ============
Net income per common |
share-assuming dilution......... $ 0.21 $ 0.05 | $ 0.20 $ 0.87
============ =========== | ============ ============
Shares used in computing |
net income per common share: |
Net income per common share.... 27,500 24,338 | 25,119 29,950
Net income per common |
share-assuming dilution....... 29,056 25,894 | 26,685 31,864
</TABLE>
See accompanying notes to consolidated financial statements.
34
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Accumulated
Common Stock Other
$0.01 par value Additional Com- Total
----------------- Paid-in- Retained prehensive Treasury Stockholders'
Shares Amount Capital Earnings Income Stock Equity
-------- ------- ---------- -------- ----------- -------- -------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Predecessor:
Balances at December 31,
1995................... 27,500 $ 275 $11,877 $20,447 $ -- $ -- $ 32,599
Net income.............. -- -- -- 6,209 -- -- 6,209
Cash dividends ($0.33
per share)............. -- -- -- (9,000) -- -- (9,000)
-------- ------ ------- ------- ----- ----- --------
Balances at December 31,
1996................... 27,500 275 11,877 17,656 -- -- 29,808
Net income.............. -- -- -- 1,373 -- -- 1,373
-------- ------ ------- ------- ----- ----- --------
Balances at March 31,
1997................... 27,500 $ 275 $11,877 $19,029 $ -- $ -- $ 31,181
======== ====== ======= ======= ===== ===== ========
- ----------------------------------------------------------------------------------------------------
Successor:
Initial capitalization.. 27,500 $ 275 $37,108 $ -- $ -- $ (32) $ 37,351
Amortization of deferred
compensation expense... -- -- 323 -- -- -- 323
Net proceeds from Ini-
tial Public Offering... 5,178 52 46,754 -- -- -- 46,806
Net income.............. -- -- -- 5,338 -- -- 5,338
-------- ------ ------- ------- ----- ----- --------
Balances at December 31,
1997................... 32,678 327 84,185 5,338 -- (32) 89,818
Retirement of treasury
stock.................. (3,163) (32) -- -- -- 32 --
Amortization of deferred
compensation expense... -- -- 776 -- -- -- 776
Stock options exer-
cised.................. 933 9 2,260 -- -- -- 2,269
Costs incurred relating
to public offerings.... -- -- (371) -- -- -- (371)
Stock issued through Em-
ployee Stock Purchase
Plan................... 69 1 1,112 -- -- -- 1,113
Tax benefit on stock op-
tions exercised........ -- -- 7,512 -- -- -- 7,512
Net income.............. -- -- -- 27,710 -- -- 27,710
Other comprehensive in-
come................... -- -- -- -- (919) -- (919)
-------- ------ ------- ------- ----- ----- --------
Balances at December 31,
1998................... 30,517 $ 305 $95,474 $33,048 $(919) $ -- $127,908
======== ====== ======= ======= ===== ===== ========
</TABLE>
See accompanying notes to consolidated financial statements.
35
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Predecessor Successor
--------------------------- ---------------------------
Year Three months Nine months Year
ended ended ended ended
Dec. 31, 1996 Mar. 31, 1997 Dec. 31, 1997 Dec. 31, 1998
------------- ------------- ------------- -------------
(in thousands)
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income................................. $ 6,209 $ 1,373 | $ 5,338 $ 27,710
Adjustments to reconcile net income |
to net cash provided by operating |
activities: |
Depreciation and amortization............ 3,660 941 | 6,205 7,992
Loss (gain) on disposal of |
property and equipment.................. 156 -- | (5) 236
Deferred income taxes.................... (1,242) (1,143) | (3,041) (463)
Deferred gain............................ (140) (36) | -- --
Net proceeds from sales of accounts |
receivable.............................. 28,448 -- | 24,314 18,119
Write-off of acquired in-process |
R&D costs............................... -- -- | 6,051 --
Write-off of long-term investment........ -- -- | 1,529 848
Amortization of deferred compensation |
expense................................. -- -- | 323 776
Change in: |
Accounts receivable, excluding net |
proceeds from sales................... (28,674) 10,996 | (43,074) (54,434)
Prepaid expenses....................... (1,698) (3,894) | 4,313 (899)
Other current and long-term |
assets................................ (1,870) 3,083 | (2,988) 947
Accounts payable....................... 3,472 673 | 779 1,285
Accrued payroll and employee |
benefits.............................. (2,194) (3,632) | 2,059 2,037
Payable to SAG......................... 16,185 6,265 | (1,336) 834
Other current liabilities.............. 1,571 (927) | (558) (1,766)
Income taxes payable................... 1,285 (568) | (1,542) 9,768
Deferred revenues, net................. 12,285 (2,705) | 4,476 8,825
-------- ------- | -------- --------
Net cash provided by operating |
activities.......................... 37,453 10,426 | 2,843 21,815
-------- ------- | -------- --------
Cash flows from investing activities: |
Additions to property, equipment and |
leasehold improvements.................... (3,740) (208) | (4,084) (3,817)
Purchase of short-term investments......... -- -- | -- (10,600)
Proceeds from sales of property and |
equipment................................. 9,044 -- | 2 35
Notes receivable, SAG...................... (10,000) -- | -- --
Purchase of Cooperation Agreement.......... -- -- | (22,612) --
Change in other assets, net................ 443 -- | -- --
Acquisition, net of cash received.......... -- -- | (6,325) --
-------- ------- | -------- --------
Net cash used in investing |
activities.......................... (4,253) (208) | (33,019) (14,382)
-------- ------- | -------- --------
Cash flows from financing activities: |
Proceeds from stock options exercised...... -- -- | -- 2,269
Proceeds from Employee Stock Purchase |
Plan...................................... -- -- | -- 1,113
Expenses relating to public offerings...... -- -- | -- (371)
Payment made on capital leases............. -- -- | -- (286)
Dividends paid............................. (9,000) -- | -- --
Net proceeds from Initial Public |
Offering.................................. -- -- | 46,806 --
Repurchase of common stock................. -- -- | (33,919) --
Issuance of common stock................... -- -- | 31,727 --
-------- ------- | -------- --------
Net cash provided by (used in) |
financing activities................ (9,000) -- | 44,614 2,725
-------- ------- | -------- --------
Effect of exchange rate changes on cash and |
cash equivalents............................ -- -- | -- (289)
Net increase in cash and cash equivalents.... 24,200 10,218 | 14,438 9,869
Cash and cash equivalents, beginning......... 1,573 25,773 | 35,991 50,429
-------- ------- | -------- --------
Cash and cash equivalents, ending............ $ 25,773 $35,991 | $ 50,429 $ 60,298
======== ======= | ======== ========
Non-cash investing and financing activity: |
Deferred gain on sale leaseback of |
customer support facility................. $ 2,830 $ -- | $ -- $ --
Tax benefit on stock options exercised..... $ -- $ -- | $ -- $ 7,512
Supplemental disclosures: |
Interest paid.............................. $ 103 $ -- | $ 14 $ 128
Income taxes paid, net of refunds.......... $ 4,272 $ 3,630 | $ 11,056 $ 9,547
</TABLE>
See accompanying notes to consolidated financial statements.
36
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Description of Operations and Summary of Significant Accounting Policies
Reporting Entity and Principles of Consolidation
Prior to March 31, 1997, Software AG Systems, Inc. and subsidiaries (the
"Company") was a wholly owned subsidiary of Software AG, a German software
company ("SAG"). As is more fully described in Note 2, on March 31, 1997, the
Company consummated a recapitalization agreement under which the Company
repurchased from SAG 24,750,000 shares of 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"). At December 31, 1998, SAG and Thayer owned 9% and
35% of the Company, respectively.
The consolidated financial statements include the accounts of Software AG
Systems, Inc. and its wholly owned subsidiaries. All inter-company balances
and transactions between the Company and its wholly owned subsidiaries have
been eliminated.
Description of Operations
The Company is an enterprise solutions company that provides robust software
products and related professional services to large organizations with complex
computing requirements. The Company's products are used to build, enhance and
integrate mission-critical applications that require reliability, scalability
and security, such as customer billing systems, financial accounting systems
and inventory management systems. The Company also has comprehensive
professional services offerings, including consulting, software integration,
systems implementation and large project management services. The Company
markets and sells its software products and services, as well as third party
products, through direct and indirect channels in North America, South
America, Japan and Israel. The Company operates in one reportable segment,
enterprise solutions, that provides software and related professional
services.
