<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NO. 001-13609
SAGA SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
Delaware 54-1167173
-------- ----------
(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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ]
The aggregate market value of the Registrant's common stock held by non-
affiliates of the Registrant based on the closing price at which stock was sold
on the New York Stock Exchange on March 20, 2000 was $555,184,540.
As of March 20, 2000, 28,608,732 shares of the Registrant's common stock
were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Stockholders of the
registrant to be held on May 17, 2000 are incorporated by reference in Part III
(Items 10, 11, 12 and 13) of this Annual Report on Form 10-K from the date such
document is filed.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Item Page
- ---- ----
<S> <C>
PART I
1. Business................................................................................................. 3
2. Properties............................................................................................... 16
3. Legal Proceedings........................................................................................ 17
4. Submission of Matters to a Vote of Security Holders...................................................... 17
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters.................................... 18
6. Selected Consolidated Financial Data .................................................................... 18
7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................... 20
7A. Quantitative and Qualitative Disclosures About Market Risk............................................... 27
8. Consolidated Financial Statements and Supplementary Data ................................................ 29
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..................... 55
PART III
10. Directors and Executive Officers of the Registrant....................................................... 55
11. Executive Compensation................................................................................... 55
12. Security Ownership of Certain Beneficial Owners and Management........................................... 55
13. Certain Relationships and Related Transactions........................................................... 55
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................................... 56
</TABLE>
2
<PAGE>
PART I
Forward-Looking Statements
The statements contained in this Annual Report and in documents incorporated
herein by reference, including any statements regarding beliefs, plans,
expectations or intentions regarding the future, 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, references to the development, acquisition, marketing and
acceptance of the Company's products and services including, but not limited to,
Sagavista and its adapters, Adabas, Natural and EntireX, professional services
and customer support; alliances and relationships with third parties including
but not limited to the Company's distributors, Software AG, 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 facts.
The statements 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 including, but not limited to, the signing of large contracts in
certain quarters but not others; reliance on Software AG for development and
timely delivery of products; reliance on acquisitions and the timely
development, production, marketing, delivery and acceptance of new products and
services including, but not limited to, Sagavista and its adapters; the
Company's ability to implement its business strategy; risks associated with
conducting a professional services business; reliance on the mainframe and
enterprise computing environments and demand for and acceptance of 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; development by competitors of new or competitive
products or services; entry into the market by new competitors; the Company's
ability to retain customers or attract customers from other businesses; risks of
protecting intellectual property rights and litigation; dependence on third-
party technology and relationships; 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, technologies, 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 distributors, Software AG, original
equipment manufacturers, value-added resellers, vendors, and other third parties
and attract and retain key employees; volatility of the Company's stock price;
the Company's ability to successfully defend itself in current or future
litigation; general economic and business conditions; and other risks detailed
from time to time in the Company's Securities and Exchange Commission reports,
including Quarterly Reports on Form 10-Q. See "Factors That May Affect Future
Results," in Item 7 of Part II for additional risk factors. Readers should
carefully review the risk factors described in these documents. The Company
undertakes no obligation to revise or publicly release the results of any
revision to these forward-looking statements.
ITEM 1. Business
Company Background and Recent Business Developments
SAGA SYSTEMS, Inc., together with its subsidiaries (collectively, the
"Company") is an enterprise software solutions company that provides robust
software products and related professional services to large organizations with
complex computing requirements. The Company's products are used, among other
things, to build, enhance and integrate mission critical applications that
require reliability, scalability and security, such as customer billing systems,
financial accounting systems and inventory management systems. To complement its
products, the Company has a suite of comprehensive professional services
offerings. The Company has over 26 years of experience in addressing the needs
of organizations with complex enterprise-level computing environments.
The Company's enterprise system products and related professional services are
used by organizations to develop new mission critical applications. The
Company's e-business integration software products and related professional
services are used by organizations to extend and integrate business
applications, databases and middleware technologies. The Company's professional
services complement its products and include technical consulting, education,
application development, application integration and outsourcing.
3
<PAGE>
In February 1981, SAGA SYSTEMS, Inc. was incorporated under the name Software
AG Systems, Inc. as a Delaware corporation and established as a holding company
for Software AG Americas, Inc., now known as SAGA SOFTWARE, Inc. In June 1981,
the Company sold approximately 30% of its then outstanding common stock in an
initial public offering. In 1988, Software AG, a German software company ("SAG")
purchased all of the Company's outstanding stock. In March 1997, the Company
consummated a recapitalization pursuant to which the senior management of the
Company and Thayer Equity Investors III, L.P. ("Thayer"), a private equity fund,
acquired approximately 89% of the Company's then outstanding common stock, par
value $0.01 per share ("Common Stock") ("Recapitalization"). Then the Company
and certain stockholders consummated an initial public offering in November 1997
and a secondary offering in May 1998. In May 1999, the Company's name was
changed from Software AG Systems, Inc. to SAGA SYSTEMS, Inc.
Since 1973, SAGA SOFTWARE, Inc. has primarily licensed and serviced products
of SAG, both directly in the United States and indirectly in other countries
through various licensing agreements with SAG. The most recent licensing
arrangements with SAG were renegotiated by the Company in September 1999. See
"Relationship with and Royalty Payments to SAG", also in this Item 1 of Part I.
Effective June 9, 1999, the Company acquired 100% of the issued and
outstanding stock of Blue Lobster Software, Inc. ("Blue Lobster"), a privately-
owned enterprise software development company based in San Jose, California for
approximately $12.0 million. Effective September 30, 1997, the Company acquired
R.D. Nickel and Associates, Inc. ("R.D. Nickel"), a software company based in
Ontario, Canada, for approximately $10.1 million. R.D. Nickel developed,
licensed and supported a family of application development products and served
as the exclusive distributor of the Company's products in Canada prior to the
acquisition. Both of these acquisitions were accounted for using the purchase
method of accounting for business combinations. See Note 4 of the Notes to
Consolidated Financial Statements for further details on these acquisitions.
Product and Professional Services Offerings
Enterprise Systems Products and Services
The Company provides a family of enterprise systems products and related
professional services that allow its customers to develop and deploy enterprise
solutions that are integrated with existing data and applications.
. Natural, the 4GL programming language for the enterprise environment, is
designed to increase productivity in application software design,
development and deployment. Natural supports rapid application development
to relational database management systems environments with applications
that are portable, scaleable and interoperable across multiple computing
platforms.
. Add-on products for the Natural environment include: Predict, for
repository-based development environments; Construct, for model-based rapid
application development; and Construct Spectrum, for automated development
of components on the desktop.
. Adabas, the flagship high-performance database management solutions
product, delivers access to data and is designed to handle large volumes of
changing data requiring high levels of availability and to ensure the
reliability, integrity, and security of such data throughout an
organization's computing environment. It provides multi-data model support,
multi-platform support, comprehensive SQL support, and a variety of
extended capabilities that take advantage of technological advances in both
hardware and software.
. Add-on products for the Adabas environment include: Adabas SQL Server, an
SQL interface to Adabas data; Adabas Adaplex+, a technology that
distributes and presents a single view of multiple databases; Adabas
Fastpath, which optimizes database and application performance; and Adabas
Delta Save Facility, a product for reducing backup time and database
recovery processing.
For 1999, 1998 and 1997, product revenues generated from sale of enterprise
systems products represented 82%, 83% and 81% of the total product revenue,
respectively.
Enterprise Systems Services. The Company provides the necessary services
required to successfully deploy its products to its customers. These
professional enterprise systems services focus on assisting end users in
deploying and using the Company's database management and application
development products. Such services include
4
<PAGE>
application development and enhancement, application re-engineering, application
management and other technical support services and education.
E-business Integration Products and Services
The Company's e-business integration products and professional services
offerings help end users minimize the complexity of integrating distributed
computing environments that can encompass a variety of platforms, protocols,
programming languages and databases.
. Sagavista is the Company's new e-business integration suite, which was
generally released on September 29, 1999. Sagavista is a business-centric
e-business integration software product that intelligently links
applications resident on various systems in order to access desired
enterprise information, helping end users integrate disparate computing
environments within an enterprise. With pre-built integration adapters and
integration brokering technology from the Company, Sagavista can help
global and rapidly changing businesses experience improved sharing of data
among connected applications or data sources in the enterprise, including
Enterprise Resource Planning, custom, Internet, packaged and database
applications.
. The EntireX product family includes: Broker, a cross-platform messaging
product that links mainframe applications and components to ActiveX- and
Java-enabled desktops; and SAF Gateway, a central security administration
environment. The Company also offers Broker APPC, a product that links
Advanced Program-to-Program Communication and IBM's MQSeries-enabled
mainframe applications to ActiveX- and Java-enabled desktops; Broker SDK, a
set of software products for building and deploying distributed
applications; and EntireX DCOM, a product that allows applications or
pieces of applications to work together transparently on Windows, UNIX and
MVS/VSE mainframe platforms.
. iXpress is an Internet-enablement technology that combines component
technology, such as Java and ActiveX, with enterprise systems, allowing
organizations to deliver and manage business-critical information solutions
via the Web.
For 1999, 1998 and 1997, product revenue generated from sale of e-business
integration products represented 18%, 16% and 19% of the total product revenue,
respectively.
