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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NO. 001-13609
SAGA 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
incorporation or organization) identification no.)
11190 Sunrise Valley Drive
Reston, Virginia 20191
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(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:
Name of each exchange
Title of each class on which registered
------------------- --------------------
Common Stock, $0.01 par value 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 [_]
As of July 26, 1999, 30,031,788 shares of the Registrant's common stock
were outstanding.
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TABLE OF CONTENTS
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Item Page
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P A R T I
1. Financial Statements:
Condensed Consolidated Balance Sheets at June 30, 1999 and December
31, 1998............................................................. 3
Condensed Consolidated Statements of Operations for the three and
six months ended June 30, 1999 and 1998.............................. 5
Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 1999 and 1998......................................... 6
Notes to Condensed Consolidated Financial Statements................... 7
2. Management's Discussion and Analysis of Financial Condition and Results of
Operations.................................................................. 10
3. Quantitative and Qualitative Disclosures about Market Risk.................. 16
P A R T II
1. Legal Proceedings........................................................... 18
4. Submission of Matters to a Vote of Security Holders......................... 18
6. Exhibits and Reports on Form 8-K............................................ 19
</TABLE>
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Item 1. Financial Statements
SAGA SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
June 30, Dec. 31,
1999 1998
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(Unaudited)
<S> <C> <C>
Assets
Current:
Cash and cash equivalents........................................................... $ 46,531 $ 60,298
Short-term investments.............................................................. 13,000 10,600
Accounts receivable:
Invoiced and currently due........................................................ 40,497 50,110
Advanced billings on maintenance.................................................. 14,477 11,899
Unbilled services................................................................. 3,906 8,771
Installment....................................................................... 34,540 32,016
Other............................................................................. 2,003 1,231
Less: allowance for doubtful accounts............................................. (4,565) (5,042)
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Total accounts receivable....................................................... 90,858 98,985
Current portion of deferred income taxes............................................ 5,389 5,392
Prepaid expenses.................................................................... 4,766 2,265
Other current assets................................................................ 301 1,855
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Total current assets............................................................ 160,845 179,395
Installment accounts receivable, net of current portion................................. 32,632 30,248
Goodwill and other intangible assets, net of accumulated amortization................... 21,477 9,720
Cooperation agreement, net of accumulated amortization.................................. 18,212 19,387
Property, equipment and leasehold improvements, net of accumulated depreciation
and amortization...................................................................... 8,895 10,176
Deferred income taxes................................................................... 4,136 4,136
Other assets............................................................................ 812 703
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Total assets.................................................................. $ 247,009 $ 253,765
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</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
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SAGA SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS - (continued)
(in thousands, except share data)
<TABLE>
<CAPTION>
June 30, Dec. 31,
1999 1998
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(Unaudited)
<S> <C> <C>
Liabilities and Stockholders' Equity
Current:
Current portion of long-term obligations......................................... $ 438 $ 478
Accounts payable................................................................. 6,499 9,675
Accrued payroll and employee benefits............................................ 7,075 12,181
Payable to Software AG........................................................... 6,924 10,884
Income taxes payable............................................................. 1,697 3,991
Other current liabilities........................................................ 6,458 7,912
Current portion of deferred revenues, net of deferred royalties.................. 48,487 48,328
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Total current liabilities.................................................... 77,578 93,449
Long-term obligations, net of current portion........................................ 432 635
Deferred revenues, net of deferred royalties......................................... 31,878 31,773
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Total liabilities............................................................ 109,888 125,857
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Stockholders' equity
Common stock ($0.01 par value, 75,000,000 shares authorized;
30,779,688 shares issued at June 30, 1999; and 30,516,946 shares issued
and outstanding at December 31, 1998).......................................... 308 305
Additional paid-in capital....................................................... 97,890 95,474
Retained earnings................................................................ 43,570 33,048
Accumulated other comprehensive income........................................... (662) (919)
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141,106 127,908
Less treasury stock, at cost (346,200 shares at June 30, 1999 and no shares
at December 31, 1998)......................................................... (3,985) ---