Revenue Recognition
On January 1, 1998, the Company adopted Statement of Position 97-2,
"Software Revenue Recognition" ("SOP 97-2"), as amended by SOP 98-4 and SOP
98-9. SOP 97-2 focuses on when and in what amounts revenue should be
recognized for licensing, selling, leasing, or otherwise marketing computer
software. SOP 98-4 and SOP 98-9 defers certain portions of SOP 97-2 until the
Company's fiscal year 2000. Management of the Company is currently evaluating
what impact, if any, SOP 97-2 will have on the Company's revenue recognition
policies once the portions of SOP 97-2 which have been deferred become
effective.
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
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.
37
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO 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 based on the fair value of their component
parts using the criteria described above.
Cash Equivalents
The Company considers all highly liquid instruments with a maturity of three
months or less at time of purchase to be cash equivalents. Cash equivalents
generally consist of commercial paper and institutional money market funds.
Short-Term Investments
The Company's short-term marketable debt securities at December 31, 1998
have been categorized as available-for-sale and are carried at fair value.
Unrealized holding gains and losses are included as a separate component of
stockholders' equity until realized. All of the Company's investment holdings
have been classified in the consolidated balance sheet as current assets, as
they are available to be used for current operations.
Property, Equipment and Leasehold Improvements
Property, equipment and leasehold improvements are recorded at cost.
Depreciation, which includes the amortization of assets recorded under capital
leases, of property and equipment is computed on a straight-line basis over
the estimated useful asset lives, generally 31.5 years for property and three
to five years for equipment. Leasehold improvements and assets recorded under
capital leases are amortized on a straight-line basis over the lesser of the
respective lease term or estimated useful asset lives.
Intangible Assets
Goodwill, which represents the excess of purchase price over fair market
value of net assets acquired, and other intangible assets, are amortized on a
straight-line basis over the expected periods to be benefited, generally 10
years. The Company assesses the recoverability of intangible assets by
determining whether the amortization of the assets over the remaining lives
can be recovered through undiscounted future operating cash flows. The amount
of impairment, if any, is measured based on projected discounted future
operating cash flows. The assessment of the recoverability of intangible
assets will be impacted if estimated future operating cash flows are not
achieved.
Research and Development Expenditures
Research and development expenditures are charged to operations as incurred.
SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased
or Otherwise Marketed" ("SFAS No. 86"), 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. At December 31, 1998, technological feasibility, as defined by SFAS No.
86, has not been met on any products that are internally being developed.
Income Taxes
The Company uses the asset and liability method to account for income taxes.
Under the asset and liability method, deferred income taxes are recognized for
the future tax consequences attributable to future years for differences
between the financial statement carrying amounts and the tax bases of existing
assets and liabilities. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in
38
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the years in which those temporary differences are expected to be recovered or
settled. The effect on deferred taxes of a change in tax rates is recognized
in income in the period that includes the enactment date.
Foreign Currency Translation
The local currencies of the Company's foreign subsidiaries are the
functional currencies. The assets and liabilities of foreign subsidiaries are
translated into U.S. dollars at current exchange rates, and the resulting
translation gains and losses are included as an adjustment to stockholders'
equity. Revenue and expense accounts of these operations are translated at
average exchange rates prevailing during the year.
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 and has amended earnings
per share calculations for all periods presented prior to 1997. Basic earnings
per share is based on income available to common shareholders divided by the
weighted average number of common shares outstanding. Diluted earnings per
share is based on income available to common shareholders 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
------------------------------ -----------------------------
Year Three months Nine months Year
ended ended ended ended
Dec. 31, Mar. 31, Dec. 31, Dec. 31,
1996 1997 1997 1998
------------- --------------- -------------- -------------
(in thousands, except for per share dollar amounts)
<S> <C> <C> <C> <C>
Numerator:
Net income............ $ 6,209 $ 1,373 | $ 5,338 $ 27,710
============= ============= | ============= =============
Denominator: |
Basic weighted average |
shares outstanding... 27,500 24,338 | 25,119 29,950
Effect of dilutive |
securities: |
Stock options......... 1,556 1,556 | 1,566 1,914
------------- ------------- | ------------- -------------
Diluted weighted average |
shares outstanding..... 29,056 25,894 | 26,685 31,864
============= ============= | ============= =============
EPS: |
Net income per common |
share................ $ 0.23 $ 0.06 | $ 0.21 $ 0.93
Net income per common |
share--assuming |
dilution............. $ 0.21 $ 0.05 | $ 0.20 $ 0.87
</TABLE>
Comprehensive Income
In June 1997, Financial Accounting Standards Board ("FASB") issued SFAS No.
130, "Reporting Comprehensive Income" ("SFAS No. 130") 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. This statement requires only additional disclosures in
the consolidated financial statements, and does not affect the Company's
financial position or results of operations. The Company adopted SFAS No. 130
effective as of January 1, 1998. Comprehensive income includes foreign
currency translation adjustments. The Company has not recorded the foreign
currency translation net of an income tax benefit, since management does not
believe that it is probable that the Company will ultimately realize the
benefit.
39
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock Option Plan
The Company accounts for issuance of stock options in accordance with SFAS
No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). SFAS No.
123 permits entities to recognize as expense over the vesting period the fair
value of all stock-based awards on the date of grant. Alternatively, SFAS No.
123 also allows entities to continue to apply the provisions of Accounting
Principles Board Opinion No. 25 ("APB Opinion No. 25") and provide pro forma
net income and pro forma earnings per share disclosures for employee stock
option grants made in 1997 and 1998 and future years as if the fair-value
based method defined in SFAS No. 123 had been applied. Under APB Opinion No.
25, compensation expense would be recorded only if the current market price of
the underlying stock on the date of the grant exceeded the exercise price. The
Company has elected to continue to apply the provisions of APB Opinion No. 25
and provide the pro forma disclosure provisions of SFAS No. 123.
Transfers and Servicing of Financial Assets
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS No.
125"). SFAS No. 125 is effective for transfers and servicing of financial
assets and extinguishments of liabilities occurring after December 31, 1996
and is to be applied prospectively. This Statement provides accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities based on consistent application of a financial-
components approach that focuses on control. It distinguishes transfers of
financial assets that are sales from those transfers that are secured
borrowings.
Financial Statement Presentation
The historical financial information set forth in these consolidated
financial statements for the periods ended, or as of the dates prior to March
31, 1997 reflect the results of operations of the Company prior to the
Recapitalization when the Company was a wholly owned subsidiary of SAG and is
captioned as "Predecessor". The historical financial information subsequent to
March 31, 1997 reflects the consolidated financial position and results of
operations subsequent to the Recapitalization and is captioned as "Successor".
As a result of the Recapitalization, the consolidated financial information
for the periods after the Recapitalization is presented on a different cost
basis than that for the periods before the Recapitalization and, therefore, is
not comparable.
Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Reclassifications
Certain amounts in 1996 and 1997 have been reclassified to conform to the
1998 presentation.
(2) 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
common stock and sold 21,450,000 shares of common stock to Thayer and certain
of the Company's senior managers. As a result of this change in control,
40
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 (unless otherwise terminated by the written agreement of the
parties) cooperation agreement, dated March 31, 1997, as amended ("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 an 89% interest in 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 Cooperation
Agreement to the Company has been recorded at $23,500,000, based on an
independent appraisal. The amortization period for the Cooperation Agreement
is ten years. The Company recorded remaining assets and liabilities at book
value which approximates the fair value at 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 ten
years. Accumulated amortization on the Cooperation Agreement and the goodwill
was $1,763,000 and $480,000, respectively; and $4,113,000 and $1,120,000,
respectively, at December 31, 1997 and 1998.
(3) Public Offerings
In September 1997, the Company's Board of Directors authorized the Company
to file a Registration Statement on Form S-1 with the Securities and Exchange
Commission permitting the Company to sell shares of its common stock to the
public. The Company's Board of Directors also approved a 275-for-1 stock split
which became effective on November 17, 1997. Common share and per share data
in these consolidated financial statements have been retroactively adjusted to
reflect such stock split. Additionally, the Company's Certificate of
Incorporation was amended and restated to authorize an additional 20,000,000
shares of $0.01 par value common stock and an additional 11,250,000 shares of
$0.01 par value preferred stock, for a total of 75,000,000 authorized shares
of common stock and 25,000,000 authorized shares of $0.01 par value preferred
stock. The Company had previously authorized 13,750,000 shares of $0.01 par
value preferred stock on March 14, 1997.
