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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 SEPTEMBER 30, 2000
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 identification no.)
incorporation or organization)
11190 Sunrise Valley Drive
Reston, Virginia 20191
-----------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: (703) 860-5050
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
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 November 3, 2000, 29,368,919 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 September 30, 2000 and December 31, 1999.......................... 3
Condensed Consolidated Statements of Operations for the three and nine months ended
September 30, 2000 and 1999.............................................................................. 5
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30,
2000 and 1999............................................................................................ 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
6. Exhibits and Reports on Form 8-K.......................................................................... 19
</TABLE>
2
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ITEM 1. Financial Statements
SAGA SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
Sept. 30, Dec. 31,
2000 1999
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<S> <C> <C>
Assets (Unaudited)
Current:
Cash and cash equivalents............................................... $ 53,838 $ 33,701
Short-term investments.................................................. 2,450 14,500
Accounts receivable:
Invoiced and currently due.......................................... 30,072 36,486
Advanced billings on maintenance.................................... 11,991 9,355
Unbilled services................................................... 2,432 1,792
Installment......................................................... 61,800 42,672
Other............................................................... 3,051 2,131
Less: allowance for doubtful accounts............................... (3,657) (2,884)
----------------- ----------------
Total accounts receivable...................................... 105,689 89,552
Income taxes receivable................................................. 1,484 ---
Prepaid expenses........................................................ 3,328 3,186
Current portion of deferred income taxes................................ 1,980 2,175
Other current assets.................................................... 708 939
----------------- ----------------
Total current assets........................................... 169,477 144,053
Installment accounts receivable, net of current portion......................... 51,428 35,510
Goodwill and other intangible assets, net of accumulated amortization........... 19,711 22,674
Cooperation agreement, net of accumulated amortization.......................... 15,275 17,037
Property, equipment and leasehold improvements, net of accumulated depreciation
and amortization............................................................ 7,369 8,423
Deferred income taxes........................................................... 975 883
Purchased software costs, net of accumulated amortization....................... 832 861
Other assets.................................................................... 375 1,303
----------------- ----------------
Total assets................................................... $ 265,442 $ 230,744
================= ================
</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>
Sept. 30, Dec. 31,
2000 1999
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<S> <C> <C>
(Unaudited)
Liabilities and Stockholders' Equity
Current:
Current portion of long-term obligations................................ $ 553 $ 649
Accounts payable........................................................ 6,007 6,640
Accrued payroll and employee benefits................................... 4,720 6,044
Payable to SAG.......................................................... 8,651 8,427
Income taxes payable.................................................... --- 1,376
Other current liabilities............................................... 5,389 6,481
Current portion of deferred revenues, net of deferred royalties......... 63,395 47,882
---------------- --------------
Total current liabilities...................................... 88,715 77,499
Long-term obligations, net of current portion................................... 271 680
Deferred revenues, net of deferred royalties.................................... 43,719 33,110
---------------- --------------
Total liabilities.............................................. 132,705 111,289
Stockholders' equity
Common stock ($0.01 par value, 75,000,000 shares authorized;
32,099,969 issued at September 30, 2000; and 30,882,422 shares issued
at December 31, 1999)................................................ 321 309
Additional paid-in capital.............................................. 110,708 98,936
Retained earnings....................................................... 57,333 50,123
Accumulated other comprehensive income.................................. (380) (225)
---------------- --------------
167,982 149,143
Treasury stock, at cost, 2,733,800 shares at September 30, 2000 and
2,414,600 shares at December 31, 1999............................... (35,245) (29,688)
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Total stockholders' equity..................................... 132,737 119,455
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Total liabilities and stockholders' equity..................... $ 265,442 $ 230,744
================ ==============
</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 nine months ended September 30, 2000 and 1999
(in thousands, except per share dollar amounts)
<TABLE>
<CAPTION>
Three months ended Sept. 30, Nine months ended Sept. 30,
-------------------------------- --------------------------------
2000 1999 2000 1999
------------- ------------- ------------- -------------
(Unaudited)
<S> <C> <C> <C> <C>
Revenues:
Software license fees................... $ 13,498 $ 15,569 $ 51,340 $ 45,921
Maintenance fees........................ 20,436 20,754 61,768 62,216
Professional services fees.............. 9,804 15,445 31,370 53,175
------------- ------------- ------------- -------------
Total revenues................. 43,738 51,768 144,478 161,312
------------- ------------- ------------- -------------
Cost of revenues:
Software license........................ 3,442 3,893 12,100 11,045
Maintenance............................. 6,627 6,692 20,461 20,647
Professional services................... 8,504 11,921 28,515 40,928
