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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 MARCH 31, 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
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
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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
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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 May 11, 1999, 30,602,814 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 March 31, 1999 and December 31, 1998............................... 3
Condensed Consolidated Statements of Operations for the three months ended March 31, 1999 and 1998.......... 5
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 1999 and 1998.......... 6
Notes to Condensed Consolidated Financial Statements........................................................ 7
2. Management's Discussion and Analysis of Financial Condition and Results of Operations......................... 9
3. Quantitative and Qualitative Disclosures about Market Risk.................................................... 14
P A R T II
1. Legal Proceedings............................................................................................. 15
5. Other Information............................................................................................. 15
6. Exhibits and Reports on Form 8-K.............................................................................. 15
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ITEM 1. FINANCIAL STATEMENTS
SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
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MAR. 31, DEC. 31,
1999 1998
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(UNAUDITED)
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Assets
Current:
Cash and cash equivalents............................................... $ 60,011 $ 60,298
Short-term investments.................................................. 11,000 10,600
Accounts receivable:
Invoiced and currently due............................................. 40,611 50,110
Advanced billings on maintenance....................................... 7,140 11,899
Unbilled services...................................................... 8,931 8,771
Installment............................................................ 32,459 32,016
Other.................................................................. 1,927 1,231
Less: allowance for doubtful accounts.................................. (3,920) (5,042)
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Total accounts receivable............................................. 87,148 98,985
Current portion of deferred income taxes................................ 5,392 5,392
Prepaid expenses........................................................ 3,669 2,265
Other current assets.................................................... 1,910 1,855
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Total current assets................................................... 169,130 179,395
Cooperation agreement, net of accumulated amortization................... 18,799 19,387
Installment accounts receivable, net of current portion.................. 30,667 30,248
Property, equipment and leasehold improvements, net of accumulated
depreciation and amortization........................................... 9,504 10,176
Goodwill, net of accumulated amortization................................ 9,486 9,720
Deferred income taxes.................................................... 4,136 4,136
Other assets............................................................. 812 703
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Total assets............................................................ $ 242,534 $ 253,765
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</TABLE>
See accompanying notes to condensed consolidated financial statements.
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SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS - (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
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<CAPTION>
MAR. 31, DEC. 31,
1999 1998
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(UNAUDITED)
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Liabilities and Stockholders' Equity
Current:
Current portion of long-term obligations................................ $ 459 $ 478
Accounts payable........................................................ 6,229 9,675
Accrued payroll and employee benefits................................... 8,025 12,181
Payable to SAG.......................................................... 5,081 10,884
Income taxes payable.................................................... 2,786 3,991
Other current liabilities............................................... 7,787 7,912
Current portion of deferred revenues, net of deferred royalties......... 46,622 48,328
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Total current liabilities.............................................. 76,989 93,449
Long-term obligations, net of current portion............................ 534 635
Deferred revenues, net of deferred royalties............................. 30,651 31,773
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Total liabilities...................................................... 108,174 125,857
Stockholders' equity
Common stock ($0.01 par value, 75,000,000 shares authorized, issued
and outstanding: 30,599,721 shares at March 31, 1999 and 30,516,946
shares at December 31, 1998)........................................... 306 305
Additional paid-in capital.............................................. 96,337 95,474
Retained earnings....................................................... 38,462 33,048
Accumulated translation adjustments..................................... (745) (919)
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Total stockholders' equity............................................. 134,360 127,908
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Total liabilities and stockholders' equity............................. $ 242,534 $ 253,765
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</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
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SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(IN THOUSANDS, EXCEPT PER SHARE DOLLAR AMOUNTS)
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1999 1998
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(UNAUDITED)
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Revenues:
Software license fees................................................. $ 13,180 $ 21,649
Maintenance fees...................................................... 20,634 19,800
Professional services fees............................................ 19,792 14,414
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Total revenues....................................................... 53,606 55,863
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Cost of revenues:
Software license...................................................... 3,118 5,670
Maintenance........................................................... 7,041 7,057
Professional services................................................. 14,990 11,501
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Total cost of revenues............................................... 25,149 24,228
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Gross profit........................................................... 28,457 31,635
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Operating expenses:
Software product development.......................................... 2,409 755
Sales and marketing................................................... 9,811 11,873