On November 21, 1997, 7,700,000 shares of the Company's common stock were
sold to the public at $10 per share, of which 3,100,000 shares were sold by
certain shareholders of the Company, and 4,600,000 shares were sold by the
Company ("IPO"). On December 17, 1997, the Company and certain shareholders,
combined, sold 1,155,000 shares of common stock at $10 per share to cover the
over-allotment option exercised by the underwriters. The aggregate proceeds,
net of underwriting discounts and commissions, to the Company and certain
shareholders from these transactions were $48,151,000 and $34,201,000,
respectively.
On May 22, 1998, Thayer and certain senior management of the Company and SAG
sold in a secondary offering ("Secondary Offering") 5,460,212 shares and an
additional 819,031 shares to cover the over-allotment option exercised by the
underwriters. The Company received no proceeds from the Secondary Offering.
After
41
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the Secondary Offering, Thayer and SAG owned approximately 36% and 9%,
respectively, of the Company's then outstanding common stock.
(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"). R.D. Nickel now operates as SAGA SOFTWARE (CANADA) Inc. R.D.
Nickel, located in Ontario, Canada, was a software company that had a family
of application development products and had been the exclusive distributor of
SAG'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 IPO.
In connection with the transaction, the Company recorded a $6,051,000 non-
recurring charge against earnings for in-process research and development
costs. The remaining excess purchase price of Cdn$6,944,000 (US$4,960,000)
represented goodwill on R.D. Nickel's books. The related amortization period
for the goodwill is ten years. At December 31, 1997 and 1998, accumulated
amortization on the goodwill was approximately Cdn$179,000 (US$125,000) and
Cdn$873,000 (US$570,000), respectively.
The Company accounted for the acquisition effective September 30, 1997, and
as such, the operating results of R.D. Nickel have been consolidated with the
Company's operating results as of October 1, 1997.
The R.D. Nickel acquisition was not determined to be significant to the
operations or financial position of the Company; accordingly, the pro forma
financial information has not been presented.
(5) Concentrations of Credit Risk and Fair Values of Financial Instruments
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to credit risk
include accounts receivable, cash, cash equivalents and short-term
investments. For the installment accounts receivables that are sold, the
Company continues to service the receivables sold, including invoicing and
collection. In addition, the Company remains contingently liable under the
recourse provisions associated with the installment accounts receivable sold
prior to 1998. Management believes that credit risk related to the Company's
accounts receivable is limited due to a large number of customers in differing
industries and geographic areas. The Company does not require collateral for
accounts receivable. Historically, the Company has not experienced significant
losses on accounts receivable, including the installment accounts receivables
sold, except in isolated situations. The Company maintains depository
relationships with several banks. At times, the Company's cash deposits may
exceed federally insured limits. The Company invests excess cash in highly
liquid short-term investments, such as high grade corporate and United States
government debt securities. The Company has not experienced any losses in its
depository accounts or short-term investments and management believes that the
Company is not exposed to any significant credit risks.
Fair Value of Financial Instruments
The carrying amounts of cash, cash equivalents, short-term investments,
accounts receivable, accounts payable, payable to SAG, and amounts included in
other current assets and current liabilities that meet the definition of a
financial instrument, approximate fair value because of the short-term nature
of these amounts.
42
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The carrying amount of installment accounts receivable, net of related
deferred revenues, approximates the fair value.
(6) Short-Term Investments
The following is a summary of the estimated fair value of available-for-sale
securities held by the Company:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1997 1998
-------- --------
(in thousands)
<S> <C> <C>
Commercial paper........................................... $-- $ 5,100
Debt securities............................................ -- 5,500
---- -------
$-- $10,600
==== =======
</TABLE>
The fair value of these securities approximates cost. As such, there were no
unrealized holding gains or losses for the years ended December 31, 1997 and
1998. There were no realized gains and losses for the years ended December 31,
1997 and 1998. Short-term investments are comprised of fixed rate securities
with the contractual maturities that are less than 24 months.
(7) Accounts Receivable
Total current and non-current accounts receivable (including installment
accounts receivable) consist of the following:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1997 1998
-------- --------
(in thousands)
<S> <C> <C>
Domestic.................................................. $83,659 $120,262
International............................................. 13,448 14,013
Less: allowance for doubtful accounts..................... 3,690 5,042
------- --------
$93,417 $129,233
======= ========
</TABLE>
Installment Accounts Receivable
Installment accounts receivable represent unbilled receivables from
enterprise license agreements and other long-term and short-term contracts
with deferred invoicing terms.
Installment accounts receivable include:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1997 1998
-------- --------
(in thousands)
<S> <C> <C>
Gross installment accounts receivable...................... $35,172 $65,480
Less: unearned interest.................................... 1,806 3,216
------- -------
33,366 62,264
Less: current portion...................................... 24,434 32,016
------- -------
$ 8,932 $30,248
======= =======
</TABLE>
The effective interest rate on the installment accounts receivable, net of
related deferred revenues, at December 31, 1997 and 1998 was approximately 9%.
43
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
At December 31, 1998, installment accounts receivable are scheduled to be
invoiced as follows:
<TABLE>
<CAPTION>
Years ending December 31, Amount
------------------------- --------------
(in thousands)
<S> <C>
1999.......................................................... $33,564
2000.......................................................... 21,179
2001.......................................................... 7,531
2002.......................................................... 3,206
-------
$65,480
=======
</TABLE>
In 1997 and 1998, the Company sold installment accounts receivable relating
to certain enterprise license agreements and other long-term contracts to
unrelated financing companies, receiving net proceeds of $24,314,000 and
$18,119,000, respectively. The installment accounts receivable sold include
those relating to software license fees, maintenance services, and
professional consulting services. Under SFAS No. 125, the sales of the
receivables during 1997 and 1998 have been reflected as a reduction of the
accounts receivable. Under the terms of the agreements with the financing
companies, the Company continues to service the receivables sold, including
invoicing and collection, and makes payments to the financing companies under
pre-determined amortization schedules based on the scheduled invoicing dates
of the receivables sold. The Company has determined that there is no servicing
asset or liability to record under SFAS 125 as a result of the sales. The
amortization schedules provide rates of return to the financing companies
ranging from 8.5% to 8.9%.
The agreements allow for substitution of contracts for early terminations
and require the Company to repurchase contracts that cease to meet eligibility
requirements, such as those contracts that become 90 days past due. At
December 31, 1997 and 1998, the Company remained contingently liable under the
recourse provisions for the installment accounts receivable sold prior to 1998
in the amount of $47,927,000 and $24,723,000, respectively. Management has
determined that the fair value of the recourse liabilities on the sales are
not material to the financial statements, and as a result, believes that the
allowance for doubtful accounts is maintained at a level that is sufficient to
cover potential losses under the recourse provisions on the receivables sold
prior to 1998.
Under the terms of the agreements, the Company is required to maintain
specified amounts of net worth and cash availability, and a debt to equity
ratio that does not exceed a specified amount. If the Company fails to
maintain these specified amounts, the financing companies may assume the
servicing rights on receivables sold.
Unbilled Services
Unbilled services relate primarily to long-term professional consulting
services and custom application contracts accounted for using the percentage
of completion method. Billings on these contracts generally are tied to
achieving specific milestones.
Unbilled services include:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1997 1998
-------- --------
(in thousands)
<S> <C> <C>
Unbilled work in process................................... $ 9,524 $10,777
Retainage.................................................. 1,761 1,409
------- -------
11,285 12,186
Less: advance billings and prepayments..................... 901 3,415
------- -------
$10,384 $ 8,771
======= =======
</TABLE>
44
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(8) Property, Equipment and Leasehold Improvements
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1997 1998
-------- --------
(in thousands)
<S> <C> <C>
Computer equipment......................................... $22,524 $16,834
Leasehold improvements..................................... 9,188 10,486
Furniture and other equipment.............................. 8,162 8,891
------- -------
39,874 36,211
Less: accumulated depreciation and amortization............ 29,797 26,035
------- -------
$10,077 $10,176
======= =======
</TABLE>
Depreciation and amortization for the year ended December 31, 1996, three
months ended March 31, 1997, nine months ended December 31, 1997 and year
ended December 31, 1998 was $3,473,000, $896,000, $2,952,000 and $4,540,000,
respectively.