------------- ------------- ------------- -------------
Total cost of revenues......... 18,573 22,506 61,076 72,620
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Gross profit.................................... 25,165 29,262 83,402 88,692
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Operating expenses:
Software product development............ 4,145 2,592 11,612 7,316
Sales and marketing..................... 10,360 11,894 32,353 31,945
Administrative and general.............. 9,977 9,625 29,755 29,677
------------- ------------- ------------- -------------
Total operating expenses....... 24,482 24,111 73,720 68,938
------------- ------------- ------------- -------------
Income from operations.......................... 683 5,151 9,682 19,754
Other income and expense, net........... 1,465 1,343 4,033 3,990
Loss from Class Action Lawsuit
Settlement............................ (2,049) --- (2,049) ---
------------- ------------- ------------- -------------
Income before income taxes...................... 99 6,494 11,666 23,744
Income tax provision.................... 38 2,533 4,457 9,261
------------- ------------- ------------- -------------
Net income...................................... 61 3,961 7,209 14,483
Other comprehensive income (loss):
Foreign currency translation
adjustments........................... 70 (61) (155) 197
------------- ------------- ------------- -------------
Comprehensive income............................ $ 131 $ 3,900 $ 7,054 $ 14,680
============= ============= ============= =============
Net income per common share:
Basic.................................. $ 0.00 $ 0.13 $ 0.25 $ 0.48
Diluted................................ $ 0.00 $ 0.13 $ 0.24 $ 0.46
Shares used in computing net income per common
share:
Basic................................... 29,364 29,714 28,949 30,304
Diluted................................. 30,064 30,893 30,288 31,459
</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 nine months ended September 30, 2000 and 1999
(in thousands)
<TABLE>
<CAPTION>
2000 1999
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(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income............................................................... $ 7,209 $ 14,483
Adjustments to reconcile net income to net cash provided by operating
Activities:
Depreciation and amortization...................................... 7,534 6,434
Loss on disposal of property and equipment......................... 41 33
Loss from Class Action Lawsuit Settlement.......................... 2,049 --
Compensation expenses on options granted........................... (158) 452
Changes in operating accounts...................................... (7,969) (10,405)
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Net cash provided by operating activities............. 8,706 10,997
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Cash flows from investing activities:
Proceeds from sale of short-term investments............................. 16,482 8,600
Purchase of short-term investments....................................... (4,432) (13,000)
Additions to property, equipment and leasehold improvements.............. (1,879) (1,000)
Proceeds from sales of property and equipment............................ 31 --
Cash received from settlement of an acquisition, net..................... 187 --
Acquisition, net of cash received........................................ -- (12,088)
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Net cash provided by / (used) in investing
activities.......................................... 10,389 (17,488)
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Cash flows from financing activities:
Proceeds from stock options exercised.................................... 6,269 267
Proceeds from Employee Stock Purchase Program............................ 882 1,071
Repurchase of common stock............................................... (5,557) (22,396)
Payments made on capital leases.......................................... (444) (368)
-------------- --------------
Net cash provided by / (used) in financing
activities.......................................... 1,150 (21,426)
-------------- --------------
Effect of exchange rate changes on cash and cash equivalents................. (108) (70)
-------------- --------------
Net increase / (decrease) in cash and cash equivalents....................... 20,137 (27,987)
Cash and cash equivalents, beginning......................................... 33,701 60,298
-------------- --------------
Cash and cash equivalents, ending............................................ $ 53,838 $ 32,311
============== ==============
</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 ("SEC"). 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 consolidated financial statements and notes
thereto included in SAGA SYSTEMS, Inc. Annual Report on Form 10-K for the year
ended December 31, 1999.
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 nine and
three months ended September 30, 2000 are not necessarily indicative of the
results expected for the full year. See ITEM 2, Management's Discussion and
Analysis of Financial Condition and Results of Operations, of this Quarterly
Report on Form 10-Q for further detail on the full year outlook.
(2) Accounting Policies
Revenue Recognition
As of January 1, 1998, SAGA SYSTEMS, Inc., together with 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
deferred certain portions of SOP 97-2 until the Company's fiscal year 2000.
Effective January 1, 2000, the Company adopted SOP 98-9, which has resulted in
application of the "residual method" (as defined in SOP 98-9) in the accounting
for certain contracts. Under the residual method, the arrangement fee for
certain multiple-element arrangements, which bundle products and services is as
follows: (a) the total fair value of the undelivered elements, as indicated by
vendor-specific objective evidence, is deferred and (b) the difference between
the total arrangement fee and the amount deferred for the undelivered elements
is recognized as revenue related to the delivered elements. Had the Company not
adopted the residual method and accounted for all of its contracts consistent
with the method used during 1999, the Company's product revenue would have been
higher by $2.3 million and $129,000 for the nine and three months ended
September 30, 2000, respectively. The Company's maintenance revenue would have
been lower by $278,000 and $244,000 for the nine and three months ended
September 30, 2000, respectively. In addition, the deferred maintenance revenue
would have been lower by approximately $2.0 million at September 30, 2000 had
the Company not applied the residual method.