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Total stockholders' equity................................................... 137,121 127,908
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Total liabilities and stockholders' equity................................... $ 247,009 $ 253,765
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</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
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SAGA SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three and six months ended June 30, 1999 and 1998
(in thousands, except per share dollar amounts)
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
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1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Revenues:
Software license fees.............................. $ 17,172 $ 24,578 $ 30,352 $ 46,227
Maintenance fees................................... 20,828 20,496 41,462 40,296
Professional services fees......................... 17,938 15,278 37,730 29,692
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Total revenues................................. 55,938 60,352 109,544 116,215
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Cost of revenues:
Software license................................... 4,034 5,055 7,152 10,725
Maintenance........................................ 6,914 7,039 13,955 14,096
Professional services.............................. 14,017 12,047 29,007 23,548
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Total cost of revenues......................... 24,965 24,141 50,114 48,369
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Gross profit.......................................... 30,973 36,211 59,430 67,846
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Operating expenses:
Software product development...................... 2,315 1,146 4,724 1,901
Sales and marketing............................... 10,240 13,124 20,051 24,997
Administrative and general........................ 11,347 12,521 20,052 23,326
------------ ----------- ----------- -----------
Total operating expenses....................... 23,902 26,791 44,827 50,224
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Income from operations................................ 7,071 9,420 14,603 17,622
Other income and expense, net..................... 1,303 953 2,647 1,859
------------ ----------- ----------- -----------
Income before income taxes............................ 8,374 10,373 17,250 19,481
Income tax provision.............................. 3,266 4,228 6,728 7,946
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Net income............................................ 5,108 6,145 10,522 11,535
Other comprehensive income (loss):
Foreign currency translation adjustments.......... 83 8 256 (64)
------------ ----------- ----------- -----------
Comprehensive income.................................. $ 5,191 $ 6,153 $ 10,778 $ 11,471
============ =========== =========== ===========
Net income per common share:
Basic............................................. $ 0.17 $ 0.21 $ 0.34 $ 0.39
Diluted........................................... $ 0.16 $ 0.19 $ 0.33 $ 0.36
Shares used in computing net income per common share:
Basic............................................. 30,630 29,764 30,603 29,641
Diluted........................................... 31,653 31,976 31,746 31,791
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
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SAGA SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended June 30, 1999 and 1998
(in thousands)
<TABLE>
<CAPTION>
1999 1998
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(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income.......................................................... $ 10,522 $ 11,535
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization..................................... 4,071 4,008
Loss on sales of property and equipment........................... 21 347
Net proceeds from sales of accounts receivable.................... --- 18,119
Write off of investment........................................... --- 848
Compensation expenses on options granted.......................... 356 388
Changes in operating accounts..................................... (10,657) (29,914)
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Net cash provided by operating activities................... 4,313 5,331
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Cash flows from investing activities:
Additions to property, equipment and leasehold improvements......... (757) (1,637)
Proceeds from sales of property and equipment....................... --- 22
Purchase of short-term investments.................................. (11,000) ---
Sale of short-term investments...................................... 8,600 ---
Acquisition, net of cash received................................... (12,036)
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Net cash used in investing activities....................... (15,193) (1,615)
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Cash flows from financing activities:
Proceeds from stock options exercised............................... 241 1,157
Expenses relating to initial public offering........................ --- (144)
Proceeds from Employee Stock Purchase Plan.......................... 1,071 ---
Payments made on capital leases..................................... (243) ---
Repurchase of common stock.......................................... (3,985) ---
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Net cash provided by / (used) in financing activities....... (2,916) 1,013
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Effect of exchange rate changes on cash and cash equivalents.......... 29 ---
Net increase (decrease) in cash and cash equivalents.................. (13,767) 4,729
Cash and cash equivalents, beginning.................................. 60,298 50,429
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Cash and cash equivalents, ending..................................... $ 46,531 $ 55,158
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</TABLE>
See accompanying notes to condensed consolidated financial statements.
6
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SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) Basis of Presentation
The condensed consolidated financial statements included herein have been
prepared by management, pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. These condensed consolidated financial statements should be read
in conjunction with the financial statements and notes thereto included in the
SAGA SYSTEMS, Inc. (formerly known as Software AG Systems, Inc.) Annual Report
on Form 10-K for the year ended December 31, 1998.