Administrative and general............................................ 8,705 10,805
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Total operating expenses............................................. 20,925 23,433
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Income from operations................................................. 7,532 8,202
Other income and expense, net......................................... 1,344 906
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Income before income taxes............................................. 8,876 9,108
Income tax provision.................................................. 3,462 3,718
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Net income............................................................. 5,414 5,390
Other comprehensive income:
Foreign currency translation adjustments.............................. 173 (72)
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Comprehensive income................................................... $ 5,587 $ 5,318
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Net income per common share:
Basic................................................................. $ 0.18 $ 0.18
Diluted............................................................... $ 0.17 $ 0.17
Shares used in computing net income per common share:
Basic................................................................. 30,577 29,517
Diluted............................................................... 31,839 31,491
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
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SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(IN THOUSANDS)
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1999 1998
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(UNAUDITED)
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Cash flows from operating activities:
Net income.. ........................................................... $ 5,414 $ 5,390
Adjustments to reconcile net income to net cash provided by operating
Activities:
Depreciation and amortization......................................... 2,005 2,070
Loss (Gain) on sales of property and equipment........................ 15 (22)
Write off of investment............................................... -- 848
Compensation expenses on options granted.............................. 194 194
Changes in operating accounts......................................... (7,177) (7,044)
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Net cash provided by operating activities............................ 451 1,436
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Cash flows from investing activities:
Additions to property, equipment and leasehold improvements............. (430) (1,523)
Proceeds from sales of property and equipment........................... -- 22
Purchase of short-term investments...................................... (400) --
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Net cash used in investing activities................................ (830) (1,501)
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Cash flows from financing activities:
Proceeds from stock options exercised.................................. 131 12
Adjustment to expenses relating to initial public offering.............. -- (100)
Payments made on capital leases......................................... (120) --
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Net cash provided by/(used) in financing activities.................. 11 (88)
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Effect of exchange rate changes on cash and cash equivalents............. 81 --
Net decrease in cash and cash equivalents................................ (287) (153)
Cash and cash equivalents, beginning..................................... 60,298 50,429
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Cash and cash equivalents, ending........................................ $ 60,011 $ 50,276
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</TABLE>
See accompanying notes to condensed consolidated financial statements.
6
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SOFTWARE AG SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The condensed consolidated financial statements included herein have been
prepared by management, pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. These condensed consolidated financial statements should be read
in conjunction with the financial statements and notes thereto included in the
Software AG Systems, Inc. Annual Report on Form 10-K for the year ended December
31, 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 three months
ended March 31, 1999 are not necessarily indicative of the results expected for
the full year.
(2) ACCOUNTING POLICIES
Revenue Recognition
On January 1, 1998, Software AG 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 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.
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.
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SOFTWARE AG 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 which are dilutive. The following
information is a reconciliation of the amounts used in these calculations:
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<CAPTION>
THREE MONTHS ENDED MARCH 31,
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1999 1998
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(UNAUDITED)
(IN THOUSANDS, EXCEPT FOR PER
SHARE DOLLAR AMOUNTS)
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Numerator:
Net income................................................... $ 5,414 $ 5,390
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Denominator:
Basic weighted average shares outstanding....................... 30,577 29,517
Effect of dilutive securities:
Stock options................................................ 1,262 1,974
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Diluted weighted average shares outstanding..................... 31,839 31,491
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Net income per common share:
Basic........................................................ $ 0.18 $ 0.18
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Diluted...................................................... $ 0.17 $ 0.17
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</TABLE>
(3) SUBSEQUENT EVENT
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 Company intends to finance the Offer with cash on
hand.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 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 $53.6
million and $55.9 million for the three months ended March 31, 1999 and 1998,
respectively, representing a decrease of 4%. 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 39% to $13.2 million for the three months ended March 31,
1999 compared to $21.6 million from the prior period. Software license fees in
the first quarter of 1998 were positively impacted by one large enterprise
license agreement ("ELA") with software license fees of $5.9 million. Excluding
this one large ELA from 1998, the software license fees would have decreased 16%
compared to the prior period. 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 through 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 can be expected only
if the customer continues to use the licensed products. Maintenance fees were
$20.6 million and $19.8 million for the three months ended March 31, 1999 and
1998, respectively, representing an increase of 4%. This increase was primarily
due to expansion of the installed base due to increased license sales combined
with the overall maintenance renewal rate of over 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 $19.8 million and $14.4 million for the three months ended
March 31, 1999 and 1998, respectively, representing an increase of 37%.