In December 1999, the SEC issued Staff Accounting Bulletin ("SAB") No. 101,
"Revenue Recognition in Financial Statements", as amended by SAB No. 101A and
SAB No. 101B. This SAB expresses the SEC's views in applying generally accepted
accounting principles to revenue recognition in financial statements. The
Company can apply the accounting and disclosure requirements of this SAB
retrospectively, or may report a change in accounting principle as of January 1,
2000 no later than the quarter beginning October 1, 2000. Management does not
believe that the adoption of SAB No. 101 will have an impact on the Company's
financial statements for the years ending December 31, 1999 and prior.
Management is currently evaluating whether the adoption of SAB No. 101 will
materially impact its quarterly financial statements in the year ending December
31, 2000.
7
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SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
Software Development Costs
In accordance with Statement of Financial Accounting Standards No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise
Marketed", the Company expenses software development costs as incurred until
technological feasibility has been established, at which time such costs are
capitalized until the product is available for general release to customers.
Based on the Company's development cycle, technological feasibility is
established upon the completion of a working model.
For products where technological feasibility has been reached, software
purchased to be used in the development of those products has been capitalized.
Capitalized purchased software is recorded at the lower of cost or net
realizable value and is amortized over the estimated useful life of three years
beginning at the point in which the product becomes available for general
release to customers. Capitalized purchased software costs were $861,000 each
at September 30, 2000 and December 31, 1999, and accumulated amortization was
$29,000 at September 30, 2000. None of the products for which these costs were
capitalized were available for general release at December 31, 1999; therefore,
there was no accumulated amortization balance at December 31, 1999. Related
amortization expense (included in the cost of software license fees) was $29,000
and $7,000 for the nine and three months ended September 30, 2000. There was no
amortization expense in the comparable prior year period, as there were no
capitalized purchased software costs at September 30, 1999.
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 Sept. 30, Nine months ended Sept. 30,
----------------------------- -------------------------------
2000 1999 2000 1999
----------- ----------- ------------ -----------
(In thousands, except for per share dollar amounts)
(Unaudited)
<S> <C> <C> <C> <C>
Numerator:
Net income.................................. $ 61 $ 3,961 $ 7,209 $ 14,483
============= ============= ============== =============
Denominator:
Basic weighted average shares outstanding... 29,364 29,714 28,949 30,304
Effect of dilutive securities:
Stock options.......................... 700 1,179 1,339 1,155
------------- ------------- -------------- -------------
Diluted weighted average shares outstanding...... 30,064 30,893 30,288 31,459
============= ============= ============== =============
Net income per common share:
Basic....................................... $ 0.00 $ 0.13 $ 0.25 $ 0.48
============= ============= ============== =============
Diluted..................................... $ 0.00 $ 0.13 $ 0.24 $ 0.46
============= ============= ============== =============
</TABLE>
Reclassification
Certain amounts in 1999 have been reclassified to conform to the 2000
presentation.
8
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
(3) Class Action Lawsuit
The Company, certain of its directors and executive officers and the
Company's principal shareholder were named as defendants in a class action suit
consolidated as In re: Software AG Systems, Inc. Securities Litigation in the
Federal District Court for the Eastern District of Virginia. The suit alleged
violations of the federal securities laws, claiming, 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. The parties to the litigation entered into a settlement, which
received final approval by the court on September 8, 2000. The class action
lawsuit was settled for $3.5 million, which satisfied all participating
shareholders' claims as well as the fees and expenses of plaintiffs' counsel. In
addition, the Company paid litigation expenses of approximately $1.5 million. To
offset these costs, the Company received a $3.0 million payment on August 3,
2000 from its insurance carrier. As a result, a $2.0 million loss was recorded
as a non-operating expense in the accompanying Condensed Statement of Operations
for the three and nine months ended September 30, 2000. The net income impact of
the settlement was $1.3 million after taxes or $0.04 per diluted share. The
Company funded the uninsured portion of the settlement and legal fees by cash on
hand. No other expenses are anticipated relating to this matter.
(4) Subsequent Event
On November 2, 2000, the Company, together with Software AG ("Software
AG"), issued a joint press release announcing that Software AG, Software AG
Acquisition Corporation, a Delaware corporation and wholly owned subsidiary of
Software AG ("Acquisition Corp."), and SAGA SYSTEMS had entered into an
Agreement and Plan of Merger, dated as of November 1, 2000 (the "Merger
Agreement"), providing for the merger of Acquisition Corp. with and into SAGA
SYSTEMS (the "Merger"). Under the terms of the Merger Agreement, if the Merger
is consummated, SAGA SYSTEMS stockholders (other than Software AG and
stockholders who elect to exercise appraisal rights under Delaware law) will
receive $11.50 in cash for each share of SAGA SYSTEMS common stock held. The
Merger is subject to customary closing conditions, including the approval of the
Merger by the stockholders of SAGA SYSTEMS.