In the opinion of management, the accompanying balance sheets and related
statements of operations and cash flows include all adjustments (consisting only
of normal recurring items) necessary for their fair presentation in conformity
with generally accepted accounting principles. The results for the six and
three months ended June 30, 1999 are not necessarily indicative of the results
expected for the full year.
(2) Accounting Policies
Revenue Recognition
On January 1, 1998, SAGA SYSTEMS, Inc. and its subsidiaries (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 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.
Software license revenues for an arrangement to deliver software that does
not require significant production, modification or customization of software
are 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.
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.
7
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SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
Net Income per Common Share
The Company reports earnings per share under Statement of Financial
Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128"). In
accordance with SFAS No. 128 requirements, the Company presents basic and
diluted earnings per share. Basic earnings per share is based on income
available to common stockholders divided by the weighted average number of
common shares outstanding. Diluted earnings per share is based on income
available to common stockholders divided by the sum of the weighted average
number of common shares outstanding and all potential common shares that are
dilutive. The following information is a reconciliation of the amounts used in
these calculations:
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
----------------------------- -----------------------------
1999 1998 1999 1998
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(In thousands, except for per share dollar amounts)
(Unaudited)
<S> <C> <C> <C> <C>
Numerator:
Net income.................................. $ 5,108 $ 6,145 $ 10,522 $ 11,535
============ ============ ============ ============
Denominator:
Basic weighted average shares outstanding...... 30,630 29,764 30,603 29,641
Effect of dilutive securities:
Stock options............................... 1,023 2,212 1,143 2,150
------------ ------------ ------------ ------------
Diluted weighted average shares outstanding.... 31,653 31,976 31,746 31,791
============ ============ ============ ============
Net income per common share:
Basic....................................... $ 0.17 $ 0.21 $ 0.34 $ 0.39
============ ============ ============ ============
Diluted..................................... $ 0.16 $ 0.19 $ 0.33 $ 0.36
============ ============ ============ ============
</TABLE>
(3) Treasury Stock
On April 27, 1999, the Company commenced an offer to repurchase up to
6,000,000 shares of its common stock, par value $0.01 per share ("Common
Stock"), at a price not greater than $8.00 per share nor less than $6.50 per
share (the "Offer"). The Offer expired on May 25, 1999 and 200 shares of Common
Stock were tendered at $8.00 per share. In addition, the Company incurred
approximately $160,000 of expenses relating to the Offer, which were expensed as
period costs. These expenses included printing fees, legal fees, depositary
fees, information agent fees, filing fees and other miscellaneous expenses.
In June 1999, the Company began acquiring shares of its Common Stock in
connection with a stock repurchase program announced on June 14, 1999 ("Stock
Repurchase Program"). The Stock Repurchase Program authorizes the Company to
repurchase up to 2,000,000 shares from time to time on the open market starting
on June 14, 1999 and to continue over an indefinite period. The Company had
repurchased 346,000 shares of Common Stock as of June 30, 1999 at an aggregate
cost of approximately $4.0 million.
(4) Acquisition
Effective June 9, 1999, the Company acquired 100% of the issued and
outstanding stock of a privately-owned enterprise software development company
based in San Jose, California, Blue Lobster Software, Inc. ("Blue Lobster"), for
$12.0 million. The acquisition was funded through cash on hand. Blue Lobster
has a development team located in Rochester, New York, which has already been
employed toward further enhancement of the Company's in-development enterprise
integration product suite, Sagavista(TM).
8
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The acquisition was accounted for using the purchase method of accounting
and the operating results of the acquired business have been included in the
consolidated financial statements since the acquisition date. The purchase
price has been preliminarily allocated based on estimated fair values at the
date of acquisition, pending final determination of certain acquired balances.
The Company has allocated approximately $12.3 million to the fair value of
certain intellectual property rights, which is being amortized on a straight-
line basis over seven years.
The Blue Lobster 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.