(9) Other Current Liabilities
Other current liabilities are comprised of the following amounts:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1997 1998
-------- --------
(in thousands)
<S> <C> <C>
Reserve for losses on long term contracts.................. $5,611 $2,427
Other accrued expenses..................................... 4,274 5,485
------ ------
$9,885 $7,912
====== ======
</TABLE>
(10) Sale of Customer Support Facility
In 1996, the Company recorded a sale-leaseback transaction for its customer
support facility. In connection with the sale, the Company realized a gain of
$2,830,000, which was being recognized on a straight-line basis over the term
of the related operating lease. In connection with the Recapitalization of the
Company (Note 2) in March 1997, no value was recorded in the financial
statements for this deferred gain.
(11) Transactions with Related Party
Royalties
During 1996 and the three months ended March 31, 1997, the Company and SAG
operated under a license agreement whereby the Company was required to pay
royalties of 24% of the net sales amounts for licenses of and technical
services on SAG's products. For the year ended December 31, 1996 and three
months ended March 31, 1997, royalty expense related to SAG's products was
$26,058,000 and $5,683,000, respectively.
Under the license agreement, SAG paid royalties to the Company on sales of
the Company's products under the same terms. For the year ended December 31,
1996 and three months ended March 31, 1997, royalty revenues related to the
Company's products were $294,000 and $339,000, respectively.
In connection with the Recapitalization (Note 2), the Company entered into
the Cooperation Agreement under which the Company paid $23,595,000 and
$39,601,000 of royalties to SAG for the nine months ended December 31, 1997
and year ended December 31, 1998, respectively. SAG paid royalties of $300,000
and
45
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
$997,000 to the Company for the nine months ended December 31, 1997 and year
ended December 31, 1998, respectively.
Cost Reimbursements
As an accommodation to SAG, the Company houses certain of SAG's product
development and quality assurance personnel. SAG reimburses the Company for
the costs incurred related to such product development and quality assurance
activities. All intellectual property resulting from this work is the sole
property of SAG. The reimbursements from SAG are netted against costs
incurred. Reimbursements for the year ended December 31, 1996, three months
ended March 31, 1997, nine months ended December 31, 1997 and year ended
December 31, 1998 were $15,931,000, $3,416,000, $7,406,000 and $8,454,000,
respectively.
Notes Receivable/Payable
In 1995, the Company loaned $20,000,000 to SAG, which originally was
scheduled to be repaid in 2000. In 1996, the Company loaned an additional
$10,000,000 to SAG, which originally was scheduled to be repaid in 2001.
Interest at 6.5% and 7%, respectively, was payable quarterly on the 1995 and
1996 loans. In March 1997, the Company and SAG agreed to offset the entire
balance of the notes receivable from SAG as of December 31, 1996 against the
payable to SAG. Interest earned for the year ended December 31, 1996 and three
months ended March 31, 1997 was $1,590,000 and $333,000, respectively.
The payable to SAG of $10,050,000 and $10,884,000 at December 31, 1997 and
1998, respectively, includes royalties due under the Cooperation Agreement on
sales of both product licenses and maintenance services, as well as net
amounts due on other transactions between the Company and SAG. In accordance
with the Cooperation Agreement, royalty payments are made 90 days after
invoicing. Any payments resulting from other transactions between the Company
and SAG are made monthly as expenses are incurred. These amounts are non-
interest bearing.
Dividends
In 1996 the Company paid dividends of $9,000,000 to SAG, which at the time
owned 100% of the outstanding common stock of the Company. No dividends were
paid during 1997 and 1998 to SAG and there are no plans for future dividend
payments.
(12) Income Taxes
Income tax expense consisted of:
<TABLE>
<CAPTION>
Predecessor Successor
--------------------- --------------------
Year Three months Nine months Year
ended ended ended ended
Dec. 31, Mar. 31, Dec. 31, Dec. 31,
1996 1997 1997 1998
-------- ------------ ----------- --------
(in thousands)
<S> <C> <C> <C> <C>
Current expense:
Federal........................... $4,167 $1,196 | $6,226 $14,047
State............................. 586 258 | 1,551 1,894
Foreign........................... 791 604 | 3,395 2,896
------ ------ | ------ -------
5,544 2,058 | 11,172 18,837
------ ------ | ------ -------
Deferred expense (benefit): |
Federal........................... (1,136) (959) | (2,560) (421)
State............................. (106) (184) | (481) (42)
------ ------ | ------ -------
(1,242) (1,143) | (3,041) (463)
------ ------ | ------ -------
$4,302 $ 915 | $8,131 $18,374
====== ====== | ====== =======
</TABLE>
46
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Income tax expense for the year ended December 31, 1996, three months ended
March 31, 1997, nine months ended December 31, 1997 and year ended December
31, 1998 differed from the amounts computed by applying the U.S. federal
income tax rate of 34%, 35%, 35%, and 35% respectively, to pretax income as a
result of the following:
<TABLE>
<CAPTION>
Predecessor Successor
--------------------- --------------------
Year Three months Nine months Year
ended ended ended ended
Dec. 31, Mar. 31, Dec. 31, Dec. 31,
1996 1997 1997 1998
-------- ------------ ----------- --------
(in thousands)
<S> <C> <C> <C> <C>
Computed "expected" tax expense..... $3,573 $ 801 | $4,714 $16,129
Increase (reduction) in income taxes |
resulting from: |
State income taxes, net of federal |
benefit.......................... 314 48 | 696 1,204
Expenses, principally meals and |
entertainment, not deductible.... 224 6 | 209 262
Amortization and write-off of |
intangibles...................... -- 49 | 2,439 369
Other, net........................ 191 11 | 73 410
------ ----- | ------ -------
$4,302 $ 915 | $8,131 $18,374
====== ===== | ====== =======
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of deferred income tax assets and liabilities consist of:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1997 1998
-------- --------
(in thousands)
<S> <C> <C>
Deferred tax assets arising from deductible temporary
differences:
Accrued compensation costs and other expenses............. $2,679 $2,884
Allowance for doubtful accounts........................... 3,617 2,849
Depreciation and amortization............................. 1,473 2,004
Deferred gain--installment method......................... 1,000 1,031
Investments............................................... 642 956
------ ------
9,411 9,724
Deferred tax liabilities arising from taxable temporary
differences:
Leases of product licenses................................ 346 196
------ ------
Net deferred income taxes................................... 9,065 9,528
Less: current portion, deferred tax assets.................. 6,217 5,392
------ ------
Non-current portion, deferred tax assets.................... $2,848 $4,136
====== ======
</TABLE>
In assessing the realization of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred
tax assets will not be realized. The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Based upon the
level of historical taxable income and projections for future taxable income
over the periods for which the deferred tax assets are deductible, management
believes that it is more likely than not that the Company will realize the
benefits of these deductible differences. The amount of the deferred tax asset
considered realizable, however, could be reduced in the near term if estimates
of future taxable income are reduced.
(13) Retirement Plans
The Company has a retirement plan covering substantially all of its
employees. This plan meets the requirements of Section 401(k) of the Internal
Revenue Code. The Company matches employee contributions
47
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
and may make additional contributions based on the Company's profitability.
For the year ended December 31, 1996, three months ended March 31, 1997, nine
months ended December 31, 1997 and year ended December 31, 1998, the Company's
matching (and total) contributions were $1,854,000, $696,000, $1,190,000 and
$2,391,000, respectively.
The Company also has entered into deferred compensation agreements with
certain key executives. Under these agreements, the executives are credited
with annual pre-determined amounts and amounts based on bonuses received, and
earn interest on the deferred amounts. Total deferrals are included in accrued
payroll and employee benefits, net of any outstanding loans. Total deferrals
were $1,068,000 (net of $1,164,000 loan balance) and $1,755,000 (net of
$363,000 loan balance) at December 31, 1997 and 1998, respectively. The
expense for these agreements was $1,218,000, $150,000, $160,000 and $450,000
for the year ended December 31, 1996, three months ended March 31, 1997, nine
months ended December 31, 1997 and year ended December 31, 1998, respectively.