In addition, Thayer Equity Investors III, L.P. and its affiliate, TC Co-
Investors, LLC, which collectively own approximately 37% of the outstanding SAGA
SYSTEMS common stock, and Daniel F. Gillis, President and Chief Executive
Officer of SAGA SYSTEMS (who owns less than 1% of the outstanding shares of SAGA
SYSTEMS common stock), have agreed, among other things, to vote their shares of
SAGA SYSTEMS common stock to approve the Merger Agreement, the Merger and
related agreements. Their respective obligations to vote in this manner will
terminate upon termination of the Merger Agreement.
The foregoing description is qualified in its entirety by reference to the
complete text of the Merger Agreement, a copy of which is files as Exhibit 2.1
to the Current Report on Form 8-K which was filed by the Company on November 3,
2000, which contains the complete text of the Merger Agreement.
9
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ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Forward-Looking Statements
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the Management's
Discussion and Analysis of Financial Condition and Results of Operations and the
Consolidated Financial Statements and Notes thereto included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1999. This Quarterly
Report on Form 10-Q includes forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Words such as "may," "plans,"
"expects," "anticipates," "approximates," "believes," "estimates," "intends,"
"hopes," "potential," or "continue" and variations of such words and similar
expressions are intended to identify such forward-looking statements. The
Company intends such forward-looking statements, all of which are qualified by
this statement, to be covered by the safe harbor provisions for forward-looking
statements contained in the Private Litigation Securities Reform Act of 1995 and
is including this statement for purposes of complying with these safe harbor
provisions. The Company has based these statements on its current expectations
and projections about future events. These forward-looking statements are not
guarantees of future performance and are subject to risks and uncertainties that
could cause actual results to differ materially from those projected in these
statements. These risks and uncertainties include, but are not limited to,
significant quarterly and other fluctuations in revenues and results of
operations including the signing of large contracts in certain quarters but not
others, reliance on acquisitions and the timely development, production,
marketing, delivery and acceptance of products and services including Sagavista
and its adapters, interoperability of the Company's products with other software
application products, new or competitive products or services offered by
competitors, demand for the Company's products and services, and reliance on the
mainframe and enterprise computing environments and Software AG, a German
software company, to develop and deliver products timely. The forward-looking
statements contained in this Quarterly Report on Form 10-Q include, but are not
limited to, statements about the following:
. statements in the "Outlook" section;
. references to the development, acquisition, marketing and acceptance of
the Company's products and services including, but not limited to
Sagavista and its adapters, professional services and customer support;
. alliances and relationships with third parties including but not limited
to the Company's distributors, original equipment manufacturers and
value-added resellers;
. markets in which the Company competes; competition and competitors;
results of operations; and
. the Company's financial condition and other statements regarding matters
that are not historical fact.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which reflect management's views only as of the date hereof. The
Company is not obligated to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
In light of these risks, uncertainties and assumptions, the forward-looking
events discussed in this Quarterly Report on Form 10-Q might not occur. Readers
should carefully review the risk factors described in other documents the
Company files from time to time with the Securities and Exchange Commission,
including the Annual Report on Form 10-K for the fiscal year ended December 31,
1999 and the Quarterly Reports on Form 10-Q filed by the Company in fiscal 2000.
10
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Results of Operations
Nine months ended September 30, 2000 and 1999
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
decreased $16.8 million or 10% to $144.5 million for the nine months ended
September 30, 2000 compared to the same period in 1999. This decrease in total
revenues was primarily due to a decrease in professional services 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 e-business
integration products. Enterprise systems products include Adabas, a high-
performance data management system, and Natural, a 4GL programming language.
E-business integration products include Sagavista, the Company's e-business
integration product suite, and EntireX, a family of integration products.
Software license fees increased 12% to $51.3 million for the nine months ended
September 30, 2000 compared to $45.9 million from the respective nine-month
period in 1999. This increase was primarily attributable to Sagavista sales of
$8.4 million in the current year, compared to $468,000 in 1999. Sagavista was
generally released in September 1999. Included in the $51.3 million of software
license fees was one large contract that contributed $9.3 million of revenue,
which included a Sagavista sale. Despite this increase, software license fees
were negatively impacted in the first nine months of 2000 by approximately $2.3
million due to the adoption of the residual method under SOP 98-9 for accounting
for certain contracts. See Note 2 of Notes to Condensed Consolidated Financial
Statements for further detail.
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 e-business 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
$61.8 million and $62.2 million for the nine months ended September 30, 2000 and
1999, respectively. Maintenance fees were negatively affected in the current
year primarily by the decreased royalties received from the international
distributors, as well as from our Canadian and Mexican subsidiaries. This
decrease in maintenance fees was offset by an increase of approximately $278,000
for the first nine months in the current year due to the adoption of the
residual method in accordance with SOP 98-9. Additionally, deferred maintenance
fees were positively impacted and were approximately $2.0 million higher at
September 30, 2000 due to the application of the residual method.