9
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ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Results of Operations
Six months ended June 30, 1999 and 1998
Revenues
Total Revenues. 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 total revenues were
$109.5 million and $116.2 million for the six months ended June 30, 1999 and
1998, respectively, representing a decrease of 6%. This decrease in total
revenues was primarily due to a decrease in software license fees as described
below.
Software License Fees. 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 iXpress, a web enablement and deployment platform. Software
license fees decreased 34% to $30.4 million for the six months ended June 30,
1999 compared to $46.2 million from the same period in 1998. The decline in the
software license fees in the first six months of 1999 compared to the same
period in 1998 was primarily due to two large orders aggregating approximately
$12.3 million during the first six months of 1998. There were no comparably
large orders in 1999. Excluding these large orders from 1998, the software
license fees would have decreased 11% compared to 1998. Management believes
that the decrease in software license fees is attributable, in part, to
customers' decisions to postpone new orders until such customers address their
own internal year 2000 concerns. Management expects this trend to continue in
the remainder of 1999.
Maintenance Fees. 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 may occur only if
the customer continues to use the licensed products. Maintenance fees were $41.5
million and $40.3 million for the six months ended June 30, 1999 and 1998,
respectively, representing an increase of 3%. This increase was primarily due
to expansion of the installed base due to increased license sales combined with
the current overall maintenance renewal rate of approximately 90%.
Professional Services 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 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. Professional
services fees were $37.7 million and $29.7 million for the six months ended June
30, 1999 and 1998, respectively, representing an increase of 27%. Approximately
60% of this increase was attributable to the traditional core professional
services offerings, such as application development and engineering consulting
services, while approximately 40% of the increase was attributable to the year
2000 professional services area. Even though year 2000 professional services
revenues increased in the first six months in 1999 compared to the same period
in 1998, year 2000 professional services revenues have continued to decrease
from $11.4 million in the fourth quarter of 1998 to $7.3 million in the first
quarter of 1999 and $5.6 million in the second quarter of 1999. Management
anticipates this decreasing trend to continue in the remainder of 1999 and that
year 2000 professional service revenues will be insignificant thereafter.
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Cost of Revenues
Software License. Software license costs consist primarily of royalties
paid to third parties. Software license costs were $7.2 million and $10.7
million for the six months ended June 30, 1999 and 1998, respectively,
representing 24% and 23% of software license fees for each respective period.
The decrease in dollar amount was primarily due to a decrease in software
license fees. The slight increase in the percentage was primarily due to a shift
in the mix of third party products sold from those with a low royalty rate to
those with a higher royalty rate. Royalty rates on third-party products vary
from 24% to 40% of gross software license fees.
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 $14.0 million and $14.1 million for the six
months ended June 30, 1999 and 1998, respectively, representing 34% and 35% of
maintenance fees for each respective period. The decrease in percentage was
primarily attributable to improved utilization and efficiency of existing
support personnel.
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 $29.0 million and $23.5 million for the six
months ended June 30, 1999 and 1998, respectively, representing 77% and 79% of
professional services fees for each respective period. The increase in dollar
amount was primarily due to an increase in revenue volume. The improvement in
margin was primarily attributable to 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 $4.7 million and
$1.9 million for the six months ended June 30, 1999 and 1998, respectively. This
increase was primarily due to expenses incurred in support of the Company's
current product in development, Sagavista. Sagavista remains on schedule for
delivery in late September 1999 and the Company began beta testing in July 1999.
Sales and Marketing. Sales and marketing expenses consist primarily of
employee salaries, benefits, commissions, marketing programs, public relations,
trade shows, seminars, advertising and related communications and associated
overhead costs. Sales and marketing expenses were $20.1 million and $25.0
million for the six months ended 1999 and 1998, respectively, representing 18%
and 22% of total revenues for each respective reporting period. This decrease
was attributable to a decrease in sales commission as a result of the software
license fees revenue decrease in 1999 compared to 1998. The decrease in sales
and marketing expenses was also attributable to the fact that the sales and
marketing expenses in 1998 included costs relating to several new marketing
programs and events, including a major trade show and symposiums. Similar costs
were incurred in 1999 but not to the magnitude of those incurred in 1998. The
Company anticipates that sales and marketing expenses will increase in the
second half of 1999 in connection with new product introductions.