To assist in the funding of these agreements, the Company has purchased
corporate-owned life insurance on certain of these executives. The cash
surrender value of these policies, which is included in other assets, was
$764,000 and $703,000 at December 31, 1997 and 1998, respectively.
(14) Stock Option Plan and Employee Stock Purchase Plan
The Company adopted the Software AG Systems, Inc. 1997 Stock Option Plan
(the "Stock Option Plan") on April 29, 1997. The Stock Option Plan permits a
maximum of 6,875,000 shares of common stock to be issued pursuant to grants of
stock options. Unless sooner terminated by the Company's Board of Directors,
the Stock Option Plan will terminate on April 11, 2007. Pursuant to the Stock
Option Plan, the exercise price per share shall not be less than the fair
market value of each share at the date of grant. All options issued generally
have vesting periods of zero to four years from the grant date and expire
after the seventh anniversary from the date of grant. At December 31, 1997 and
1998, 1,831,775 and 1,761,776 shares, respectively, were available for grant
under the Stock Option Plan.
Following is a summary of activity under the Stock Option Plan for the years
ended December 31, 1997 and 1998:
<TABLE>
<CAPTION>
1997 1998
------------------------ ------------------------
Weighted Weighted
average average
Shares exercise price Shares exercise price
--------- -------------- --------- --------------
<S> <C> <C> <C> <C>
Outstanding, January 1,...... -- $ -- 5,043,225 $ 5.02
Granted...................... 5,069,900 4.66 450,500 19.50
Exercised.................... -- -- 933,260 2.43
Forfeited/Expired............ 26,675 2.90 380,501 7.27
--------- ----- --------- ------
Outstanding, December 31,.... 5,043,225 $5.02 4,179,964 $ 6.97
========= ===== ========= ======
</TABLE>
48
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes information about the Stock Option Plan at
December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- ----------------------------------------------------------------- ----------------------------
Weighted average
Actual range of remaining Weighted Weighted
exercise prices 150% Shares contractual average Shares average exercise
increments outstanding life years exercise price exercisable price
- -------------------- ----------- ---------------- -------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$ 1.47-- 1.47 2,110,640 5.3 $ 1.47 171,210 $ 1.47
9.60--13.88 1,675,724 6.3 11.01 862,020 10.50
15.56--23.31 310,600 6.5 17.50 -- --
24.44--30.19 83,000 6.3 25.95 -- --
- -------------- --------- --- ------ --------- ------
$ 1.47--30.19 4,179,964 5.8 $ 6.97 1,033,230 $ 9.00
============== ========= === ====== ========= ======
</TABLE>
In 1998, the Company's Board of Directors and the shareholders approved a
qualified employee stock purchase plan ("ESPP") and authorized the issuance of
1,500,000 shares of common stock, for purchase pursuant to the ESPP. The ESPP
commenced on June 1, 1998. Under the terms of the ESPP, employees may
contribute, through payroll deduction, up to 15% of eligible compensation to
purchase stock with the limitation of $25,000 annually in fair market value of
the shares. Employees may elect to withdraw from the ESPP at any time during
the two separate offering periods which run from December to May and June to
November and have their contributions for the period returned to them. Also,
employees may elect to change the rate of contribution only once during the
offering periods. The price at which employees may purchase shares is 85% of
the lower of the fair market value of the stock at the beginning or end of the
six months offering period. The ESPP is qualified under Section 423 of the
Internal Revenue Code of 1986, as amended. In 1998, employees purchased 68,686
shares at an average price of $16.20. At December 31, 1998, 1,431,000 shares
are remaining for future issuance.
The Company applies APB Opinion No. 25 in accounting for its stock options
granted and stock issued through the ESPP, under which compensation cost is
recognized to the extent that the fair value of the underlying stock exceeds
the exercise price of the stock options granted or stock issued through the
ESPP. Under SFAS No. 123, the Company is required to provide pro forma
disclosure of the net income and earnings per share that would have resulted
had the Company adopted the fair value method for recognition purposes. The
following information is presented as if the Company had adopted SFAS No. 123
and restated its results for the nine months ended December 31, 1997 and for
the year ended December 31, 1998:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1997 1998
---------- -----------
(in thousands, except
per share data)
<S> <C> <C>
Net income--as reported............................... $ 5,338 $ 27,710
Net income--pro forma................................. 4,741 25,501
Earnings per share--as reported....................... 0.21 0.93
Earnings per share (assuming dilution)--as reported... 0.20 0.87
Earnings per share--pro forma......................... 0.19 0.85
Earnings per share (assuming dilution)--pro forma..... 0.18 0.80
</TABLE>
For the above information, the fair value of each option grant was estimated
on the date of grant using the Black-Scholes option pricing model with the
following assumptions used for grants in 1997 and 1998: dividend yield of zero
percent each; risk-free interest rate of 6.0% and 5.2%; expected volatility of
40.0% and 73.9%; and expected lives of 2 to 6 years and 4.5 years,
respectively. The weighted average fair value of options granted during the
nine months ended December 31, 1997 and the year ended December 31, 1998 was
$1.97 and $11.90 per option, respectively.
49
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In addition, the fair value of each stock purchased through the ESPP was
estimated on the purchase date using the Black-Scholes pricing model with the
following assumptions in 1998: Dividend yield of zero percent; risk free
interest rate of 5.3%; expected volatility of 73.9%; and expected lives of 0.5
years. The weighted average fair value of stocks purchased through ESPP during
the year ended December 31, 1998 was $8.31.
The full impact of calculating cost for stock options under SFAS No. 123 is
not reflected in the pro forma net income amounts presented above because
compensation cost is reflected over the options vesting period of four years.
(15) Lease Commitments
The Company leases certain computer equipment under agreements which are
classified as capital leases. Lease terms are generally less than 36 months.
Assets under capital leases are included in the consolidated balance sheets as
follows:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1997 1998
-------- --------
(in thousands)
<S> <C> <C>
Computer equipment............................................ $ -- $1,512
Less: accumulated amortization................................ -- 428
----- ------
$ -- $1,084
===== ======
</TABLE>
In addition, the Company leases office space and equipment under operating
lease agreements that expire at various dates through 2015. Facility rent
expense for the year ended December 31, 1996, three months ended March 31,
1997, nine months ended December 31, 1997 and year ended December 31, 1998,
was $7,002,000, $1,722,000, $5,179,000 and $6,658,000, respectively. Rent
expense includes the current year effect of determinable scheduled rent
increases and initial rent abatement periods contained in certain of the
Company's facility lease agreements. Equipment lease expense for the year
ended December 31, 1996, three months ended March 31, 1997, nine months ended
December 31, 1997 and year ended December 31, 1998 was $1,678,000, $339,000,
$1,018,000 and $2,002,000, respectively.
Future minimum rent payments under the aforementioned leases, net of
aggregate rents of $4,189,000 expected to be received from subleasing of a
portion of the customer support facility and another facility, at December 31,
1998 are:
<TABLE>
<CAPTION>
Years ending December 31, Capital Leases Operating Leases
- ------------------------- -------------- ----------------------------
Facilities Equipment Total
---------- --------- -------
(in thousands)
<S> <C> <C> <C> <C>
1999............................... $ 552 $ 5,643 $2,915 $ 8,558
2000............................... 453 5,633 1,495 7,128
2001............................... 226 5,351 120 5,471
2002............................... -- 4,776 90 4,866
2003............................... -- 4,140 34 4,174
Thereafter......................... -- 18,971 -- 18,971
----- ------- ------ -------
Total minimum lease payments....... 1,231 $44,514 $4,654 $49,168
======= ====== =======
Less: amount representing
interest.......................... 118
-----
Present value of net minimum lease
payments.......................... 1,113
Less: current portion.............. 478
-----
$ 635
=====
</TABLE>
50
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company's operating lease agreement for its customer support facility
requires the Company to maintain minimum amounts of net worth and retained
earnings. If the minimum amounts are not maintained, the Company will be
required to post a $500,000 irrevocable letter of credit for each $2,000,000
shortfall, to be applied by the lessor in the event of default under the
lease.