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 e-business integration products and
through educational services. The Company's professional services offerings
include consulting, software integration, system implementation and large
project management. The services are delivered on either a time and material
basis or a fixed price basis. Professional services fees were $31.4 million and
$53.2 million for the nine months ended September 30, 2000 and 1999,
respectively, representing a decrease of 41%. This decrease was, in part, due to
the absence of year 2000 analysis and remediation services revenue in the
current period compared to $15.9 million in 1999. The decrease was also, in
part, attributable to lower traditional core professional services fees in 2000
compared to 1999, which primarily resulted from changing market conditions where
companies are focusing more on the emerging e-business integration area than the
traditional enterprise systems area. Accordingly, the Company expects the mix of
its professional services revenue to continue to shift from traditional core
professional services to e-business integration services.
11
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Cost of Revenues
Software License. Software license costs consist primarily of royalties
paid to third parties. Software license costs were $12.1 million and $11.0
million for the nine months ended September 30, 2000 and 1999, respectively,
each representing 24% of software license fees for each respective period. The
increase in dollar amount was primarily due to an increase in software license
fees coupled with nine months of amortization expense in 2000 relating to the
capitalized acquired technology costs resulting from the Blue Lobster Software,
Inc. ("Blue Lobster") acquisition in June 1999. For 1999, the three months of
Blue Lobster amortization expense from the capitalized acquired technology has
been reclassed from general and administrative for comparative purposes.
Excluding the amortization expense, the software license costs would have been
only 21% of software license fees in 2000 compared to 23% in 1999. This decrease
in percentage was primarily due to a shift in the mix of products sold from
third party owned products to Company owned products. Royalty rates on third
party products vary from 24% to 40% of software license fees, whereas the
royalties on Company owned products is generally less than 5% of Company owned
product revenue. The Company owned product sales represented 21% of the total
software license fees compared to 8% from the prior period.
Maintenance. Maintenance costs consist primarily of royalties paid to third
parties, the costs of providing customer support and the distribution costs of
new releases. Maintenance costs were $20.5 million and $20.6 million for the
nine months ended September 30, 2000 and 1999, respectively, each representing
33% of maintenance fees for each respective period.
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 $28.5 million and $40.9 million for the nine
months ended September 30, 2000 and 1999, respectively, representing 91% and 77%
of professional services fees for each respective period. The decrease in dollar
amount was primarily due to a decrease in professional services fees revenue.
The increase in percentage was primarily due to less than expected new
professional services business in the current period, which resulted in an
under-utilization of existing personnel hired to establish the enterprise
integration services practice. The Company believes the professional services
gross margin may improve as the Company has taken certain actions to improve the
utilization rate.
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 increased $4.3 million
or 59% to $11.6 million for the nine months ended September 30, 2000 compared to
the respective prior year period. This increase was primarily due to the hiring
of additional developers needed for the ongoing enhancements being made to the
core Sagavista product since its release in September 1999 and to build
additional adapters. The total number of developers has increased to 117
compared to 72 as of September 30, 1999.
Sales and Marketing. Sales and marketing expenses consist primarily of
employee salaries, benefits, commissions, marketing programs, public relations,
proposal writing, trade shows, seminars, advertising and related communications
and associated overhead costs. Sales and marketing expenses were $32.4 million
and $31.9 million for the nine months ended September 30, 2000 and 1999,
respectively, representing 22% and 20% of total revenues for each respective
reporting period. The increases in both dollar amount and percentage were
attributable to the increase in the infrastructure needed throughout the year
2000 to support the ongoing marketing and sale of Sagavista. The increase in
percentage was also affected by the decrease in total revenues compared to the
prior year.
Administrative and General. Administrative and general expenses include
employee salaries and benefits for administration, executive, finance, legal,
human resources, data center, distribution and internal systems personnel and
associated overhead costs, as well as bad debt, accounting and legal expenses.
Administrative and general expenses were $29.8 million and $29.7 million for the
nine months ended September 30, 2000 and 1999, respectively, representing 21%
and 18% of total revenues for each respective nine month period. The increase
in percentage was due to lower total revenues in 2000 compared to the same
period in 1999.
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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.
Other income and expense, net, increased $43,000 or 1% to $4.0 million for the
nine months ended September 30, 2000 compared to the respective prior period.
Loss from Class Action Lawsuit Settlement. The class action lawsuit was
settled for $3.5 million, which satisfied all participating shareholders' claims
as well as the fees and expenses of plaintiffs' counsel. In addition, the
Company paid litigation expenses of approximately $1.5 million. To offset these
costs, the Company received a $3.0 million payment on August 3, 2000 from its
insurance carrier, which resulted in a $2.0 million non-operating loss. See
Note 3 of Notes to Condensed Consolidated Financial Statements for further
detail.