E-business Integration Services. The Company provides the necessary services
required to successfully deploy its products to its customers. The Company
offers its customers a variety of application integration professional services,
such as strategy and assessment, solution design, pilot and other
implementation, technical, education and management services.
Year 2000 Products and Services
. Sagacertify Tool Kit allows developers to analyze and remediate Natural
code by providing a picture of how much code needs to be remediated or
modified to ensure Y2K compliance and helping project managers break year
2000 projects into segments.
. Year 2000 Services include analysis, remediation and testing to assist
customers in resolving their year 2000 problem. These services were
provided through a professional staff with expertise in managing large
projects and in the methodologies and products that underlie software
integration and systems management.
Product revenues generated from sale of year 2000 products represented less
than 1% of the total product revenue in 1999 and 1997 and approximately 1% of
total product revenue in 1998. Services revenues generated from year 2000
services offerings represented 24%, 42% and 15% of the total professional
services revenues in 1999, 1998 and 1997, respectively. Demand for products and
professional services that address the year 2000 problem has been decreasing
since December 31, 1998. Management anticipates that revenues from the sale of
year 2000 products and professional services will be virtually non-existent
after 1999.
The Company believes that its future software license revenues depend in part
on growth in the hardware computing environment within the Company's customer
base. Such growth is measured in millions of instructions per second or MIPS.
Future software license revenues are also dependent, in part, on continued
demand for the Company's enterprise systems products and increased demand for
the Company's e-business integration product
5
<PAGE>
offerings.
Presently, the Company's strategy is to further leverage its position in
enterprise software solutions by extending its product and professional services
offerings with a particular focus on the e-business integration market. Key
elements of the Company's strategy include marketing and further developing the
Company's own flagship e-business integration product offerings, leveraging its
customer base, existing and new distribution channels and expanding professional
service offerings.
The Company intends to enhance and extend its product offerings with a
primary focus on e-business integration products, including developing adapters
to be used with Sagavista. The Company believes that a significant opportunity
exists for software solutions, which enable the integration of mainframe
Internet applications with commercial enterprise resource planning systems,
applications developed internally by the Company and other client/server and
Internet/intranet-based applications. The Company believes that Sagavista, used
in conjunction with its adapters, will allow customers to integrate these
applications, databases and middleware environments. With EntireX, the Company
will continue to provide basic messaging solutions to enable point-to-point
integration. In addition, the Company intends to broaden its product offerings
through additional product licenses from third parties and through acquisitions.
Other Services
Education Services. The Company provides customers with in-depth training in
the Company's products, with courses available through scheduled and customized
classes. In addition, the Company offers programs to accelerate the
implementation of application development and application integration.
Systems Engineering Services. The Company provides comprehensive post-sales
consulting services to its customers. The staff primarily works on-site with the
customer, performing multiple services including installations, upgrades,
product/application migration, technical support, database administration,
training and other tasks. Systems engineering services support all of the
Company's products and some other environments such as DB2, Oracle Corporation
("Oracle"), Microsoft NT, UNIX, MVS/VSE and CICS/TSO.
Product Maintenance and Customer Support
The Company offers a wide range of product maintenance and customer support
services. The Company believes that its future success is dependent in part on
its ability to provide high levels of customer service in order to retain
royalty and good relationships with the Company's installed customer base. For
the year ended December 31, 1999, approximately 92% of the Company's customers
who were eligible renewed at least one of their maintenance agreements. There
can be no assurance that customers will continue to renew their maintenance
agreements at this rate in the future.
Customers may choose from three levels of service and support offerings:
basic, extended and custom, which are differentiated by service deliverables and
access to support personnel, experts or consultants. Some of these customer
support services include support during product proof-of-concept/trial, 24 hours
a day, seven days a week or eight hours a day, five days a week technical
support, customized support offerings, onsite installation and implementation,
remote analysis, automated customer assistance and web-based electronic
services.
Research and Development
Since its Recapitalization in 1997, the Company has been building its internal
product development group to expand its product offerings, which included the
development of Sagavista and adapters, its new e-business integration product
suite. As of December 31, 1999, the Company had 82 developers, which was an
increase of 28 from December 31, 1998. The Company is continuing to enhance the
core Sagavista product and build additional adapters. The Company intends to
continue expanding its product development capabilities through additional
acquisitions and hiring of new employees. The Company's research and development
expenses were $10.2 million, $5.5 million and $1.1 million in 1999, 1998 and
1997, respectively.
Since the Cooperation Agreement (defined in next section) provides the
Company with the right to license certain products developed by SAG, the Company
also expects to continue to benefit from SAG's product development efforts. See
"Relationship with and Royalty Payments to SAG."
6
<PAGE>
Relationship with and Royalty Payments to SAG
On March 31, 1997, the Company entered into an exclusive, perpetual license
agreement (the "Original Cooperation Agreement") with its former German parent
company, SAG. On September 30, 1999, the Company amended and restated the
Original Cooperation Agreement, the amended and restated agreement being
referred to herein as the "Cooperation Agreement." The Cooperation Agreement
permits, among other things, the Company and SAG to expand their respective
distribution channels for certain newly developed or acquired products,
including Sagavista. Specifically, the Cooperation Agreement removes certain
distribution exclusivity provisions, which were part of the Original Cooperation
Agreement, allowing both companies to sell certain new products in geographic
territories that were previously restricted to the other.
The Original Cooperation Agreement, among other things provided (i) the
Company the exclusive and perpetual right to license and service in North
America, South America, Japan and Israel (collectively, the "Territory") both
existing and future products developed or acquired by SAG and (ii) SAG the
exclusive and perpetual right to license and service outside the Territory both
existing and future products developed or acquired by the Company.
Following the amendment of the Original Cooperation Agreement, the Company
has retained, with the exception of the Company's Construct product, the
exclusive right to license and service on a worldwide basis the products that it
develops or acquires. Additionally, the Company retained the exclusive and
perpetual right to license and service the core SAG product lines, including
Adabas, Natural and the existing core Entire family products, but exclusive of
EntireX, to current Company customers in the United States, Canada and Mexico
("North America"). The Company also retained the exclusive right to license and
service EntireX in North America, except under certain circumstances, to current
Company customers through June 2000, and a non-exclusive right to license and
service EntireX in North America after June 2000. In addition, outside of North
America, the Company retained the exclusive and perpetual right to license and
service all current and future SAG products within the Territory.
The Company has non-exclusive and perpetual rights under the Cooperation
Agreement, as amended, to license and service the SAG products Bolero and
Tamino, as well as SAG's future database and software development tools, if any,
to current Company customers in North America. The Company also has non-
exclusive rights to license and service certain new SAG products other than the
core SAG products, the EntireX, Bolero and Tamino products and future database
and software development tools to current Company customers in North America.
This right terminates on December 31, 2005 although, it may continue under
certain circumstances. In addition, the Company has the non-exclusive and
perpetual right to license and service the core SAG product lines, including
Adabas, Natural and the existing core products in the Entire family, including
EntireX, to new Company customers in North America.
The Company has no rights to license or service new SAG products to the
Company's new customers in North America.
Under the Cooperation Agreement, SAG has the non-exclusive, perpetual right
to license the Company's Construct products outside of the Territory. SAG has no
right to license any other Company product anywhere else in the world.
Each of the Company and SAG had to pay the other 24% of the net revenues
derived from licenses granted under the Original Cooperation Agreement. This 24%
royalty rate was fixed for 20 years. Except under certain circumstances, the
Company's minimum annual royalty payment to SAG under the Original Cooperation
Agreement through the year 2000 was required to equal at least $21.0 million.
Under the Cooperation Agreement, each of the Company and SAG must still pay
the other 24% of the net revenues derived from the distribution of the other
party's products and the provision of maintenance within the Territory, in the
case of the Company, and outside of the Territory, in the case of SAG. This
royalty rate shall be effective through the year 2017 and thereafter unless the
parties agree otherwise. Additional payments may be made by the Company if the
Company grants certain discounts.
Except under certain circumstances, the Company's minimum annual royalty
payment to SAG under the Cooperation Agreement must equal at least $21.0 million
for year 1999, $23.0 million for each of years 2000, 2001 and 2002, $21.0
million for year 2003, $20.0 million for year 2004 and $17.0 million for year
2005. The Company paid royalty payments of approximately $32.4 million, $39.6
million and $29.3 million to SAG in 1999, 1998 and
7
<PAGE>
1997, respectively.
The Cooperation Agreement contains certain safeguards to ensure that the
Company and SAG are able to continue to exercise their respective rights to
license and service each other's products in their respective territories. These
safeguards include rights of first refusal with respect to assignments of
proprietary rights to third parties and certain restrictions on SAG from
competing against the Company with respect to any SAG product in which SAG
granted SAGA an exclusive right to market and license such product in certain
geographic areas. The Cooperation Agreement also prohibits either party from
consummating a change of control unless such party's successor agrees to be
bound by the terms of the Cooperation Agreement with respect to all existing
products that were licensed to the other party under the Cooperation Agreement
as of the date of the change of control of such party and future products that
are materially derived therefrom.
Under the Original Cooperation Agreement, SAG was precluded from consummating
a change of control unless its successor agreed to continue supporting the
research and development of SAG's then existing and planned products for two
years following the change in control. In addition, the Company was precluded
from consummating a change in control in which certain specified entities would
be its successor unless such entities agreed to pay the Company's minimum annual
royalty payments to SAG until the later of December 31, 2000 or two years
following the change in control. The Cooperation Agreement does not contain
these provisions.