(16) Geographic, Product and Services Revenue Information
Net revenue, operating income, and identifiable assets by geographic area
were as follows:
<TABLE>
<CAPTION>
Predecessor Successor
--------------------- --------------------
Year Three months Nine months Year
ended ended ended Ended
Dec. 31, Mar. 31, Dec. 31, Dec. 31,
1996 1997 1997 1998
-------- ------------ ----------- --------
(in thousands)
<S> <C> <C> <C> <C>
Revenue:
U.S. operations................. $129,879 $ 30,424 | $116,378 $209,838
Canadian operations............. -- -- | 3,861 15,062
Mexican operations.............. -- -- | 4,507 6,209
Other operations................ 26,961 4,217 | 23,329 25,845
Intercompany elimination........ -- -- | (1,492) (7,965)
-------- -------- | -------- --------
Total revenue................. $156,840 $ 34,641 | $146,583 $248,989
======== ======== | ======== ========
Income (loss) from operations: |
U.S. operations................. $ 5,281 $ 1,310 | $ 18,732 $ 38,875
Canadian operations............. -- -- | (5,129) 3,046
Mexican operations.............. -- -- | (1,151) (22)
Other operations................ -- -- | -- --
Intercompany elimination........ -- -- | -- 182
-------- -------- | -------- --------
Total operating income........ $ 5,281 $ 1,310 | $ 12,452 $ 42,081
======== ======== | ======== ========
Identifiable assets (including |
long-lived assets): |
U.S. operations................. $158,088 $127,749 | $193,503 $253,142
Canadian operations............. -- -- | 9,143 11,158
Mexican operations.............. -- -- | 1,538 302
Other operations................ -- -- | -- --
Intercompany elimination........ -- -- | (2,447) (10,837)
-------- -------- | -------- --------
Total identifiable assets..... $158,088 $127,749 | $201,737 $253,765
======== ======== | ======== ========
</TABLE>
Canadian operations include one subsidiary, SAGA SOFTWARE (CANADA) Inc.
(formerly R.D. Nickel and Associates, Inc.), which was acquired in September
1997. Mexican operations include one subsidiary located in Mexico. The
Company's Mexican operations commenced in 1996 and operated as a branch office
until it became a wholly owned subsidiary in May 1997. Other operations
include royalty revenue from international distributors.
51
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Royalty revenues from international distributors are as follows:
<TABLE>
<CAPTION>
Predecessor Successor
----------------- -----------------
Three Nine
Year months months Year
ended ended ended ended
Dec. 31, Mar. 31, Dec. 31, Dec. 31,
1996 1997 1997 1998
-------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C>
Japan..................................... $ 9,207 $ 971 |$10,481 $12,469
Brazil.................................... 7,000 1,500 | 7,500 7,777
Canada.................................... 4,640 805 | 2,026 --
Other..................................... 6,114 941 | 3,322 5,599
------- ------ |------- -------
Total royalty revenues from international |
distributors............................. $26,961 $4,217 |$23,329 $25,845
======= ====== |======= =======
</TABLE>
Royalty revenues from international distributors included in software
license fees and maintenance fees on the consolidated statements of operations
were $16,982,000 and $9,979,000, respectively, in 1996; $2,331,000 and
$1,886,000, respectively, for the three months ended March 31, 1997;
$16,105,000 and $7,224,000, respectively, for the nine months ended December
31, 1997 and $18,696,000 and $7,149,000, respectively, for the year ended
December 31, 1998. Royalties from Canada includes royalties received from R.D.
Nickel prior to the acquisition in September 1997.
Sales and transfers between geographic areas are accounted for at prices
which the Company believes are arm's length, and in accordance with the rules
and regulations of the respective governing tax authorities.
The Company's software license fees are derived primarily from the licensing
of the Company's enterprise systems and enterprise integration products. In
1996, 1997 and 1998, revenues from sale of enterprise systems products
represented 85%, 81% and 85%, respectively, and revenues from sale of
enterprise integration products represented 15%, 19% and 15%, respectively, of
the total software license fees.
The Company's professional services fees are derived primarily from services
provided with the implementation and deployment of the Company's enterprise
systems and enterprise integration products and through educational services.
The Company's professional services offerings include software integration,
system implementation, large project management, year 2000 analysis and
remediation and consulting. In 1997 and 1998, software integration, system
implementation and large project management services contributed 64% and 44%,
respectively; year 2000 analysis and remediation services contributed 15% and
42%, respectively; educational services contributed 7% and 4%, respectively;
consulting services contributed 2% each, and other services contributed
approximately 12% and 8%, respectively, of the total services revenue. The
related 1996 information is not available as the company maintained its
financial information in a different manner compared to 1997 and thereafter.
(17) Other Income and Expense, Net
Other income and expense, net, on the consolidated statements of operations
primarily includes interest income of $2,914,000 and gain on sale of other
assets of $1,000,000 for the year ended December 31, 1996; interest income of
$779,000 for the three months ended March 31, 1997; interest income of
$728,000 for the nine months ended December 31, 1997 and interest income of
$3,550,000 for the year ended December 31, 1998.
(18) Contingencies
The Company is involved in various claims and legal proceedings of a nature
considered normal to its business, primarily relating to product and contract
performance issues, and employee termination matters. While
52
<PAGE>
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
it is not feasible to predict or determine the final outcome of these
proceedings, management does not believe that they will have a material
adverse affect on the Company's financial position or results of operations.
(19) Quarterly Financial Data (Unaudited)
Summarized financial data by quarters is as follows:
<TABLE>
<CAPTION>
Predecessor Successor
----------- ---------------------------
Three
months Three months ended,
ended ---------------------------
Mar. 31, June 30, Sept. 30, Dec. 31,
1997 1997 1997 1997
----------- -------- --------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Revenue............................... $34,641 | $42,947 $46,729 $56,907
Gross profit.......................... 17,127 | 22,845 23,748 31,264
Net income (loss)..................... 1,373 | 2,151 (3,227) 6,414
Net income (loss) per share........... 0.06 | 0.09 (0.13) 0.24
Net income (loss) per share-assuming |
dilution............................. $ 0.05 | $ 0.08 $ (0.13) $ 0.23
</TABLE>
<TABLE>
<CAPTION>
Successor
------------------------------------------
Three months ended,
------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31,
1998 1998 1998 1998
--------- --------- ---------- ---------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Revenue............................ $ 55,863 $ 60,352 $ 62,923 $ 69,851
Gross profit....................... 31,635 36,211 35,041 39,884
Net income......................... 5,390 6,145 6,823 9,352
Net income per share............... 0.18 0.21 0.23 0.31
Net income per share-assuming
dilution.......................... $ 0.17 $ 0.19 $ 0.21 $ 0.29
</TABLE>
53
<PAGE>
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
The change in the Company's accountants on July 11, 1997 was previously
reported as defined in Rule 12b-2 under the Securities Exchange Act of 1934.
P A R T III
ITEM 10. Directors and Executive Officers of the Registrant.
Information concerning the directors and executive officers of the Company
is set forth in the Proxy Statement in connection with the Company's 1999
Annual Meeting of Shareholders (the "Proxy Statement") under the heading
"Election of Directors", which information is incorporated herein by
reference. Information concerning compliance with Section 16 of the Securities
Exchange Act of 1934, as amended, by persons subject to such section is set
forth in the Proxy Statement under the heading "Section 16 (a) Beneficial
Ownership Reporting Compliance", which information is incorporated herein by
reference.
ITEM 11. Executive Compensation.
Information concerning compensation of the Company's named executive
officers and directors is set forth in the Proxy Statement under the heading
"Election of Directors", which information is incorporated herein by
reference. Information contained in the Proxy Statement under the caption
"Election of Directors--Report of the Compensation Committee of the Board of
Directors on Executive Compensation" and "Stock Performance Graph" is not
incorporated by reference herein.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management.
Information concerning security ownership of certain beneficial owners and
management is set forth in the Proxy Statement under the heading "Share
Ownership of Principal Stockholders and Management", which information is
incorporated herein by reference.
ITEM 13. Certain Relationships and Related Transactions.
Information concerning certain relationships and related transactions is set
forth in the Proxy Statement under the headings "Certain Relationships and
Transactions", which information is incorporated herein by reference.