Income Tax Provision. The income tax provision was $4.5 million and $9.3
million for the nine months ended September 30, 2000 and 1999, respectively,
resulting in effective tax rates of 38.2% and 39.0%, respectively.
Three months ended September 30, 2000 and 1999
Revenues
Total Revenues. The Company's total revenues were $43.7 million and $51.8
million for the three months ended September 30, 2000 and 1999, respectively,
representing a decrease of 16%. This decrease in total revenues was primarily
due to a decrease in professional services fees as described below.
Software License Fees. Software license fees decreased 13% to $13.5 million
for the three months ended September 30, 2000 compared to $15.6 million from the
comparable period in 1999. This decrease was mainly attributable to softness in
the mainframe enterprise software business and a failure to close several
transactions in the last days of the quarter. Software license fees for the
three months ended September 30, 2000 were also negatively impacted in the
current quarter by approximately $129,000 due to the adoption of the residual
method under SOP 98-9 for accounting for certain contracts.
Maintenance Fees. Maintenance fees decreased 2% to $20.4 million for the
third quarter of 2000 from $20.8 million for the same period in 1999 primarily
because of the decreased royalties received from the international distributors,
as well as from our Canadian and Mexican subsidiaries. This decrease in
maintenance fees was offset by additional maintenance revenue of approximately
$244,000 recorded in the current period due to the adoption of the residual
method in accordance with SOP 98-9.
Professional Services Fees. Professional services fees were $9.8 million
and $15.4 million for the three months ended September 30, 2000 and 1999,
respectively, representing a decrease of 37%. This decrease was primarily due to
the absence of year 2000 analysis and remediation services revenue in the
current period compared to $3.1 million in the prior period. The decrease was
also, in part, attributable to lower traditional core professional services fees
in 2000 compared to 1999, which primarily resulted from changing market
conditions where companies are focusing more on the emerging e-business
integration area than the traditional enterprise systems area. Accordingly, the
Company expects the mix of its professional services revenue to continue to
shift from traditional core professional services to e-business integration
services.
Cost of Revenues
Software License. Software license costs were $3.4 million and $3.9 million
for the three months ended September 30, 2000 and 1999, respectively,
representing 26% and 25% of software license fees for each respective period.
The decrease in dollar amount was primarily due to a decrease in software
license fees. The percentage increase was primarily due to an increase in third
party royalties.
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Maintenance. Maintenance costs were $6.6 million and $6.7 million for the
three months ended September 30, 2000 and 1999, respectively, each representing
32% of maintenance fees for each respective period.
Professional Services. Professional services costs were $8.5 million and
$11.9 million for the three months ended September 30, 2000 and 1999,
respectively, representing 87% and 77% of professional services fees for each
respective period. The decrease in dollar amount was primarily due to a
decrease in professional services fees revenue. The increase in percentage was
primarily due to less than expected new professional services business in the
current period which resulted in an under-utilization of existing personnel
hired to establish the enterprise integration services practice. The Company
believes the professional services gross margin may improve as the Company has
taken certain actions to improve the utilization rate.
Operating Expenses
Software Product Development. Software product development costs were $4.1
million and $2.6 million for the three months ended September 30, 2000 and 1999,
respectively, representing a 60% increase. This increase was primarily due to
the hiring of additional developers needed for the ongoing enhancements being
made to the core Sagavista product since its release in September 1999 and to
build additional Sagavista adapters.
Sales and Marketing. Sales and marketing expenses were $10.4 million and
$11.9 million for the three months ended September 30, 2000 and 1999,
respectively, representing 24% and 23% of total revenues for each respective
three-month period. The decrease in dollar amount was attributable to the need
for a greater infrastructure in the third quarter of 1999 compared to the same
period in 2000, as Sagavista was launched in September 1999. The increase in
percentage is due to lower total revenue in 2000 compared to 1999.
Administrative and General. Administrative and general expenses were $10.0
million and $9.6 million for the three months ended September 30, 2000 and 1999,
respectively, representing 23% and 19% of total revenues for each respective
period. The increase in dollar amount and percentage was primarily due to the
costs resulted from the buyout of a software lease agreement. The increase in
percentage was also affected by the lower total revenues in 2000 compared to
1999.
Other
Other Income and Expense, Net. Other income and expense, net, was $1.5
million and $1.3 million for the three months ended September 30, 2000 and 1999,
respectively.
Loss from Class Action Lawsuit Settlement. The class action lawsuit was
settled for $3.5 million, which satisfied all participating shareholders' claims
as well as the fees and expenses of plaintiffs' counsel. In addition, the
Company paid litigation expenses of approximately $1.5 million. To offset these
costs, the Company received a $3.0 million payment on August 3, 2000 from its
insurance carrier, which resulted in a $2.0 million non-operating loss. See
Note 3 to Notes to Condensed Consolidated Financial Statements for further
detail.