As previously disclosed herein, the Company has certain rights to license and
service existing products developed or acquired by SAG and, historically, a
significant portion of the Company's revenues have been generated from the
licensing and servicing of products developed or acquired by SAG. As a result, a
materially adverse change in the financial condition or a change in control of
SAG could have a material adverse effect on the business, financial condition
and results of operations of the Company. In addition, the failure of SAG to
develop enhancements to existing products in a timely manner, to provide ongoing
technical support for its products or to adequately protect its proprietary
rights could have a material adverse effect on the business, financial condition
and results of operations of the Company. In the past, the Company has
experienced delays in receiving products from SAG in a timely manner. Under the
terms of the Cooperation Agreement, SAG is contractually required to ensure that
its products are year 2000 compliant. SAG has provided the Company with written
assurances that the SAG-developed products that the Company is selling are year
2000 compliant. Because of the unprecedented nature of potential year 2000
issues and claims, any failure of any SAG product to perform after December 31,
1999 could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company is not aware of any material
year 2000 related problems with respect to its products licensed from SAG. There
can be no assurances, however, that SAG has not or will not in the future
encounter any year 2000 related problems which may have a material adverse
effect on the Company's or SAG's business, financial condition or results of
operations. In addition, to the extent that the Company's aggregate royalty
payments to SAG fall below the minimum amount set forth above, the Company
generally is required to pay the differential to SAG, and any such differential
payment could have a material adverse effect on the Company's business,
financial condition and results of operations.
Sales and Marketing
Under the Original Cooperation Agreement, the Company sold and marketed its
products through both direct and indirect channels in over 20 countries strictly
within the Territory through exclusive distributors and wholly owned
subsidiaries. In addition, the Company had access to SAG's distribution channels
for the Company's products (other than those licensed from SAG) outside the
Territory. Under the terms of the Cooperation Agreement, as amended, the Company
intends to directly and indirectly sell and market Company owned products
worldwide, including the Territory. In North America, the Company sells and
markets its products, including third party products, and services through a
direct channel, operating 20 sales offices as of December 31, 1999. The Company
sells its products in approximately 20 additional countries through six
exclusive distributorships in South America, Japan and Israel. In addition, the
Company plans to establish additional channels which could include both direct
and indirect approaches to sell its products in Europe. See Note 21 of Notes to
Consolidated Financial Statements for financial data pertaining to the
geographic distribution of the Company's operations.
The Company places a strong emphasis on developing strategic business
alliances. The Company intends to sell and market Company owned products
worldwide and third party owned products in the Territory through both direct
and indirect channels and with the assistance of third parties with whom it has
strategic alliances. The Company currently has alliances with International
Business Machines Corporation ("IBM"), Microsoft Corporation
8
<PAGE>
("Microsoft") and SAP AG. In addition, the Company has established alliances
with platform application vendors and system integrators including Syntel Inc.,
Concept 5 Technologies, Inc., Sun Microsystems, Inc., Lawson Associates, Inc.
and Clarify, Inc. In the future, the Company plans to develop additional
alliances with other key platform packaged application vendors and systems
integrators, additional Original Equipment Manufacturer ("OEM") and Value-added
Reseller ("VAR") relationships. Existing relationships with the Company's
distributors, SAG and other third parties and any future alliances with
additional third parties, are or may be integral to the Company's success. The
Company's financial results could be materially adversely affected if the
financial condition of SAG or any of the Company's distributors, OEMs, VARs and
other third party relationships weaken or if the Company's relationships with
any of these entities deteriorate or fail to materialize.
The Company's corporate marketing organization supports the Company's sales
and professional services channels through the efforts of professionals with
expertise in product marketing and marketing communications.
As a part of the Company's strategy to further leverage its position in the
enterprise software solutions market by focusing on the e-business integration
market, the Company has implemented several new marketing programs in 1999 to
market and sell its new e-business integration product suite, Sagavista. The
Company anticipates that the Company will continue to incur costs in the year
2000 in connection with ongoing market support for Sagavista.
Customers and Markets
Most of the Company's current customers are large, sophisticated
organizations with complex information systems in dispersed, heterogeneous
computing environments. The Company's current customers consist primarily of
major corporations, government agencies and educational institutions. In fiscal
years 1999, 1998 and 1997, no single customer accounted for more than 10% of the
Company's total annual revenue. However, it is possible that a significant
license sold to a single customer may materially affect the Company's results of
operations and may not be repeated in a subsequent period.
Most of the Company's revenues have been derived from sales of software
licenses, maintenance or professional services to the Company's existing
customer base. Customers typically pay a licensing fee for use of the Company's
products and generally pay an annual charge for maintenance services, which
include software updates and technical support. There can be no assurance that
customers will continue to purchase the Company's products and services, that
the Company's historic maintenance renewal rates will continue, that the Company
will make sales to new customers or that the Company will be able to maintain
its current pricing levels for products and maintenance services. Customers'
decisions not to renew their maintenance agreements or to renew them on
different terms or the Company's failure to make sales to new customers could
have a material adverse effect on the Company's business, financial condition
and results of operations.
The majority of the Company's products are currently purchased by customers
using IBM branded and IBM-compatible mainframe computing platforms. Worldwide,
an increasing proportion of computing functions are being performed on
alternative computing platforms, including mid-range computers and client/server
networks. A significant shift in the way the Company's customers use computing
platforms may have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, although the Company
believes that any migration away from mainframe computing platforms is subsiding
as a result of more cost effective mainframe technology and other factors, any
further significant reduction in the role of mainframe or other legacy systems
could have a material adverse effect on the Company's business, financial
condition and results of operations.
Competition
The markets for the Company's software products and professional services are
highly competitive and characterized by continual change and improvement in
technology. The Company provides products and professional services to several
markets within the computer industry and encounters a variety of competitors
within each market. The Company's competitors are numerous in all business areas
ranging from highly specialized small firms to some of the largest corporations
in the world. Many of the Company's competitors have significantly greater
financial, marketing and other competitive resources than the Company. In
addition, in certain markets in which the Company competes there are no
significant barriers to entry by competitors.
In the enterprise systems markets, the Company's competitors with respect to
enterprise and departmental
9
<PAGE>
database management products include IBM, Oracle, Informix Corporation and
Sybase, Inc. In addition, the Company's 4GL applications programming language,
Natural, competes with offerings from both large and small companies, including
Compuware, Inc., Oracle, IBM and Computer Associates, Inc. In the e-business
integration markets, the Company's products compete in both the integration
broker and the message oriented middleware segments of the middleware market,
where its competitors include IBM, Oracle, Microsoft, TSI International Software
Ltd., TIBCO Software, Inc., STC Software Technologies Corporation, CrossWorlds
Software, Inc., BEA Systems, Inc., NEON Systems, Inc., Active Software, Inc. and
Vitria, Inc.
The principal competitive factors affecting the markets for the Company's
product and professional services offerings include: (1) product functionality,
performance, reliability and ease of use, (2) quality of technical support,
training and consulting services, (3) responsiveness to customer needs, (4)
reputation, experience and financial stability and (5) cost of ownership,
including initial price and deployment costs as well as ongoing maintenance
costs. Current and potential competitors may introduce new and better products,
make strategic acquisitions, offer products or services at a lower cost or
establish cooperative relationships among themselves or with third parties,
thereby increasing the ability of their products to address the needs of the
Company's current and prospective customers.
There can be no assurance that the Company will be able to compete
successfully against current and future competitors, and its failure to do so
could have a material adverse effect upon the Company's business, financial
condition and results of operations. In addition, no assurance can be given that
the Company will not be required to make substantial additional investments in
connection with its research, development, marketing, sales and customer service
efforts in order to meet any competitive threat, or that such required
investments will not have a material adverse effect on operating margins.
Increased competition could result in reduction in market share, pressure for
price reductions and related reductions in gross margins, any of which could
materially adversely affect the Company's business, financial condition and
results of operations.
Factors That May Affect Future Results
In addition to other risk factors herein, the Company may be subject to the
following risks and uncertainties.
Dependence on Third-Party Technology. The Company's products are currently
designed, and may in the future be designed, to work on or in conjunction with
certain third-party hardware and/or software products. In addition, the Company
relies on the timely delivery of competitive products and enhancements from SAG
for a material part of its revenue. If any of these current or future third-
party vendors or SAG were to discontinue making their products available to the
Company or to licensees of the Company's products on a timely basis, or to
increase materially the cost to the Company or its licensees to acquire, license
or purchase such third-party vendor's products, or if a material problem were to
arise in connection with the ability of the Company's products to properly use
or operate with third-party hardware and/or software products, the Company's
products may have to be redesigned by the Company, or the licensor of the
product to the Company, to function with or on alternative third-party products,
or the Company or its licensees may not be able to sell the product at all.
There can be no assurance that in such an event, an alternative source of
suitable technology would be available or that the Company or the licensor of
the product to the Company would be able to develop an alternative product on a
timely basis or at a reasonable cost. The failure of the Company to license,
acquire or develop alternative technologies or products on a timely basis and at
a reasonable cost could have a material adverse effect on the Company's
business, financial condition and results of operations.
Potential Fluctuations in Quarterly Performance/Seasonality of the Business.