54
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1.The following consolidated financial statements are included in Part II,
Item 8 of this report:
Report of Independent Auditors
Consolidated Balance Sheets--December 31, 1997 and 1998
Consolidated Statements of Operations--For the year ended December 31,
1996, three months ended March 31, 1997 and nine months ended December
31, 1997, and for the year ended December 31, 1998
Consolidated Statements of Stockholders' Equity--For the year ended
December 31, 1996, three months ended March 31, 1997 and nine months
ended December 31, 1997, and for the year ended December 31, 1998
Consolidated Statements of Cash Flows--For the year ended December 31,
1996, three months ended March 31, 1997 and nine months ended December
31, 1997, and for the year ended December 31, 1998
Supplementary Financial Information
2.The following financial statement schedule is filed as a part of this
Annual Report:
Financial statement schedule covered by report of Independent Auditors:
Schedule II--Valuation and Qualifying Accounts as of and for the three
years in the period ended December 31, 1998.
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are
omitted because they are not required under the related instructions or
are not applicable.
3.Exhibits
<TABLE>
<C> <S>
3.1 Second Amended and Restated Certificate of Incorporation of the
Registrant*
3.2 Third Amended and Restated Bylaws of the Registrant**
4 Specimen Common Stock Certificate of the Registrant*
10.1 Recapitalization Agreement among Software AG, Software AG Systems,
Inc., Thayer Equity Investors III, L.P. and certain Managers of
Software AG Systems, Inc. (dated as of March 18, 1997)*
10.2 Cooperation Agreement between Software AG and Software AG
Americas, Inc. (dated as of March 31, 1997)*
10.3 Share purchase Agreement among Software AG Americas, Inc.,
Software AG (Canada), Inc., Robert D. Nickel and Caelum
Investments, Inc. (dated as of September 26, 1997)*
10.4 Memorandum of Understanding between Daniel F. Gillis and Software
AG Systems, Inc. (dated as of April 24, 1997)*+
10.5 Memorandum of Understanding between Harry K. McCreery and Software
AG Americas, Inc. (dated as of December 16, 1996)*+
10.6 Memorandum of Understanding between Derek M. Brigden and Software
AG Americas, Inc. (dated as of December 13, 1996)*+
10.7 Software AG Systems, Inc. 1997 Stock Option Plan, as amended***+
10.8 Software AG Systems, Inc. Employee Stock Purchase Plan, as
amended****+
10.9 Management and Consulting Agreement between TC Management LLC and
Software AG Americas, Inc. (dated as of April 1, 1997)*
10.10 Deferred Compensation Agreement between Daniel F. Gillis and
Software AG Americas, Inc. (dated as of July 1, 1995), as amended*+
</TABLE>
55
<PAGE>
<TABLE>
<C> <S>
10.11 Deferred Compensation Agreement between Harry K. McCreery and
Software AG Americas, Inc. (dated as of January 1, 1991), as
amended*+
10.12 Administrative Services Agreement between Software AG and Software AG
Americas, Inc. (dated as of March 31, 1997), as amended*
10.13 Registration Rights Agreement between Software AG Systems, Inc. and
Thayer Equity Investors III, L.P. (dated as of September 26, 1997)*
10.14 Subscription Agreement between Timothy L. Hill and Software AG
Systems, Inc., (dated as of August 22, 1997), as amended*
10.15 Shareholders Agreement among Software AG Systems, Inc., Thayer Equity
Investors III, L.P. and certain shareholders of Software AG Systems,
Inc. (dated as of April 1, 1997)*
10.16 Promissory Note made by Daniel F. Gillis (effective date March 24,
1997)*
10.17 Promissory Note made by Harry K. McCreery (effective date March 24,
1997)*
10.18 Promissory Note made by Harry K. McCreery (effective date August 9,
1996)*
10.19 Promissory Note made by James H. Daly (effective date March 24,
1997)*
16 Letter regarding Change in Certifying Accountant*
21 Subsidiaries of the Registrant*****
23 Consent of KPMG LLP*****
24 Powers of Attorney*****
27 Financial Data Schedule*****
</TABLE>
- --------
* Previously filed as an exhibit to the Company's Registration Statement on
Form S-1 (File No. 333-36567) and incorporated herein by reference.
** Previously filed as an exhibit to the Company's Registration Statement on
Form S-1 (File No. 333-50645) and incorporated herein by reference.
*** Previously filed as an exhibit to the Company's Registration Statement on
Form S-8 (File No. 333-44687) and incorporated herein by reference.
**** Previously filed as an exhibit to the Company's Registration Statement on
Form S-8 (File No. 333-49221) and incorporated herein by reference.
***** Filed herewith.
+ Management contracts or compensatory plan or arrangement.
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on December 9, 1998 to report
the appointment of Gary M. Voight as Vice President, Sales of the Company
effective December 1, 1998.
56
<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.
/s/ Daniel F. Gillis
By: _________________________________
Daniel F. Gillis
Director, President and Chief
Date: March 30, 1999 Executive Officer (Principal
Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Daniel F. Gillis Director, President and March 30, 1999
By: __________________________________ Chief Executive Officer
Daniel F. Gillis (Principal Executive
Officer)
/s/ Harry K. McCreery Vice President, Treasurer March 30, 1999
By: __________________________________ and Chief Financial
Harry K. McCreery Officer (Principal
Financial and Accounting
Officer)
* Chairman of the Board of March 30, 1999
By: __________________________________ Directors
Carl J. Rickertsen
* Director March 30, 1999
By: __________________________________
Dr. Philip S. Dauber
* Director March 30, 1999
By: __________________________________
Dr. Erwin Koenigs
* Director March 30, 1999
By: __________________________________
Edward E. Lucente
* Director March 30, 1999
By: __________________________________
Dr. Paul G. Stern
/s/ Harry K. McCreery
*By: _________________________________
Harry K. McCreery
Attorney-In-Fact
</TABLE>
57
<PAGE>
SCHEDULE II
Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Additions
Balance at Charged to Balance
Beginning Costs and Deductions at End
Description of Period Expenses Write-offs of Period
----------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Predecessor:
1/1/96-12/31/96
Allowance for Doubtful Ac-
counts......................... $4,035,518 $ 757,060 $1,083,575 $3,709,003
1/1/97-3/31/97
Allowance for Doubtful Ac-
counts......................... 3,709,003 204,406 (138,274) 4,051,683
- -------------------------------------------------------------------------------
Successor:
4/1/97-12/31/97
Allowance for Doubtful Ac-
counts......................... 4,051,683 1,202,325 1,564,412 3,689,596
1/1/98-12/31/98
Allowance for Doubtful Ac-
counts......................... $3,689,596 $3,424,222 $2,071,216 $5,042,602
</TABLE>
<PAGE>
Exhibit 21
Subsidiaries of the Registrant
The companies listed below are directly or indirectly owned 100% by Software
AG Systems, Inc. and are included in its consolidated financial statements.
SAGA SOFTWARE, Inc. (formerly Software AG Americas, Inc.) and Systems Software
I, Inc. are wholly owned subsidiaries of Software AG Systems, Inc. Argenta,
Inc., Insight Consulting, Inc., Software AG Insurance Solutions, Inc.,
Software AG Professional Services, Inc., Software AG FSC, Inc., SAGA SOFTWARE
Venezolana, C.A. (formerly Software AG Venezolana, C.A.), SAGA SOFTWARE
Services, Inc., SAGA SOFTWARE International, Inc., SAGA SOFTWARE Technologies,
Inc. and SAGA SOFTWARE Funding Corporation are wholly owned subsidiaries of
SAGA SOFTWARE, Inc. Articles of dissolution have been filed with the Clerk of
the State Corporation Commission of the Commonwealth of Virginia and a plan of
dissolution has been approved by the boards of directors of Argenta, Inc. and
Software AG Insurance Solutions, Inc. SAGA SOFTWARE, S.A. de C.V. (formerly
Software AG Americas, Latin America Operations, S.A. de C.V.) and SAG Systems
(Canada) Holdings Ltd. are jointly owned by Software AG Systems, Inc. and SAGA
SOFTWARE, Inc. SAGA SOFTWARE (CANADA) Inc. (formerly Software AG Systems
(Canada) Inc.) is a wholly owned subsidiary of SAG Systems (Canada) Holdings
Ltd. SAGA SOFTWARE Atlantic, L.L.C. is a wholly owned subsidiary of SAGA
SOFTWARE Technologies, Inc.