Approximately half of this increase was attributable solely to the year 2000
professional services area while the other half of the increase was attributable
to traditional core professional services offerings, such as application
development and engineering consulting. Year 2000 professional service revenues
in the first quarter of 1999 decreased to $7.3 million compared to $11.4
million in the fourth quarter of 1998. Management anticipates this decrease to
continue in 1999 and year 2000 professional service revenues to significantly
decrease thereafter.
COST OF REVENUES
Software License. Software license costs consist primarily of royalties paid
to third parties. Software license costs were $3.1 million and $5.7 million for
the three months ended March 31, 1999 and 1998, respectively, representing 24%
and 26% of software license fees for each respective period. The decrease in
dollar amount was
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primarily due to a decrease in sales volume. The percentage decrease was
primarily due to a shift in the mix of third party products sold from those with
a high royalty rate to those with a low royalty rate. Royalty rates on third-
party products vary from 24% to 40% of gross software license fees. The decrease
in the percentage was also attributable to an increase of 43% in the sale of the
Company owned products compared to the prior period.
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 $7.0 million and $7.1 million for the three
months ended March 31, 1999 and 1998, respectively, representing 34% and 36% 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.
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 $15.0 million and $11.5 million for the three
months ended March 31, 1999 and 1998, respectively, representing 76% and 80% of
professional services fees for each respective period. The increase in dollar
amount was primarily due to an increase in sales 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 $2.4 million and
$0.8 million for the three months ended March 31, 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 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 $9.8 million and $11.9
million for the three months ended 1999 and 1998, respectively, representing 18%
and 21% of total revenues, respectively. Sales and marketing expenses in the
first quarter of 1998 included costs relating to several new marketing programs
and events. Similar costs were not incurred in the first 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 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 $8.7 million and $10.8 million for the
three months ended March 31, 1999 and 1998, respectively, representing 16% and
19% of total revenues for each respective period. This decrease was primarily
due to planned reductions in infrastructure and reduction in bad debt reserve,
which resulted from a credit against administrative and general expenses from
lower accounts receivable balance in the first quarter of 1999.
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 $1.3
million and $0.9 million for the three months ended March 31, 1999 and 1998,
respectively. This increase was primarily attributable to the increase in
interest income as cash, cash equivalents and the short-term investments
balances increased to $71.0 million at March 31, 1999 compared to $50.3 million
from the prior period.
Income Tax Provision. The income tax provision was $3.5 million and $3.7
million for the three months ended March 31, 1999 and 1998, respectively,
resulting in effective tax rates of 39.0% and 40.8%, respectively.
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LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations principally through cash flow from
operating activities. Net cash provided by operating activities was $0.5 million
and $1.4 million for the three months ended March 31, 1999 and 1998,
respectively, primarily from net income from each respective period.
Investing activities used net cash of $0.8 million and $1.5 million for the
three months ended March 31, 1999 and 1998, respectively, primarily to fund
capital expenditures and to purchase short-term investments.
Financing activities provided net cash of $11,000 for the three months ended
March 31, 1999 primarily from the proceeds from stock options exercised offset
by payments made on long-term capital leases. For the three months ended March
31, 1998, financing activities used net cash of $88,000 primarily for expenses
related to the initial public offering in November 1997.