The Company has experienced significant quarterly and other fluctuations in
revenues and results of operations and, although future results may vary, the
Company expects these fluctuations to continue in the future. The Company's
future operating results may vary significantly from quarter to quarter due to a
variety of factors, many of which are outside of the Company's control. Because
the Company cannot accurately predict the amount and timing of individual sales,
the Company's quarterly operating results may vary significantly. The Company
operates with no material backlog orders because its products are shipped and
revenues are recognized shortly after orders are received. In addition, the
amount of revenues associated with sales of software can vary significantly. The
Company may derive a significant portion of its software license revenues from a
small number of relatively large sales. An inability to close one or more large
sales that the Company tried to close in a particular period could materially
adversely affect the Company's operating results for that period. Moreover, the
Company typically realizes a majority of its software license revenues in the
last month of a quarter. As a result, minor delays in the timing of customer
orders can shift a sale from its contemplated quarter of completion to a
subsequent quarter and cause significant variability
10
<PAGE>
in the Company's operating results for any particular period. Further, the
Company believes that period-to-period comparisons of its operating results are
not necessarily a meaningful indication of future performance.
The Company believes that past fluctuations have been in part attributable to
the budgeting and purchasing practices of its customers, and, to a lesser
extent, the Company's sales commission practices, which are based partly on
annual quotas, and other factors. The Company's revenues and results of
operations may also be affected by seasonal trends which have resulted in higher
revenues in the Company's third and fourth quarters and lower revenues in its
first and second quarters. The Company's professional services fees tend to
fluctuate due to the completion or commencement of significant projects, the
number of working days in a quarter and the Company's ability to attract, retain
and efficiently utilize professional services personnel. The Company's future
revenues and operating results may fluctuate as a result of these and other
factors, including the demand for the Company's products and services, the
timing and cost of new product and service introductions and product
enhancements by the Company or its competitors, changes in the mix of products
and services sold by the Company and in the mix of sales by distribution
channels, commencement or conclusion of significant service contracts, timing of
any acquisitions and associated costs, the size, timing and terms of customer
orders, including delays in significant orders, changes in pricing policies by
the Company or its competitors, the timing of collection of accounts receivable,
changes in foreign currency exchange rates, competitive conditions in the
industry and general economic conditions.
The Company's expense levels are based, in part, on its expectation of future
revenues, and expense levels are, to a large extent, fixed in the short term.
The Company may be unable to adjust spending in a timely manner to compensate
for any unexpected revenue shortfall. If revenue levels are below expectations
for any reason, the Company's results of operations are likely to be materially
and adversely affected. The Company's net income may be disproportionately
affected by a reduction in revenue because a large portion of the Company's
expenses cannot be easily reduced. The Company's net income may also be
negatively affected by an increase in expenses. The Company expects to
experience a significant time lag between the date professional services, sales
and technical personnel are hired and the date such personnel become fully
productive. The timing of such expansion and the rate at which new technical,
professional services and sales personnel become productive as well as the
timing of the introduction and the productivity of new distribution channels
could cause material fluctuations in quarterly results of operations.
Furthermore, to the extent such increased operating expenses precede or are not
subsequently followed by increased revenues, the Company's business, financial
condition and results of operations could be materially and adversely affected.
Due to all of the foregoing factors, it is likely that in some future periods
the Company's revenues or results of operations will be below the expectations
of securities analysts or investors, in which case the market price of the
Company's Common Stock would likely be materially and adversely affected.
Complexity of Software Products and Product Development and Competitive
Market Conditions. The process of developing new high-technology products is
inherently complex and uncertain and requires innovative designs anticipating
customer demands and technological trends. Without the development or
acquisition of new products and services, the Company's products and services
offerings could become obsolete and the Company's operating results could be
materially adversely affected. The Company must quickly develop and deploy its
products in a cost effective manner to meet market needs. There can be no
assurance that any potential product, including future versions of Sagavista and
any of its adapters, will ever be fully developed or work as expected.
The Company's success will depend in part on its ability to acquire and/or
develop product enhancements, adapters and new products that keep pace with
continuing changes in technology and evolving customer preferences, and the
timely delivery of products and product enhancements from SAG and other third
party licenses. There can be no assurance that the Company will be successful
in acquiring and/or developing product enhancements, adapters or new products to
adequately address changing technologies, that it can introduce such products,
enhancements or adapters on a timely basis, that such products, enhancements or
adapters will be successful in the marketplace or that SAG will deliver in a
timely manner new products or product enhancements that will be successful in
the marketplace. The Company's failure to acquire and/or develop technological
improvements or to adapt its products to technological change could have a
material, adverse effect on the Company's business, financial condition and
results of operations.
In addition, the Company's products compete in markets that are intensely
competitive and feature rapidly changing technology and evolving standards. The
Company's competitors may be able to respond more quickly than the Company to
new or emerging technologies and changes in customer requirements. Competitive
pressures could reduce the Company's market share, require the Company to reduce
the price of its products or require the
11
<PAGE>
Company to make a significant research and development investment to adapt its
products, any of which could have a material adverse effect on the Company's
business, operating results or financial conditions.
Software products as complex as those offered by the Company can contain
errors or defects, especially when first introduced or when new versions or
enhancements are released. Despite product testing, new products may contain
defects or software errors and, as a result, the Company may experience delayed
or lost revenues during the period required to correct any defects or errors.
Any such defects or errors could result in adverse customer reactions, negative
publicity regarding the Company and its products, harm to the Company's
reputation, loss of or delay in market acceptance, or could require expensive
product changes, any of which could have a material adverse effect upon the
Company's business, financial condition and results of operations. The Company's
Cooperation Agreement with SAG, as amended, provides for only limited warranties
by SAG with respect to the software products licensed by it to the Company and,
therefore, the Company may be primarily liable to its customers for defects in
SAG-supplied software.
Dependence on Mainframe Computers. Reduced customer reliance upon mainframe
computers could adversely affect the Company's business. The Company is
dependent on the continued use and acceptance of mainframe computers in a
computing environment increasingly based on distributed platforms, including
client/server and Internet-based computing networks. Decreased use of the
mainframe or in the growth of demand for Web-based and client/server
applications accessing mainframe data and transactions could have a material
adverse effect on the Company's business, operating results and financial
condition. Although demand for mainframe access and management solutions has
grown in recent years, it may not continue to grow. The Company's continued
success depends on a number of factors, including continued use of the mainframe
as a central repository of mission critical data and transactions and growth in
business demands for access to the data, applications and transactions residing
on mainframe computers from Web-based and client/server applications.
Dependence on Revenue from Sale of Sagavista and Adapters and Core Enterprise
Systems Products. The Company anticipates that the revenue from the sale of the
Company's new e-business integration product suite, Sagavista and its adapters,
will increase as a percentage of total revenues for the foreseeable future.
Consequently, the Company's future success will partly depend on increased
market acceptance of and demand for Sagavista and adapters and enhancements to
these products. The Company's future success is also dependent on customers
continued demand and use of its core enterprise systems products. Competition,
technological change or other factors could affect demand for, or market
acceptance of, these products and could have a material adverse effect on the
Company's business, operating results and financial condition. If demand for
Sagavista and its adapters and a continued demand of its core enterprise systems
products is less than anticipated, the Company's results of operation could be
materially adversely affected.
Reliance on Acquisitions. The Company believes that its future growth may
depend, in part, on its ability to successfully identify, acquire and then, if
necessary, further develop promising technologies and products. In addition, the
Company intends to build its product development staff in part through
acquisitions. The integration of R.D. Nickel, Blue Lobster or any other future
acquisitions into the Company's existing business could result in certain
unanticipated difficulties that could require a disproportionate amount of
management's attention and the Company's resources. Furthermore, there can be
no assurance that the anticipated benefits of acquiring R.D. Nickel, Blue
Lobster or any other future acquisition will be realized. The Company has
limited experience in completing acquisitions and integrating acquired
technologies or products into its operations. The Company may compete for
future acquisition opportunities with other companies that have significantly
greater financial and management resources and there can be no assurance that
the Company will be successful in identifying, acquiring and developing certain
products or technologies. Acquisitions could also have adverse short-term
effects on the Company's operating results, and could result in dilutive
issuances of equity securities and the incurrence of debt and contingent
liabilities. In addition, many business acquisitions must be accounted for as
purchases and, because most software-related acquisitions involve the purchase
of significant intangible assets, these acquisitions typically result in
substantial amortization charges and may also involve charges for acquired
research and development projects, which could have a material adverse effect on
the Company's operating results. The Company has incurred significant charges
of this nature in connection with its acquisitions of R. D. Nickel and Blue
Lobster.
Risks Associated with International Sales and Operations. The Company holds
the perpetual right to license certain SAG products in certain geographic areas.
In South America, Japan and Israel, the Company has entered into exclusive
distributorship arrangements with local firms. There can be no assurance that
such distributors will continue to perform as they have historically or that
they will not offer products that compete with the Company's products.
Additionally, the distributorships generally may be terminated by either party
at any time upon compliance with applicable notice provisions. In the event that
any of the distributorships were terminated or
12
<PAGE>
expired, there can be no assurance that the Company could find an adequate
replacement, and such a termination or expiration could have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, there can be no assurances that the Company will develop effective
marketing channels for purposes of expanding worldwide distribution of its
products.