Administrative and General. Administrative and general expenses include
employee salaries and benefits for administration, executive, finance, legal,
human resources, data center, distribution and internal systems personnel and
associated overhead costs, as well as bad debt, accounting and legal expenses.
Administrative and general expenses were $20.1 million and $23.3 million for the
six months ended June 30, 1999 and 1998, respectively, representing 18% and 20%
of total revenues for each respective six month period. This decrease was
attributable, in part, to a reduction in company-wide bonus expenses, which was
based on the Company's financial performance. The decrease in administrative
and general expenses was also attributable, in part, to a reduction in bad debt
reserve as a result of a lower accounts receivable balance as of end of the
second quarter 1999.
11
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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 $2.6
million and $1.9 million for the six months ended June 30, 1999 and 1998,
respectively. This increase was primarily attributable to the increase in
interest income as average cash, cash equivalents and short-term investments
balances increased to $65.2 million in 1999 from $52.8 million in 1998.
Income Tax Provision. The income tax provision was $6.7 million and $7.9
million for the six months ended June 30, 1999 and 1998, respectively, resulting
in effective tax rates of 39.0% and 40.8%, respectively.
Three months ended June 30, 1999 and 1998
Revenues
Total Revenues. The Company's total revenues were $55.9 million and $60.4
million for the three months ended June 30, 1999 and 1998, respectively,
representing a decrease of 7%. This decrease in total revenues was primarily
due to a decrease in software license fees as described below.
Software License Fees. Software license fees decreased 30% to $17.2 million
for the three months ended June 30, 1999 compared to $24.6 million from the
comparable period in 1998. Software license fees in the second quarter of 1998
were positively impacted by one large order of $6.4 million, which was not
replaced by a comparably large order in the second quarter of 1999. Excluding
this one order from 1998, the software license fees would have decreased 6%
compared to the same period in 1998. Management believes that the decrease in
software license fees is attributable, in part, to customers' decisions to
postpone new orders until such customers address their own internal year 2000
concerns. Management expects this trend to continue in the remainder of 1999.
Maintenance Fees. Maintenance fees increased slightly by 2% to $20.8
million for the second quarter of 1999 from $20.5 million for the same period in
1998.
Professional Services Fees. Professional services fees were $17.9 million
and $15.3 million for the three months ended June 30, 1999 and 1998,
respectively, representing an increase of 17%. This increase was primarily due
to an increase in traditional core professional services offerings, such as
application development and engineering consulting. Year 2000 related services
revenues continued to decline from the fourth quarter of 1998 and represented
less than one third of the professional services revenue in the second quarter
of 1999.
Cost of Revenues
Software License. Software license costs were $4.0 million and $5.1 million
for the three months ended June 30, 1999 and 1998, respectively, representing
24% and 21% of software license fees for each respective period. The decrease in
dollar amount was primarily due to a decrease in sales volume. The percentage
increase was primarily due to a shift in the mix of third party products sold
from those with a low royalty rate to those with a higher royalty rate. Royalty
rates on third-party products vary from 24% to 40% of gross software license
fees. The increase in the percentage was also attributable to a decrease of 18%
in the sale of Company owned products compared to the same period in 1998.
Maintenance. Maintenance costs were $6.9 million and $7.0 million for the
three months ended June 30, 1999 and 1998, respectively, representing 33% and
34% of maintenance fees for each respective period. The decreases in both
dollar amount and percentage were primarily attributable to improved utilization
and efficiency of the existing support personnel.
12
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Professional Services. Professional services costs were $14.0 million and
$12.0 million for the three months ended June 30, 1999 and 1998, respectively,
representing 78% and 79% of professional services fees for each respective
period. The increase in dollar amount was primarily due to an increase in
professional service fees. The improvement in margin was primarily attributable
to improved utilization of resources, offset by costs incurred relating to
transition of certain consultants from the year 2000 service offerings into
enterprise integration related service offerings in the second quarter of 1999.
Operating Expenses
Software Product Development. Software product development costs were $2.3
million and $1.1 million for the three months ended June 30, 1999 and 1998,
respectively. This increase was primarily due to expenses incurred in support
of the Company's current product in development, Sagavista.