Income Tax Provision. The income tax provision was $38,000 and $2.5 million
for the three months ended September 30, 2000 and 1999, respectively, resulting
in effective tax rates of 38.2% and 39.0%, respectively.
Liquidity and Capital Resources
The Company has historically financed its operations principally through
cash flow generated from operating activities. The Company had $56.3 million and
$48.2 million in cash, cash equivalents and short-term investments as of
September 30, 2000 and December 31, 1999, respectively. Working capital
increased to $80.8 million at September 30, 2000 from $66.6 million at December
31, 1999, resulting principally from increases in cash, cash equivalents and
short term investments of $8.1 million and accounts receivable of $16.1 million,
partially offset by an increase in the current portion of deferred revenues of
$15.5 million.
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Net cash provided by operating activities was $8.7 million for the nine
months ended September 30, 2000, primarily from net income of $7.2 million and
the loss resulting from the settlement of the class action lawsuit in the amount
of $2.0 million. See Note 3 of Notes to Condensed Consolidated Financial
Statements for further detail. For the nine months ended September 30, 1999, net
cash provided by operating activities was $11.0 million, primarily from net
income of $14.5 million.
Investing activities provided net cash of $10.4 million for the nine months
ended September 30, 2000, primarily due to the proceeds from the sale of short-
term investments of $16.5 million, partially offset by the purchase of short-
term investments of $4.4 million and the funding of capital expenditures of $1.9
million. For the nine months ended September 30, 1999, investing activities
used net cash of $17.5 million, primarily to fund the acquisition of Blue
Lobster in June 1999 for $12.0 million and to purchase short-term investments
for $13.0 million, partially offset by the sale of short-term investments for
$8.6 million.
Financing activities provided net cash of $1.2 million for the nine months
ended September 30, 2000, primarily from the proceeds from stock options
exercised of $6.3 million and common stock issued under the Employee Stock
Purchase Plan of $882,000, partially offset by cash used to repurchase the
Company's common stock for $5.6 million. For the nine months ended September
30, 1999, financing activities used net cash of $21.4 million, primarily to
repurchase the Company's common stock for $22.4 million, partially offset by the
proceeds from common stock issued under the Employee Stock Purchase Plan for
$1.1 million.
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 are transferred to the buyer. As of September
30, 2000 and December 31, 1999, the Company remained contingently liable under
the recourse provisions associated with the sales made prior to 1998 in the
amount of $2.3 million and $7.3 million, respectively. The Company's accounts
receivable days sales outstanding at September 30, 2000 and December 31, 1999
was 63 and 65, respectively.
The Company currently has a revolving credit agreement, which provides an
unsecured revolving credit loan in the aggregate principal amount of up to $25.0
million ("Revolving Credit Agreement"). The funds under the Revolving Credit
Agreement may be used for general corporate purposes including future potential
acquisitions, if any, but excluding any repurchase of the Company's common stock
under the stock repurchase program. The commitments made under the Revolving
Credit Agreement expire November 1, 2002. The Company has not borrowed any
funds under the Revolving Credit Agreement as of September 30, 2000.
Due to the proposed Merger, as stated in Note 4 of Notes to Condensed
Consolidated Financial Statements, the Company has suspended its plans for
international expansion.
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, funds available under the
Revolving Credit Agreement 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 at commercially
reasonable terms. The Company had no other material capital commitments or
planned expenditures as of September 30, 2000. The Company believes that
inflation did not have a material effect on its results of operations as of
September 30, 2000.
Outlook
As previously disclosed, the Company has entered into a Merger Agreement
with Software AG. This outlook disclosure assumes that the Merger transaction is
not consummated and the Company remains an independent entity. If the Merger
transaction is consummated, the Company expects results to materially differ
from this disclosure. See Note 4 to Notes to Condensed Consolidated Financial
Statements for further detail on the Merger Agreement.
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For the rest of the year, the Company offers the following guidance on its
earnings expectations. Please note that these statements are forward-looking in
nature and are based on current expectations and reflect management's view only
as of the date hereof. Readers are encouraged to read the safe harbor provision
for forward-looking statements titled "Forward-Looking Statements" in ITEM 2,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, of this Quarterly Report on Form 10-Q for, among other things, risk
factors that may cause actual results to differ materially from the Company's
expectations and the Company's obligations concerning the updating or revising
any forward-looking statements.
The Company is lowering its revenue and earnings expectations for 2000. In
the core business, persistent weakness in the mainframe environment will drive
lower than anticipated revenues. In the integration business, three factors
contribute to lower expectations: (1) a lower than expected proportion of sales
into the lower price point Microsoft TM Windows NT platform, (2) a longer than
anticipated average sales cycle and (3) a slower than expected integration
services ramp-up due, in part, to the Company's inability to control Sagavista's
implementation priority where the Company's products and services are a
component within a larger customer-managed IT initiative.