Royalty revenues from international distributors represented 10% of the
Company's total revenues in each 1999 and 1998 and 15% of the Company's total
revenues in 1997. The decline in percentage from 1997 was primarily due to the
acquisition in September 1997 of R.D. Nickel, a former international distributor
of the Company, and the revenue from R.D. Nickel prior to the acquisition in
September 1997 was included in the 1997 revenue from affiliates. The Company
anticipates that royalty revenues from international sales and services will
continue to account for approximately the same percentage of its total revenues
as they have in the past for the foreseeable future. As a result, the Company
may be subject to certain risks associated with international operations,
foreign currency exchange rate fluctuations and the application and imposition
of protective legislation and regulations relating to import or export
activities (including export of high technology products) or otherwise resulting
from foreign policy or the variability of foreign economic conditions.
The Company's international distributors report and pay royalties in U.S.
dollars. In addition, royalties reported and paid by the Company to SAG under
the Cooperation Agreement are in U.S. dollars. The Company's Mexican operations
represented approximately 3% of total revenues in each 1999, 1998 and 1997.
Revenues from the Company's Canadian subsidiary were approximately 7% and 5% of
total revenues in 1999 and 1998, respectively, and 4% of the total revenues in
the fourth quarter of 1997. The Company, therefore, has not, to date, engaged
in foreign currency hedging transactions. The Company may enter into hedging
transactions in the future.
Additional risks associated with international operations include costs of
localizing products for foreign countries, lack of acceptance of localized
products in foreign countries, the impact of economic instability and down turns
in economies outside of the United States, difficulties in enforcing
intellectual property, proprietary and contract rights, the burdens of complying
with a wide variety of foreign laws, potentially adverse tax consequences,
tariffs, quotas and other barriers, political instability and potential
difficulties in collecting accounts receivable. There can be no assurance that
these and other factors will not have a material adverse effect on the Company's
business, financial condition and results of operations.
Potential for Contract Liability. The Company markets its products and
professional services to customers for, among other things, developing,
building, deploying, integrating, maintaining and managing mission critical
computer software applications and for addressing the year 2000 problem. The
Company's standard form license and other agreements with its customers
typically contain provisions designed to limit the Company's exposure to
potential liability claims relating to the Company's products or professional
services. Despite this precaution, there can be no assurance that the
limitations of liability set forth in the Company's agreements would be
enforceable or would otherwise protect the Company from liability for damages.
Although the Company has not experienced any material liability claims to date,
the sale and support of the Company's products and professional services may
entail the risk of such claims, which could be substantial in light of the use
of such products in mission critical applications. A material liability claim
against the Company, regardless of its outcome, could result in substantial cost
to the Company and divert management's attention from the Company's operations.
Therefore, any material liability claim could have a material adverse effect on
the Company's business, financial condition and results of operations.
Dependence on State, Local and Other Government Contracts. The Company
derived approximately 30%, 20% and 30% of its total revenues in 1999, 1998 and
1997, respectively, from selling its products and professional services directly
or indirectly to state and local government agencies. In addition, the Company
derived approximately 7%, 8% and 11% of its total revenues in 1999, 1998 and
1997, respectively, from selling its products and professional services directly
or indirectly to federal government agencies. Any failure to obtain a contract
award, or a delay on the part of a government agency in making an award or in
ordering products and professional services under an awarded contract, could
have a material adverse effect on the Company's business, financial condition
and results of operations. Other risks generally involved in government sales
include the larger discounts (and thus lower margins) typically involved in
government sales, the dependence of the Company in certain instances on the
ability of a prime contractor to obtain the award and perform the contract, the
unpredictability of funding for various government programs, the ability of a
government agency to unilaterally terminate a contract, and the
creditworthiness of certain prime contractors (some of which are relatively
small organizations without substantial funds). The Company anticipates that
state, local and other government sales will continue to represent a significant
but fluctuating portion of its revenues in the future.
13
<PAGE>
Fixed Price Contracts. Revenues from fixed price contracts represented
approximately 10%, 11% and 12% of the Company's total revenues for 1999, 1998
and 1997, respectively. In making proposals to perform professional services
under fixed price contracts, the Company relies on its estimates of costs that
would be incurred in the course of completing the project. These estimates
reflect, among other factors, judgments as to the efficiencies of the Company's
technology and services as applied to the project. Any increased or unexpected
costs or unanticipated delays in connection with the performance of fixed price
contracts could have a material adverse effect on the Company's business,
financial condition and results of operations. In the past, the Company has
suffered material losses on fixed price contracts.
Dependence on Key Personnel. The Company's success will depend in part on
its continued ability to attract and retain highly qualified personnel in a
competitive market for experienced software developers, professional services
staff and sales and marketing personnel. The Company's future performance
depends to a significant degree upon the continued service of the key members of
its management, as well as marketing, sales, consulting and product development
personnel, and its ability to attract and retain new management and other
personnel. The loss of any one or more of the Company's key personnel could
have a material adverse effect on the Company's business, financial condition
and results of operations. Company employees are employed at-will and the
Company has no fixed-term employment agreements with any of its employees.
While historically the Company primarily has relied on SAG for product
development, the Company believes its future success will also depend in part
upon its ability to develop its own technologies and products and, consequently,
upon its ability to attract and retain highly skilled technical and product
development personnel. Competition for such personnel is intense, and there can
be no assurance that the Company will be able to retain its key employees or
that it will be successful in attracting, integrating and retaining new
personnel in the future. Failure to attract, integrate and retain such personnel
could have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, at December 31, 1999, the
Company had approximately 50 independent contractors working as technical
consultants primarily in connection with the Company's professional service
offerings. Competition for such contractors is intense and the failure to
continue to attract, hire and retain such contractors when they are needed could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Erratic Price Fluctuation of the Company's Stock. As a technology company,
the Company's Common Stock may be subject to erratic price fluctuations. From
time to time, the stock market experiences significant price and volume
fluctuations, which may affect the market price of the Company's Common Stock
for reasons unrelated to the Company's performance. In addition, the market
price of the Company's Common Stock may be subject to significant fluctuations
in response to numerous factors, including variations in the Company's annual or
quarterly financial results or those of the Company's competitors, changes by
financial research analysts in their estimates of the Company's future earnings
or the Company's failure to meet such estimates, conditions in the economy in
general or in the software and other technology industries, announcements of key
developments by competitors, loss of key personnel, unfavorable publicity
affecting the Company or the software, and sales of the Company's Common Stock
by stockholders. These broad market fluctuations, as well as general economic,
political and market conditions, have and may continue to have a material
adverse effect on the trading price of the Company's Common Stock. Fluctuations
in the price of the Company's Common Stock may expose the Company to the risk of
securities class action lawsuits. As a result of the significant decline in the
price of the Company's Common Stock during the first quarter of 1999, such
lawsuits were filed against the Company. Though the Company believes that these
lawsuits are without merit, defending against them could result in substantial
costs and a diversion of management's attention and resources. In addition, any
settlement or adverse determination of these lawsuits could subject the Company
to significant liabilities. There can be no assurance that there will not be
additional lawsuits in the future or that current or future lawsuits will not
have a material adverse effect on the Company's business, financial condition
and results of operations. See 3 "Legal Proceedings" in Item 3 of Part I.
The Availability of Significant Amounts of the Company's Common Stock for Sale
Could Adversely Affect Its Market Price. The Company has granted registration
rights to certain stockholders including Thayer, SAG and some of the Company's
senior managers. Those rights enable these stockholders to require that the
Company register at the Company's expense, resales of their shares of Common
Stock that cannot be sold to the public without registration under the
Securities Act of 1933, including shares that may be sold under Rule 144 under
certain conditions. Thayer and SAG owned approximately 10.7 million shares and
2.5 million shares, respectively, of the Company's Common Stock as of March 20,
2000. If the Company's stockholders begin to sell substantial amounts of the
Company's Common Stock in the public market, the market price of the Common
Stock could decrease quickly and significantly. A substantial number of sales,
or the perception that such sales might occur, also could make it more difficult
for the Company to sell equity or equity-related securities in the future at a
time and
14
<PAGE>
price that the Company deems appropriate.
Control By Officers, Directors and Thayer. As of January 31, 2000, the
Company's officers and directors, and their affiliates, in the aggregate, had
voting control of approximately 40% of the Company's outstanding Common Stock.
Specifically, Thayer and its affiliates had voting control of approximately 38%
of the Company's outstanding Common Stock as of January 31, 2000. As a result,
these stockholders may be able to control all matters requiring stockholder
approval, including the election of directors and approval of significant
corporate transactions. The voting power of Thayer and the Company's officers
and directors under certain circumstances could have the effect of preventing or
delaying a change in control of the Company.
Managing Additional Growth. The Company's future growth will place
significant demand on management as well as on the Company's administrative,
operational and financial resources. The Company's ability to staff and
effectively manage any future growth in this business will require it to
continue to improve its operational, financial and management controls and
reporting systems and procedures, and to hire, train, motivate and manage its
employees. There can be no assurance that the Company will be able to manage
these challenges in an efficient or timely manner. If management of the Company
is unable to manage growth effectively, the Company's business, financial
condition and results of operations could be materially adversely affected.