Sales and Marketing. Sales and marketing expenses were $10.2 million and
$13.1 million for the three months ended 1999 and 1998, respectively,
representing 18% and 22% of total revenues for each respective three-month
period. The decreases were attributable, in part, to lower commission expenses
in the second quarter of 1999 as a result of decreased software license fees
compared to the second quarter of 1998. Additionally, sales and marketing
expenses in the second quarter of 1998 included costs relating to a major trade
show that the Company participated in, for which similar costs were not incurred
in the second quarter of 1999. The Company anticipates that sales and marketing
expenses will increase in the second half of 1999 in connection with new product
introductions.
Administrative and General. Administrative and general expenses were $11.3
million and $12.5 million for the three months ended June 30, 1999 and 1998,
respectively, representing 20% and 21% of total revenues for each respective
period. This decrease was primarily due to a reduction in company-wide bonus
expenses, which was based on the Company's financial performance.
Other
Other Income and Expense, Net. Other income and expense, net, was $1.3
million and $1.0 million for the three months ended June 30, 1999 and 1998,
respectively. This increase was primarily attributable to the increase in
interest income as average cash, cash equivalents and the short-term investments
balances increased to $65.3 million in the second quarter of 1999 from $52.8
million in the second quarter of 1998.
Income Tax Provision. The income tax provision was $3.3 million and $4.2
million for the three months ended June 30, 1999 and 1998, respectively,
resulting in effective tax rates of 39.0% and 40.8%, respectively.
Liquidity and Capital Resources
The Company has financed its operations principally through cash flow from
operating activities. Net cash provided by operating activities was $4.3 million
and $5.3 million for the six months ended June 30, 1999 and 1998, respectively,
primarily from net income from each respective period and the net proceeds from
sales of accounts receivables in the amount of $18.1 million in 1998.
Investing activities used net cash of $15.2 million and $1.6 million for
the six months ended June 30, 1999 and 1998, respectively, primarily to fund the
acquisition of Blue Lobster in June 1999, to purchase short-term investments in
1999 and to fund capital expenditures for each respective period.
Financing activities used net cash of $2.9 million for the six months ended
June 30, 1999 primarily for the repurchase of common stock, offset by proceeds
from common stock issued under the Employee Stock Purchase Plan. For the six
months ended June 30, 1998, financing activities provided net cash of $1.0
million primarily from the proceeds from stock options exercised.
13
<PAGE>
The Company had $59.5 million and $70.9 million in cash, cash equivalents
and short-term investments as of June 30, 1999 and December 31, 1998,
respectively. The decrease in the cash, cash equivalent and short-term
investments was primarily the result of the Company's use of cash to fund the
acquisition of Blue Lobster for $12.0 million (see Note 4 of the Notes to
Condensed Consolidated Financial Statements) and the Company's repurchase
pursuant to the Stock Repurchase Program of 346,000 shares of Common Stock as of
June 30, 1999 for approximately $4.0 million (see Note 3 of the Notes to
Condensed Consolidated Financial Statements). 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 June 30, 1999 and December 31, 1998,
the Company remained contingently liable under the recourse provisions
associated with the sales made prior to 1998 in the amount of $13.4 million and
$24.7 million, respectively. The Company's accounts receivable days sales
outstanding at June 30, 1999 and December 31, 1998 was 65 and 64, 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 terminated a distributor
relationship in Mexico and instead commenced operations through a subsidiary in
1996, which has represented approximately 2% of total revenues since that time.
With the acquisition of R.D. Nickel and Associates, Inc. ("R.D. Nickel"), the
Company assumed direct sales in Canada effective October 1, 1997. Prior to the
acquisition of R.D. Nickel, the Company conducted sales in Canada through R.D.
Nickel as its Canadian distributor. Revenues from this source represented
approximately 4% of total revenues since the acquisition. The Company,
therefore, has not to date engaged in foreign currency hedging transactions. The
Company may enter into hedging transactions in the future.
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 SFAS No. 133 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 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 other material capital commitments or
planned expenditures as of June 30, 1999.