<TABLE>
<CAPTION>
Name Jurisdiction of Incorporation
---- -----------------------------
<S> <C>
SAGA SOFTWARE, Inc. .............................. Commonwealth of Virginia
Systems Software I, Inc. ......................... State of Delaware
Argenta, Inc. .................................... Commonwealth of Virginia
Insight Consulting, Inc. ......................... Commonwealth of Virginia
Software AG Insurance Solutions, Inc. ............ Commonwealth of Virginia
Software AG Professional Services, Inc. .......... Commonwealth of Virginia
SAGA SOFTWARE, S.A. de C.V. ...................... Mexico
SAGA SOFTWARE Venezolana, C.A. ................... Venezuela
SAG Systems (Canada) Holdings Ltd................. Canada
SAGA SOFTWARE (CANADA) Inc. ...................... Canada
Software AG FSC, Inc. ............................ Virgin Islands
SAGA SOFTWARE Services, Inc. ..................... State of Delaware
SAGA SOFTWARE International, Inc. ................ State of Delaware
SAGA SOFTWARE Technologies, Inc. ................. State of Delaware
SAGA SOFTWARE Atlantic, L.L.C. ................... State of Delaware
SAGA SOFTWARE Funding Corporation................. State of Delaware
</TABLE>
<PAGE>
Exhibit 23
Accountant's Consent
The Board of Directors
Software AG Systems, Inc.
We consent to incorporation by reference in the registration statement of
Software AG Systems, Inc. on Form S-8 (No. 333-44687) of our report dated
March 5, 1999, with respect to the consolidated balance sheets of Software AG
Systems, Inc. and subsidiaries (Successor) as of December 31, 1998 and 1997,
and the related consolidated statements of operations, stockholders' equity,
cash flows, and the related schedule for the year ended December 31, 1998 and
the period from April 1, 1997 to December 31, 1997 (Successor periods), and
the consolidated statements of operations, stockholders' equity and cash flows
of Software AG Systems, Inc. and subsidiaries (a wholly owned subsidiary of
Software AG, a German software company) (Predecessor) from January 1, 1997 to
March 31, 1997 and the year ended December 31, 1996 (Predecessor periods),
which report appears in the December 31, 1998, annual report on Form 10-K of
Software AG Systems, Inc.
KPMG LLP
Washington, D.C.
March 26, 1999
<PAGE>
Exhibit 24
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned director of
Software AG Systems, Inc., a corporation organized under the laws of the State
of Delaware, hereby constitutes and appoints Daniel F. Gillis, Harry K.
McCreery and Katherine E. Butler, and each of them (with full power to each of
them to act alone), his true and lawful attorneys-in-fact and agents for him
and on his behalf and in his name, place and stead, in all cases with full
power of substitution and resubstitution, in any and all capacities, to sign,
execute and affix his seal to and file with the Securities and Exchange
Commission (or any other governmental or regulatory authority) an Annual
Report on Form 10-K or any other appropriate form and all amendments or
supplements thereto with all exhibits and any and all documents required to be
filed with respect thereto, and grants to each of them full power and
authority to do and to perform each and every act and thing requisite and
necessary to be done in and about the premises in order to effectuate the same
as fully to all intents and purposes as he himself might or could do if
personally present, hereby ratifying and confirming all that said attorneys-
in-fact and agents, or any of them, may lawfully do or cause to be done by
virtue hereof.
IN WITNESS WHEREOF, the undersigned director has hereunto set his hand and
seal, as of the date specified.
/s/ Dr. Philip S. Dauber
_____________________________________
Signature
Dr. Philip S. Dauber
_____________________________________
Name
February 5, 1999
<PAGE>
Exhibit 24
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned director of
Software AG Systems, Inc., a corporation organized under the laws of the State
of Delaware, hereby constitutes and appoints Daniel F. Gillis, Harry K.
McCreery and Katherine E. Butler, and each of them (with full power to each of
them to act alone), his true and lawful attorneys-in-fact and agents for him
and on his behalf and in his name, place and stead, in all cases with full
power of substitution and resubstitution, in any and all capacities, to sign,
execute and affix his seal to and file with the Securities and Exchange
Commission (or any other governmental or regulatory authority) an Annual
Report on Form 10-K or any other appropriate form and all amendments or
supplements thereto with all exhibits and any and all documents required to be
filed with respect thereto, and grants to each of them full power and
authority to do and to perform each and every act and thing requisite and
necessary to be done in and about the premises in order to effectuate the same
as fully to all intents and purposes as he himself might or could do if
personally present, hereby ratifying and confirming all that said attorneys-
in-fact and agents, or any of them, may lawfully do or cause to be done by
virtue hereof.
IN WITNESS WHEREOF, the undersigned director has hereunto set his hand and
seal, as of the date specified.
/s/ Dr. Erwin Koenigs
_____________________________________
Signature
Dr. Erwin Koenigs
_____________________________________
Name
February 17, 1999
<PAGE>
Exhibit 24
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned director of
Software AG Systems, Inc., a corporation organized under the laws of the State
of Delaware, hereby constitutes and appoints Daniel F. Gillis, Harry K.
McCreery and Katherine E. Butler, and each of them (with full power to each of
them to act alone), his true and lawful attorneys-in-fact and agents for him
and on his behalf and in his name, place and stead, in all cases with full
power of substitution and resubstitution, in any and all capacities, to sign,
execute and affix his seal to and file with the Securities and Exchange
Commission (or any other governmental or regulatory authority) an Annual
Report on Form 10-K or any other appropriate form and all amendments or
supplements thereto with all exhibits and any and all documents required to be
filed with respect thereto, and grants to each of them full power and
authority to do and to perform each and every act and thing requisite and
necessary to be done in and about the premises in order to effectuate the same
as fully to all intents and purposes as he himself might or could do if
personally present, hereby ratifying and confirming all that said attorneys-
in-fact and agents, or any of them, may lawfully do or cause to be done by
virtue hereof.
IN WITNESS WHEREOF, the undersigned director has hereunto set his hand and
seal, as of the date specified.
/s/ Edward E. Lucente
_____________________________________
Signature
Edward E. Lucente
_____________________________________
Name
February 9, 1999
<PAGE>
Exhibit 24
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned director of
Software AG Systems, Inc., a corporation organized under the laws of the State
of Delaware, hereby constitutes and appoints Daniel F. Gillis, Harry K.
McCreery and Katherine E. Butler, and each of them (with full power to each of
them to act alone), his true and lawful attorneys-in-fact and agents for him
and on his behalf and in his name, place and stead, in all cases with full
power of substitution and resubstitution, in any and all capacities, to sign,
execute and affix his seal to and file with the Securities and Exchange
Commission (or any other governmental or regulatory authority) an Annual
Report on Form 10-K or any other appropriate form and all amendments or
supplements thereto with all exhibits and any and all documents required to be
filed with respect thereto, and grants to each of them full power and
authority to do and to perform each and every act and thing requisite and
necessary to be done in and about the premises in order to effectuate the same
as fully to all intents and purposes as he himself might or could do if
personally present, hereby ratifying and confirming all that said attorneys-
in-fact and agents, or any of them, may lawfully do or cause to be done by
virtue hereof.
IN WITNESS WHEREOF, the undersigned director has hereunto set his hand and
seal, as of the date specified.
/s/ Carl J. Rickertsen
_____________________________________
Signature
Carl J. Rickertsen
_____________________________________
Name
February 16, 1999
<PAGE>
Exhibit 24
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned director of
Software AG Systems, Inc., a corporation organized under the laws of the State
of Delaware, hereby constitutes and appoints Daniel F. Gillis, Harry K.
McCreery and Katherine E. Butler, and each of them (with full power to each of
them to act alone), his true and lawful attorneys-in-fact and agents for him
and on his behalf and in his name, place and stead, in all cases with full
power of substitution and resubstitution, in any and all capacities, to sign,
execute and affix his seal to and file with the Securities and Exchange
Commission (or any other governmental or regulatory authority) an Annual
Report on Form 10-K or any other appropriate form and all amendments or
supplements thereto with all exhibits and any and all documents required to be
filed with respect thereto, and grants to each of them full power and
authority to do and to perform each and every act and thing requisite and
necessary to be done in and about the premises in order to effectuate the same
as fully to all intents and purposes as he himself might or could do if
personally present, hereby ratifying and confirming all that said attorneys-
in-fact and agents, or any of them, may lawfully do or cause to be done by
virtue hereof.
IN WITNESS WHEREOF, the undersigned director has hereunto set his hand and
seal, as of the date specified.
/s/ Dr. Paul G. Stern
_____________________________________
Signature
Dr. Paul G. Stern
_____________________________________
Name
February 5, 1999
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