Product Protection
The products sold by the Company consist of products developed by SAG (e.g.,
Adabas, Natural and EntireX), products owned by other third parties which are
distributed by the Company (e.g., iXpress) and products developed or acquired by
the Company (i.e., Sagavista, Sagacertify Tool Kit, Construct and Construct
Spectrum). For most of these products, the Company, if not the developer, is
contractually obligated to provide appropriate security measures to protect the
proprietary materials of SAG and other third parties against misappropriation
and illegal copying.
The Company treats all of the products that it distributes as proprietary
trade secrets and confidential information. It relies primarily upon a
combination of trade secret, copyright, trademark and patent laws, its license
agreements with customers, and its internal security systems, confidentiality
procedures and employee agreements to maintain the security of its products.
The Company typically provides its products to users under nonexclusive,
nontransferable perpetual licenses which generally permit use of the licensed
software solely for the user's internal operations on designated computers at
specific sites. Under certain circumstances, the Company places copies of the
source code for certain products on deposit with an escrow agent pursuant to
source code escrow agreements which restrict access to and use of the source
code following the occurrence of certain extraordinary conditions. Although the
Company takes steps to protect its trade secrets and other proprietary rights,
there can be no assurance that misappropriation will not occur. In addition,
the laws of some foreign countries do not protect proprietary rights to the same
extent as the laws of the United States.
The Company seeks to protect its software, documentation and other written
materials under copyright and to a lesser extent patent law, and to assert
trademark rights in its product names. Although the Company has not
traditionally sought to protect its products under patent laws, the Company has
filed various patent applications with regard to its new Sagavista product. SAG
and some third parties have patented, in the United States, Japan and/or the
European Union, certain products that the Company distributes.
The Company is also dependent on SAG and other third parties that license
products to the Company to protect their respective proprietary rights in such
products. There can be no assurance that the legal protections afforded to, or
the precautions taken by the Company or its third-party licensors will be
adequate to prevent misappropriation of their respective proprietary rights. In
addition, these protections do not prevent independent third-party development
of functionally equivalent or superior technologies, products or professional
services. Any infringement or misappropriation of the Company's proprietary
rights, or those of its third-party licensors, could have a material adverse
effect on the Company's business, financial condition and results of operations.
In the future, litigation may be necessary to enforce and protect the
Company's trade secrets, copyrights, patent and other intellectual property or
proprietary rights. The Company may also be subject to litigation to defend
against claimed infringement of, or to determine the scope and validity of, the
intellectual property or proprietary rights of others. In the event of
litigation involving the use of technology by the Company, the Company could be
required to expend significant resources to develop non-infringing technology or
to obtain licenses to technology
15
<PAGE>
involved in litigation. There can be no assurance that the Company would be
successful in such development or that any such license would be available on
commercially reasonable terms, if at all. Although the Company is not aware of
any claims that its products, trademarks, patent or other proprietary rights
infringe on the proprietary rights of third parties, there can be no assurance
that third parties will not assert infringement claims against the Company in
the future with respect to current and future products or that any such
assertion may not require the Company to enter into royalty arrangements or
result in costly litigation. There can be no assurance that third parties will
not assert infringement claims against the Company and that such claims will not
have a material adverse effect on the Company's business, financial condition
and results of operations. Any litigation involving the use of technology by the
Company could result in substantial cost to the Company and divert management's
attention from the Company's operations, either of which could have a material
adverse effect on the Company's business, financial condition and results of
operations. Adverse determinations in any such litigation could result in the
loss of the Company's proprietary rights, subject the Company to significant
liabilities, require the Company to seek licenses from third parties or prevent
the Company from selling its products, any one of which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Under the Original Cooperation Agreement, the Company protected the trademark
rights of SAG in the Territory including the filing of certain trademark
applications either in the name of SAG or the Company. Under the terms of the
Cooperation Agreement, as amended, ownership interests in all SAG trademarks
became the exclusive property of SAG and the Company retained the right to use
the trademarks. iXpress(R) is a registered trademark of the Company in the
United States and/or other countries and Construct(TM), Construct Spectrum(TM),
Construct Spectrum SDK(TM), Sagacertify(TM), Sagavista(TM) and Insight 2000sm
are trademarks or service marks of the Company in the United States and/or other
countries. Adabas(R), Adaplex +(R), Entire(R), EntireX(TM), Entire Broker(TM),
Entire Broker SDK(TM), Entire Broker APPC(TM), Entire SAF Gateway(TM),
Natural(R), Natural Lightstorm(TM), Adabas Delta Save Facility(TM), Adabas
Fastpath(TM), and Adabas SQL Server(TM) are either registered trademarks or
trademarks of SAG in the United States and/or other countries. Trade names and
trademarks of other companies appearing in this report are the property of their
respective owners. The duration of each of the registered trademarks is 10 years
from their respective dates of registration and the duration of each of the
common law trademarks is perpetual. The trademarks are an integral part of the
Company's product identification.
Employees
As of January 31, 2000, the Company had approximately 850 employees. None of
the Company's employees are represented by a labor union, and the Company has
never experienced any work stoppage. The Company considers its relations with
its employees to be good.
As previously reported in Forms 8-K filed with the Securities and Exchange
Commission, Dale E. Williams was appointed Vice President and Chief Financial
Officer of the Company effective January 31, 2000, replacing Harry McCreery who
will retire from the Company. In addition, Timothy L. Hill, Vice President
Marketing and International Operations, resigned from the Company effective
February 25, 2000.
Environmental Matters
The Company does not expect compliance with Federal, state and local
provisions relating to the protection of the environment to have a material
effect on capital expenditures, earnings or the Company's competitive position.
Presently, there are no material expenditures anticipated for environmental
control facilities for 2000 or the near future.
Backlog
The Company believes that backlog is not a meaningful indicator of future
business prospects due to the relatively short period of time between acceptance
of an order and delivery and the portion of revenue related to its service and
support business. As of December 31, 1999, the Company does not have a material
backlog, and the majority of this backlog will be filled by December 31, 2000.
ITEM 2. Properties.
The Company's executive offices, principal marketing, research and development
and data center facilities are
16
<PAGE>
located in approximately 173,000 square feet of space in a three building campus
that the Company leases in Reston, Virginia. The Company also leases
approximately 10,000 square feet of space for use as a print shop and materials
distribution center in Dulles, Virginia. The Company's customer service and
support center is located in approximately 86,000 square feet that the Company
leases in Highlands Ranch, Colorado. The Company also leases approximately 7,000
square feet of space for research and development in Rochester, New York. The
Company currently sublets approximately 18,000 and 15,000 square feet of the
Reston and Highlands Ranch locations, respectively.
The Company's subsidiary in Mexico leases sales offices of approximately
15,000 square feet in Mexico City and Monterrey, Mexico. In addition, the
Company leases product sales and professional services branch offices of
approximately 37,000 square feet in the following cities in Canada: Calgary,
Cambridge, Edmonton, Montreal, Ottawa and Toronto. The Company also leases
approximately 6,000 square feet for research and development in Cambridge,
Canada.
The Company leases product sales and professional services branch offices in:
Irvine and Sacramento, California; Detroit, Michigan; Atlanta, Georgia; Chicago,
Illinois; Burlington, Massachusetts; Bloomington, Minnesota; Fort Lee, New
Jersey; Plymouth Meeting, Pennsylvania; Dallas, Texas; Bellevue, Washington and
Reston, Virginia in the United States.
The Company believes that its facilities are adequate for its current needs
and that suitable space will be available as needed to accommodate the expansion
of the Company's operations.
ITEM 3. Legal Proceedings.
In addition to the legal proceedings and litigation arising in the ordinary
course of business, the Company is involved in a class action shareholders
lawsuit. The Company, certain of its directors and executive officers and the
Company's principal shareholder 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) and May 20 and May 27, 1999 in the United States
District Court for the Eastern District of Virginia, alleging violations of the
federal securities laws. Civil action number 99-496-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.;
civil action number 99-545-A was filed by Adele Brody, et. al.; civil action
number 99-721-A was filed by Caroline Teitelbaum, et. al.; and civil action
number 99-751-A was filed by Harold Smith, et. al. In general, the lawsuits
claim, among other things, that the Company's accounting policies artificially
inflated revenues and earnings and that defendants caused or permitted the
Company to issue a series of materially false and misleading public statements
about the Company's operations and financial results while, at the same time,
selling the Company's Common Stock at artificially inflated prices while in
possession of material non-public information. Plaintiffs seek recission or
compensatory damages with interest, attorneys and expert witness fees, other
costs and other relief awarded at the discretion of the Court. On July 19, 1999,
the shareholder class action lawsuits were consolidated and an amended
complaint, civil action number 99-496-A, "In re: Software AG Systems, Inc.
Securities Litigation," was filed. On August 18, 1999, the Company filed a
motion to dismiss the consolidated and amended shareholder class action lawsuit.
The motion to dismiss was denied on October 1, 1999. Fact discovery closed
December 31, 1999. The class was certified on January 28, 2000. The trial is
currently scheduled for May 15, 2000. It is not possible at this time to predict
the outcome of the litigation or the amount or nature of any loss. The Company
believes that the allegations in the lawsuit are without merit and intends to
vigorously defend the charges. However, there are no assurances that the
resolution of the lawsuit may not materially adversely affect the Company's
financial condition or results of operations.
The Company is involved in various other claims and legal proceedings of a
nature considered normal to its business, primarily relating to product and
contract performance issues, and employee termination matters. While 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.