The Company has signed a commitment letter on July 26, 1999 and currently
is negotiating to establish the terms for a revolving credit facility in the
amount of approximately $25.0 million. If finalized, this revolving credit
facility would be available to the Company for general corporate purposes.
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 for many kinds of software, including software for
mainframes, PCs, and embedded systems. The Company is aware
14
<PAGE>
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 on
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 risks associated with these products
are not currently anticipated to have a material effect on the Company's
business, financial condition or results of operations. For the six months ended
June 30, 1999, total product revenues from the sale of other third party
products, excluding products developed or acquired by SAG, were approximately
$0.8 million which represents approximately 1% of total revenues for that
period. There can be no assurance, however, that year 2000 compliant products
will be delivered by third parties in a timely manner.
The Company's plans call for all products developed or acquired by the
Company that are in general release, as such term is defined by the Company, and
which will be supported with maintenance in the year 2000, to 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
facilities such as voice and data communications, and building management and
security systems), the Company has established an internal readiness program
which when completed is intended to 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 request to all third party suppliers
identified above requesting them to ensure that the products that the Company is
using are or 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 is continuing to test and re-implement back into production its
systems and internal applications in 1999.
Although the Company has initiated formal communications with all of its
significant suppliers and large customers to determine the extent to which the
Company's 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
15
<PAGE>
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. The use by customers of non-compliant
applications and databases could cause failure of the customer's system or
systems. The Company has provided year 2000 remediation and second opinion
services in order to assist customers in correcting year 2000 coding or
integration errors or to provide independent validation that remediation work
that customers or others have performed was accurate, under standard services
agreements with limits placed on liability and in some instances, the execution
of performance bonds. Cumulative year 2000 related services revenues through
June 30, 1999 were approximately $37.5 million. A certain amount of inaccuracy
is inherent in all remediation and validation work. As a result, the Company
cannot guarantee that errors resulting from the year 2000 related services
performed for customers will not materially adversely impact the Company's
business, financial condition or results of operations. The Company does not
believe that potential liability from these services will materially impact the
Company's financial condition or results of operations, but because of the
unprecedented nature of the year 2000 problem, it is not certain to what extent
the Company may ultimately be impacted by any such liability.
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
June 30, 1999, the Company incurred approximately $473,000 of costs associated
with preparing the Company's products and internal information technology system
to be year 2000 compliant and the remaining costs are to be approximately
$100,000. 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 failures,
and (iii) the failure of infrastructure services provided by government agencies
and other third parties (e.g., electricity, all emergency services, 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 mission critical software
and hardware failures (including systems supporting the Company's Customer
Support organization, as well as substitution of systems, if necessary). The
Company's year 2000 contingency planning around mission critical systems was
substantially completed as of June 30, 1999. After June 1999, the Company
expects that it will continue to address year 2000 contingency planning around
certain non-mission critical systems on a department-by-department basis. This
additional year 2000 contingency planning, which will have areas of overlap with
certain ongoing disaster recovery initiatives that the Company has underway,
will specifically address issues concerning how individual departments will
function in the event that the Company experiences failures with regard to
certain automated support systems.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
The Company does not believe there is material market risk exposure with
respect to its short-term investments or other financial instruments that would
require disclosure under this item.
16
<PAGE>
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; demand for year 2000 products and
services; year 2000 related failures, emergencies and other issues; risks
associated with conducting a professional services business; reliance on the
mainframe computing environment or the enterprise application integration market
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; and other
risks detailed from time to time in the Company's Securities and Exchange
Commission reports.
17
<PAGE>
PART II
Item 1. Legal Proceedings
In addition to the shareholder class action lawsuits previously disclosed
in the quarterly report on Form 10-Q filed on May 12, 1999, the Company, certain
of its directors and executive officers and the Company's principal stockholder
have been named as defendants in purported class action lawsuits filed on May 20
and May 27, 1999 in the United States District Court for the Eastern District of
Virginia, alleging violations of the federal securities laws. Civil action
number 99-721-A was filed by Caroline Teitelbaum et.al. and civil action number
99-751-A was filed by Harold Smith, et. al. In general, the lawsuits claim,
among other things, that the Company's accounting policies artificially inflated
revenues and earnings and that defendants caused or permitted the Company to
issue a series of materially false and misleading public statements about the
Company's operations and financial results while, at the same time, selling the
Company's Common Stock at artificially inflated prices while in possession of
material non-public information. Plaintiffs seek recission or compensatory
damages with interest, attorneys and expert witness fees, other costs and other
relief awarded at the discretion of the Court. On July 19, 1999, the shareholder
class action lawsuits were consolidated and an amended compliant, civil action
number 99-496-A "In re: Software AG Systems, Inc. Securities Litigation," was
filed. The Company believes that the allegations in the lawsuit are without
merit and intends to vigorously defend the charges.