In the core business, the Company believes that revenues will decline
moderately for the next several quarters and expects core business revenues to
be in the range of $170 to $175 million for the year and $38 to $43 million for
the fourth quarter. For the integration business, total Sagavista revenues are
expected to be in the range of $18 to $20 million for the year and $6 to $8
million for the fourth quarter. Sagavista version 2.0 is expected to be
released in November and version 2.5 early next year. In addition, the Company
plans to release twelve additional adapters by the end of 2000. The Company
expects diluted earnings per share in the range of $0.07 to $0.09 for the fourth
quarter and $0.31 to $0.33 for the year. Cost of revenues are expected to be in
the range of 40% to 42% of total revenues for the year. Operating expenses are
expected to be in the range of 50% to 53% of total revenue for the year. Sales
and Marketing and Software Product Development expenses are expected to
represent roughly 30% of total revenues for the year. Other income is expected
to be in the range of 2% to 3% of total revenues for the year. The average
income tax rate is expected to be 38.2% for the year.
ITEM 3. Quantitative and Qualitative Disclosure about Market Risk
Foreign Currency. The Company's international distributors primarily report
and pay in U.S. dollars. In addition, royalties reported and paid by the Company
to Software AG under a cooperation agreement, which was amended in September
1999, are in U.S. dollars. The Company's Mexican operations have represented
approximately 2% of total revenues since its inception in 1996. Revenues from
the Company's Canadian operations have represented approximately 6% of total
revenues since its acquisition in September 1997. The Company, therefore, has
not to date engaged in foreign currency hedging transactions. The Company may
enter into hedging transactions in the future.
Interest Rates. The Company manages its interest rate risk by maintaining
an investment portfolio of available-for-sale instruments that are highly liquid
short-term investments with relatively short average maturities. These
instruments include high grade corporate and United States government debt
securities and money market funds, in accordance with the Company's investment
policy. These instruments are denominated in U.S. dollars. The carrying value of
these instruments held at September 30, 2000 and December 31, 1999 was $2.5
million and $14.5 million, respectively, which approximates their fair value.
The Company also maintains depository relationships with several banks in
the United States, Canada and Mexico. The majority of these cash balances
represents operating balances only. At times, the Company's cash deposits may
exceed federally insured limits and the Company invests excess cash in highly
liquid short-term investments as indicated above.
Many of the Company's short-term investments carry a degree of interest
rate risk. When interest rates fall, the Company's income from investments in
variable-rate securities declines. When interest rates rise, the fair market
value of the Company's short-term investments with fixed rates declines. The
Company attempts to mitigate risk by investing its cash in instruments with
short maturities and holding fixed-rate securities to maturity, but should its
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liquidity needs force it to sell fixed-rate securities prior to maturity, the
Company may experience a loss of principal. The Company's management believes
its depository accounts and short-term investments are not exposed to any
significant market risk.
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PART II
ITEM 1. Legal Proceedings
The Company, certain of its directors and executive officers and the
Company's principal shareholder were named as defendants in a class action suit
consolidated as In re: Software AG Systems, Inc. Securities Litigation in the
Federal District Court for the Eastern District of Virginia. The suit alleged
violations of the federal securities laws, claiming, 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. The parties to the litigation entered into a settlement, which
received final approval by the court on September 8, 2000. The class action
lawsuit was settled for $3.5 million, which satisfied all participating
shareholders' claims as well as the fees and expenses of plaintiffs' counsel. In
addition, the Company paid litigation expenses of approximately $1.5 million. To
offset these costs, the Company received a $3.0 million payment on August 3,
2000 from its insurance carrier. As a result, a $2.0 million loss was recorded
as a non-operating expense in the accompanying Condensed Statement of Operations
for the three and nine months ended September 30, 2000. The net income impact of
the settlement was $1.3 million after taxes or $0.04 per diluted share. The
Company funded the uninsured portion of the settlement and legal fees by cash on
hand. No other expenses are anticipated relating to this matter.
The Company is involved in various other claims and legal proceedings in
the ordinary course of its business, primarily relating to product and contract
performance issues and employee termination matters. While it is not feasible to
predict or determine the final outcome of these proceedings, management does not
believe that they will have a material adverse affect on the Company's financial
position or results of operations.
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ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1(1) Agreement and Plan of Merger, dated as of November 1, 2000,
among SAGA SYSTEMS, Acquisition Corp. and Software AG
27 Financial Data Schedule
(b) Reports on Form 8-K
None.
-------------------------------
(1) Previously filed as an exhibit to the Company's Current Report on
Form 8-K on November 3, 2000 and incorporated herein by reference.
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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: November 13, 2000 By: /s/ Dale E. Williams
------------------------
Dale E. Williams
Vice President and Chief
Financial Officer
(Principal Financial and
Accounting Officer and
Duly Authorized Officer)
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