ITEM 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of security holders during the
fourth quarter of the year covered by this report.
17
<PAGE>
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Price Range of Common Stock
The Company's Common Stock trades on the New York Stock Exchange ("NYSE")
under the symbol AGS. The following table sets forth the quarterly high and low
prices as reported by the NYSE composite transactions for 1999 and 1998.
<TABLE>
<CAPTION>
1999 1998
------------------------------ ------------------------------
Quarters ended, High Low High Low
--------------- ------------------------------ ------------------------------
<S> <C> <C> <C> <C>
March 31, ....................................... $18.38 $ 8.38 $27.25 $11.13
June 30, ........................................ 13.44 4.75 33.00 22.50
September 30, ................................... 14.63 10.25 32.00 15.88
December 31, .................................... 24.88 10.00 20.75 11.88
</TABLE>
Dividends
The Company did not pay any cash dividends in 1999, 1998 or 1997 and does not
anticipate paying any cash dividends on its Common Stock in the foreseeable
future.
Holders of Record
The Company had approximately 150 stockholders of record and 5,900 beneficial
stockholders of its Common Stock at March 24, 2000.
ITEM 6. Selected Consolidated Financial Data.
The consolidated statement of operations data set forth below for each of the
years ended December 31, 1999, 1998, 1997, 1996 and 1995 and the consolidated
balance sheet data as of December 31, 1999, 1998, 1997, 1996 and 1995 have been
derived from the consolidated financial statements, which statements have been
audited by KPMG LLP, independent certified public accountants. The selected
consolidated financial data set forth below should be read in conjunction with
the Consolidated Financial Statements and Notes thereto and with "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing elsewhere in this Form 10-K. The historical financial data set forth
below for the periods ended, or as of the dates prior to, March 31, 1997 reflect
the results of operations and balance sheet data of the Company prior to the
Recapitalization (as defined in the Management's Discussion and Analysis of
Financial Condition and Results of Operations) in March 1997 when the Company
was a wholly owned subsidiary of Software AG, a German software company, and is
captioned as "Predecessor". The historical financial information subsequent to
March 31, 1997 reflects the results of operations and balance sheet data
subsequent to the Recapitalization in March 1997 and is captioned as
"Successor".
18
<PAGE>
<TABLE>
<CAPTION>
Combined
Successor Predecessor (1) Predecessor
----------------------------------- ------------- -------- ----------------------
Nine Three
Year Year months months
ended ended ended ended
Dec. 31, Dec. 31, Dec. 31, Mar. 31, Years ended December 31,
------------------------------------
1999 1998 1997 1997 1997 1996 1995
--------- --------- --------- ------------- ---------- ---------- ---------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Consolidated Statement of
Operations Data:
Software license fees................ $ 64,974 $ 94,899 $ 56,796 | $ 7,341 $ 64,137 $ 52,163 $ 52,061
Maintenance fees..................... 82,958 83,817 55,337 | 17,352 72,689 69,702 65,307
Professional services fees........... 65,351 70,273 34,450 | 9,948 44,398 34,975 35,194
--------- --------- --------- | -------- --------- --------- ---------
Total revenues..................... 213,283 248,989 146,583 | 34,641 181,224 156,840 152,562
Gross profit......................... 119,375 142,771 77,857 | 17,127 94,984 83,869 81,239
Operating expenses before 96,966 100,690 |
write-off.......................... 59,354 | 15,817 75,171 78,588 78,051
Write-off of acquired in-process |
research and development costs(2).. -- -- 6,051 | -- 6,051 -- --
Income from operations............... 22,409 42,081 12,452 | 1,310 13,762 5,281 3,188
Net income $ 17,075 $ 27,710 $ 5,338 | $ 1,373 $ 6,711 $ 6,209 $ 3,326
========= ========= ========= | ======== ========= ========= =========
Net income per common share (3)...... $ 0.57 $ 0.93 $ 0.21 | $ 0.06 $ 0.27 $ 0.23 $ 0.12
========= ========= ========= | ======== ========= ========= =========
Net income per common share - |
assuming dilution (3).............. $ 0.55 $ 0.87 $ 0.20 | $ 0.05 $ 0.25 $ 0.21 $ 0.11
========= ========= ========= | ======== ========= ========= =========
Dividends............................ $ -- $ -- $ -- | $ -- $ -- $ 9,000 $ 1,700
========= ========= ========= | ======== ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
Successor Predecessor
------------------------ ----------------------
December 31,
---------------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
Consolidated Balance Sheet Data: (in thousands)
<S> <C> <C> <C> <C> <C>
Working capital (deficit).................... $ 66,554 $ 85,946 $ 62,052 | $ 30,421 $ (2,465)
Total assets................................. 230,744 253,765 201,737 | 158,088 125,612
Long-term debt, less current maturities...... 680 635 --- | -- --
Total stockholders' equity................... 119,455 127,908 89,818 | 29,808 32,599
</TABLE>
- -------------------------
(1) Reflects combined data for the three months ended March 31, 1997 (prior to
the Recapitalization) and for the nine months ended December 31, 1997
(subsequent to the Recapitalization).
(2) The write-off of acquired in-process research and development costs for the
year ended December 31, 1997 relates to the Company's acquisition of R.D.
Nickel. See Note 4 of Notes to Consolidated Financial Statements for
further detail. Before deducting the nonrecurring write-off for this
period, income from operations was $19.8 million, net income was $12.8
million and basic and diluted earnings per share for net income was $0.51
and $0.48, respectively.
(3) In accordance with the Statement of Financial Accounting Standards No. 128
"Earnings Per Share" ("SFAS No. 128") issued by the Financial Accounting
Standards Board, the Company adopted SFAS No. 128 during 1997. For all
periods presented prior to 1997, the Company retroactively adopted SFAS No.
128 for calculating and presenting the earnings per share. See Notes 1 and
16 of Notes to Consolidated Financial Statements.
19
<PAGE>
ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
This Management's Discussion and Analysis of Financial Condition and Results
of Operations contains descriptions of the Company's expectations regarding
future trends affecting its business. These forward-looking statements and
other forward-looking statements made elsewhere in this document are made in
reliance upon safe harbor provisions of the Private Securities Litigation Reform
Act of 1995. The following discussion sets forth certain factors the Company
believes could cause actual results to differ materially from those contemplated
by the forward-looking statements. The Company undertakes no obligation to
update the information contained in this Item 7.
Overview
SAGA SYSTEMS, Inc., together with its subsidiaries (collectively, the
"Company") is an enterprise software solutions company that provides robust
software products and related professional services to large organizations with
complex computing requirements. The Company's products are used, among other
things, to build, enhance and integrate mission critical applications that
require reliability, scalability and security, such as customer billing systems,
financial accounting systems and inventory management systems. To complement its
products, the Company has a suite of comprehensive professional services
offerings. The Company has over 26 years of experience in addressing the needs
of organizations with complex enterprise level computing environments.
In February 1981, SAGA SYSTEMS, Inc. was incorporated and established as a
holding company for SAGA SOFTWARE, Inc. (formerly known as Software AG Americas,
Inc.), which has been in operation since 1973. Prior to March 31, 1997, SAGA
SYSTEMS, Inc. was a wholly owned subsidiary of Software AG, a German software
company ("SAG"). As is more fully described in Note 2 of Notes to Consolidated
Financial Statements, on March 31, 1997, the Company consummated a
recapitalization pursuant to which the senior management of the Company and
Thayer Equity Investors III, L.P. ("Thayer") acquired approximately 89% of the
Company's then outstanding common stock, par value $0.01 per share ("Common
Stock") ("Recapitalization"). Then the Company and certain stockholders
consummated an initial public offering in November 1997 and a secondary offering
in May 1998. At December 31, 1999, SAG and Thayer owned approximately 10% and
38% of the Company, respectively. In May 1999, the Company's name was changed
from Software AG Systems, Inc. to SAGA SYSTEMS, Inc.
Since its inception in 1973, SAGA SOFTWARE, Inc. has primarily licensed and
serviced products of SAG, both directly and indirectly in North America, South
America, Japan and Israel (collectively, the "Territory") through various
licensing agreements with SAG. The most recent licensing arrangement with SAG
was renegotiated by the Company in September 1999 ("Cooperation Agreement").
This most recent licensing arrangement allows the Company to sell and market
Company owned products worldwide, including the Territory. See Note 3 of Notes
to Consolidated Financial Statements for further details on the renegotiated
licensing agreement.
Effective June 9, 1999, the Company acquired 100% of the issued and
outstanding stock of Blue Lobster Software, Inc. ("Blue Lobster"), a privately-
owned enterprise software development company based in San Jose, California for
approximately $12.0 million. Blue Lobster has a development team located in
Rochester, New York, which has already been employed toward further enhancement
of the Company's e-business integration product suite, Sagavista. In addition,
effective September 30, 1997, the Company acquired R.D. Nickel and Associates,
Inc. ("R.D. Nickel"), a software company based in Ontario, Canada, for
approximately $10.1 million. R.D. Nickel developed, licensed and supported a
family of application development products and served as the exclusive
distributor of the Company's products in Canada prior to the acquisition. Both
of these acquisitions were accounted for using the purchase method of accounting
for business combinations. See Note 4 of the Notes to Consolidated Financial
Statements for details on these acquisitions.