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Stockholders of the Company was held on May 20, 1999
(the "Meeting"). Three proposals were presented for a vote at the Meeting:
Proposal 1 - The election of four directors, Dr. Erwin Koenigs, Edward E.
Lucente and Frederic V. Malek, each to serve as a Class II director of the
Company for a three-year term expiring at the annual meeting of stockholders to
be held in 2002 and until the election and qualification of each successor, and
Paul A. Brands to serve as a Class III director of the Company for a one-year
term expiring at the annual meeting of stockholders to be held in 2000 and until
the election and qualification of his successor; Proposal 2 - The approval of an
amendment to the Company's Certificate of Incorporation to provide for a change
in the Company's name from Software AG Systems, Inc. to SAGA SYSTEMS, Inc.; and
Proposal 3 - The ratification of the appointment of KPMG LLP as the Company's
independent public accountants for fiscal year 1999. All of the above proposals
were approved as follows:
<TABLE>
<CAPTION>
Against/ Withheld/ Broker
Matter For Abstain Exception Non-votes Total
- ----------------------- -------------- ------------- ------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
Proposal 1
Class II Directors:
Dr. Erwin Koenigs 28,690,704 --- 289,036 --- 28,979,740
Edward E. Lucente 28,827,076 --- 152,664 --- 28,979,740
Frederic V. Malek 28,826,576 --- 153,164 --- 28,979,740
Class III Directors:
Paul A. Brands 28,827,704 --- 152,036 --- 28,979,740
Proposal 2 28,940,151 39,589 --- --- 28,979,740
Proposal 3 28,946,329 33,411 --- --- 28,979,740
</TABLE>
The terms of Dr. Philip S. Dauber, Daniel F. Gillis, Carl J. Rickertsen and
Dr. Paul G. Stern as directors of the Company continued after the Meeting.
18
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on April 12, 1999, May 20,
1999 and June 14, 1999. The Form 8-K filed on April 12, 1999 reported the
departure of Derek M. Brigden, formerly the Vice President - Operations and
Chief Information Officer of the Company. The Form 8-K filed on May 20, 1999
announced the agreement between the Company and Blue Lobster Software, Inc. for
the acquisition of Blue Lobster by the Company. The Form 8-K filed on June 14,
1999 announced the Stock Repurchase Program.
19
<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.
SAGA SYSTEMS, Inc.
Date: August 12, 1999 By: /s/ Harry K. McCreery
---------------------------
Harry K. McCreery
Vice President, Treasurer and
Chief Financial Officer
(Principal Financial and
Accounting Officer and
Duly Authorized Officer)
20
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 46,531
<SECURITIES> 13,000
<RECEIVABLES> 95,423
<ALLOWANCES> 4,565
<INVENTORY> 0
<CURRENT-ASSETS> 160,845
<PP&E> 36,810
<DEPRECIATION> 27,915
<TOTAL-ASSETS> 247,009
<CURRENT-LIABILITIES> 77,578
<BONDS> 0
0
0
<COMMON> 308
<OTHER-SE> 136,813
<TOTAL-LIABILITY-AND-EQUITY> 247,009
<SALES> 109,544
<TOTAL-REVENUES> 109,544
<CGS> 50,114
<TOTAL-COSTS> 50,114
<OTHER-EXPENSES> 44,827
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 17,250
<INCOME-TAX> 6,728
<INCOME-CONTINUING> 10,522
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,522
<EPS-BASIC> 0.34
<EPS-DILUTED> 0.33
</TABLE>