The Company had $71.0 million and $70.9 million in cash, cash equivalents and
short-term investments as of March 31, 1999 and December 31, 1998, 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 March 31,
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 $21.0 million and $24.7 million, respectively. The Company's accounts
receivable days sales outstanding at March 31, 1999 and December 31, 1998 was 68
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's Mexican operations
commenced in 1996 and represented less than 3% of total revenues since that
time. With the acquisition of R.D. Nickel and Associates, Inc. the Company
began direct sales in Canada effective October 1, 1997. Revenues from this
source were 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 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.
As is more fully described in the Schedule 13E-4 filed by the Company with the
Securities and Exchange Commission ("Commission") on April 27, 1999, the Company
commenced an offer to purchase up to 6,000,000 shares of its common stock at a
price not greater than $8.00 per share nor less than $6.50 per share. The Offer
is scheduled to expire at 5:00 P.M. EDT on May 25, 1999 unless extended by the
Company. The Company intends to finance the Offer with its cash on hand. In
addition, the Company expects to incur approximately $700,000 of expenses
relating to the Offer.
The Company from time to time evaluates the possibility of acquiring other
businesses or technology. The Company believes the financing of such
transactions would be achieved by using the Company's cash on hand or other
financing alternatives.
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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 other material capital commitments or
planned expenditures as of March 31, 1999.
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
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 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 three
months ended March 31, 1999, total product revenues from the sale of other third
party products, excluding products developed or acquired by SAG, were
approximately $0.2 million which represents less than 1% 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.
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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 an 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 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 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. For the three months ended March
31, 1999, year 2000 remediation services revenues were 7.0 million.
Additionally, cumulative year 2000 remediation services revenues through March
31, 1999 were approximately $32.6 million. The Company does not believe that
potential liability from these services will materially impact the Company's
financial condition or results of operations, however, a certain amount of
inaccuracy is inherent in all remediation. As a result of this inherent risk in
remediation, the Company cannot guarantee that errors resulting from the year
2000 remediation services performed for customers will not materially adversely
impact the Company's business, financial condition or results of operations.
To date, the costs associated with preparing the Company's products and
internal information technology systems to be year 2000 compliant have not been
material to the Company's business, financial condition or results of operations
and the Company does not expect these costs to materially impact the Company's
business, financial condition or results of operations in the future. As of
March 31, 1999, 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 not expected to exceed
$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 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 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
13
<PAGE>
anticipates that its Year 2000 contingency planning around mission critical
systems will be completed by the end of the second quarter of 1999. After the
end of the second quarter of 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.
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.
14
<PAGE>
PART II
ITEM 1. LEGAL PROCEEDINGS
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 April 8, April 14 and April 16, 1999 (two complaints were
filed on April 16) in the United States District Court for the Eastern District
of Virginia, alleging violations of the federal securities laws. Civil action
number 99-496-A was filed by Lucian B. Cox, III, et. al.; civil action number
99-544-A was filed by Gerry Dela Pena, et. al.; civil action number 99-527-A was
filed by Katherine K. Piven, et. al.; and civil action number 99-545-A was filed
by Adele Brody, 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. The Company believes that the
allegations in the lawsuits are without merit and intends to vigorously defend
the charges.
ITEM 5. OTHER INFORMATION
On April 27, 1999, the Company commenced an offer to repurchase up to
6,000,000 shares of its Common Stock at a price not greater than $8.00 per share
nor less than $6.50 per share. The Company is conducting the Offer through a
"Dutch Auction" tender offer. The Offer is scheduled to expire at 5:00 P.M. EDT
on May 25, 1999, unless extended by the Company. The purchase of its Common
Stock is expected to be financed with the Company's cash on hand.
The Offer is explained in detail in the Schedule 13E-4 filed with the
Commission on April 27, 1999.
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 January 19, 1999 to report
the appointment of Alan Croll to the office of Vice President, Services of the
Company and SAGA SOFTWARE, Inc., a wholly-owned subsidiary of the Company.
15
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SOFTWARE AG SYSTEMS, INC.
BY: /s/ Harry K. McCreery
---------------------
Harry K. McCreery
Date: May 12, 1999 Vice President, Treasurer and
Chief Financial Officer
(Principal Financial and Accounting Officer and
Duly Authorized Officer)
16
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