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 EntireX, a family of integration products and Sagavista, the
Company's new e-business product suite, which was generally released in
September 1999.
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
20
<PAGE>
level is priced at 18% of the applicable license fee at the time of renewal.
Software customers are not required to renew their maintenance agreements and
renewals can be expected only if the customer continues to use the licensed
products.
The Company's professional services fees are derived primarily from services
provided with the implementation and deployment of the Company's enterprise
systems and e-business integration products, and through educational services.
The Company's professional services offerings include consulting, software
integration, system implementation, large project management and year 2000
analysis and remediation. The services are delivered on either a time and
material basis or a fixed price basis.
The Company offers its products and professional services to certain customers
under Enterprise License Agreements ("ELAs"). ELAs are typically long-term
contracts of three to five years, which include software products, maintenance
support and professional services. Revenues from software licenses sold as part
of an ELA are recognized as revenue when such products are shipped. Revenue from
maintenance support and professional services are recognized as provided.
As of January 1, 1998, the Company adopted Statement of Position 97-2,
"Software Revenue Recognition" ("SOP 97-2"), as amended by SOP 98-4 and SOP 98-
9. SOP 97-2 focuses on when and in what amounts revenue should be recognized for
licensing, selling, leasing, or otherwise marketing computer software. SOP 98-4
and SOP 98-9 defer certain portions of SOP 97-2 until the Company's fiscal year
2000. Management of the Company believes that the impact of adopting the
provisions of SOP 97-2 that become effective during the fiscal year 2000 will
result in application of the "residual method" (as defined in SOP 98-9) in the
accounting for certain products of the Company. Application of the residual
method may result in a significant decrease in product revenues and a
significant increase in maintenance revenues. However, the amount of impact on
future financial statements is not reasonably estimable at this time.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" ("SAB
No. 101"). SAB No. 101 expresses the SEC's views in applying generally accepted
accounting principles to revenue recognition in financial statements. Companies
can apply the accounting and disclosure requirements of SAB No. 101
retrospectively, or may report a change in accounting principle no later than
the first fiscal quarter of the fiscal year beginning after December 15, 1999.
We do not expect the application of SAB No. 101 to have a material impact on our
financial statements.
Results of Operations
Years ended December 31, 1999 and 1998
Revenues
Total Revenues. The Company's total revenues were $213.3 million and $249.0
million in 1999 and 1998, respectively, representing a decrease of 14%. This
decrease in total revenues was primarily due to a decrease in software license
fees as described below.
Software License Fees. Software license fees were $65.0 million and $94.9
million in 1999 and 1998, respectively, representing a decrease of 32%. The
decline in the software license fees in 1999 from 1998 was partly attributable
to two large orders aggregating approximately $12.3 million in 1998. There were
no comparable large orders in 1999. Excluding these large orders from 1998, the
software license fees would have decreased $17.6 million or 21% compared to
1998. Management believes that this decrease in software license fees was
attributable to customers' decisions to either postpone or cutback on new orders
until such customers address their own internal year 2000 concerns. As such, the
average ELA contract value declined in 1999 compared to 1998. Excluding the two
large contracts from 1998, there were 52 ELAs in 1999 with software license fees
of $21.8 million compared to the 52 ELAs with software license fees of $29.0
million in 1998. This decrease in software license fees was somewhat offset by
Sagavista sales totaling approximately $2.2 million since its general release in
September 1999. Growth in revenue in 2000 is dependent, in part, on increased
demand in 2000 for the Company's new e-business integration product suite,
Sagavista. If this demand is less than anticipated, the Company's results of
operations could be materially adversely affected.
21
<PAGE>
Maintenance Fees. Maintenance fees were $83.0 million and $83.8 million in
1999 and 1998, respectively, representing a slight decrease of 1%.
Professional Services Fees. Professional services fees were $65.4 million and
$70.3 million in 1999 and 1998, respectively, representing a decrease of 7%.
This decrease was primarily attributable to the decrease in the revenue
generated from the Company's year 2000 professional services program which began
in 1997. The year 2000 related professional services revenue decreased to $15.9
million in 1999 from $29.3 million in 1998. This decline in the year 2000
professional services revenue was positively offset by the increase in revenue
from the traditional core professional services offerings, such as application
development and engineering consulting services. Management anticipates revenues
from the traditional core professional services offerings to continue to
increase in 2000, however, revenues from year 2000 professional services are
expected to be virtually non-existent after 1999.
Cost of Revenues
Software License. Software license costs consist primarily of royalties paid
to third parties. Software license costs were $15.1 million and $23.3 million in
1999 and 1998, respectively, representing 23% and 25% of software license fees
for each respective period. The decrease in dollar amount was primarily due to a
decrease in software license revenue. The slight percentage decrease was
primarily due to the shift in the mix of products sold between third party owned
and company owned products. Third party products have royalty rates that
generally vary from 24% to 40% of software license fees and there are no royalty
expenses on sales of company owned products.
Maintenance. Maintenance costs consist of royalties paid to third parties,
the costs of providing customer support and the distribution costs of new
releases. Maintenance costs were $27.7 million and $30.0 million in 1999 and
1998, respectively, representing 33% and 36% of maintenance fees for each
respective period. The decreases in both the dollar amount and the percentage
were primarily attributable to improved utilization and efficiency of existing
support personnel and a shift in the mix of products sold between third party
owned and company owned products.
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 $51.1 million and $52.8 million in 1999 and
1998, respectively, representing 78% and 75% of professional services fees for
each respective period. The decrease in the dollar amount was primarily due to a
decrease in professional services revenue. The increase in percentage was
primarily due to the costs incurred relating to the transition of resources from
the year 2000 service offerings into e-business integration related service
offerings during the second half of 1999 as the demand for the year 2000
professional services declined in 1999.
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 $10.2 million and
$5.5 million in 1999 and 1998, respectively. This increase was primarily due to
expenses incurred in the development of Sagavista and adapters, the Company's
new e-business integration product suite. Sagavista became available for general
release on September 29, 1999. Additionally, the total number of developers has
increased to 82 in 1999 from 54 in 1998 in support of the development of
Sagavista and adapters. The Company is continuing to enhance the core Sagavista
product and build additional adapters and expects the software product
development expenses to increase in 2000.
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 $45.7 million
and $47.6 million in 1999 and 1998, respectively, representing 21% and 19% of
total revenues for each respective period. The decrease in dollar amount was
attributable to a decrease in sales commissions as a result of a decrease in the
software license revenues in 1999 compared to 1998. The decrease in sales and
marketing expenses was also attributable to the fact that the sales and
marketing expenses in 1998 included costs relating to several new marketing
programs and events, including a major trade show and symposiums. Similar costs
were incurred in 1999
22
<PAGE>
but not to the magnitude of those incurred in 1998. The increase in the
percentage was primarily due to the disproportionate decrease in the total
revenues in 1999 compared to the decrease in sales and marketing expenses from
1998. The Company anticipates that sales and marketing expenses will increase in
2000 in connection with ongoing marketing support for Sagavista.
Administrative and General. Administrative and general expenses include
employee salaries and benefits for administration, executive, finance, legal,
human resources, data center, distribution and internal systems personnel and
associated overhead costs, as well as bad debt, amortization expenses,
accounting and legal expenses. Administrative and general expenses were $41.1
million and $47.6 million in 1999 and 1998, respectively, representing each 19%
of total revenues for both respective periods. This decrease in dollar amount
was attributable, in part, to a reduction in company-wide bonus expenses, which
was based on the Company's financial performance. The decrease in administrative
and general expenses was also attributable, in part, to a reduction in bad debt
reserve during the fourth quarter of 1999 of approximately $1.6 million as a
result of a lower accounts receivable balance and an overall improvement of
aging of accounts receivable as of December 31, 1999 compared to December 31,
1998.
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, was $5.5 million and $4.0 million in 1999 and
1998, respectively. This increase was attributable to an increase in interest
earned on cash, cash equivalents, short-term investments and long-term customer
contracts as a result of increases in average balances in 1999 compared to 1998.
Income Tax Provision. The income tax provision was $10.8 million and $18.4
million in 1999 and 1998, respectively, resulting in effective tax rates of
38.7% and 39.9%, respectively.
Years ended December 31, 1998 and 1997
Revenues
Total Revenues. The Company's total revenues were $249.0 million and $181.2
million in 1998 and 1997, respectively, representing an increase of 37%. This
increase in total revenues was due to increases in all three business areas as
discussed below.
Software License Fees. Software license fees were $94.9 million and $64.1
million in 1998 and 1997, respectively, representing an increase of 48%. This
increase was primarily attributable to the expanded deployment of the Company's
products within the current customer base, combined with the increased number of
new ELAs entered into in 1998 compared to 1997. There were 54 new ELAs with
software license fees of $41.3 million compared to 47 ELAs with software license
fees of $27.7 million in 1997.
Maintenance Fees. Maintenance fees were $83.8 million and $72.7 million in
1998 and 1997, respectively, representing an increase of 15%. This increase was
primarily attributable to expansion of the installed base due to increased
software license sales in 1998. The increase was also attributable to the
incremental revenue recorded since the R.D. Nickel acquisition in September
1997.
Professional Services Fees. Professional services fees were $70.3 million and
$44.4 million in 1998 and 1997, respectively, representing an increase of 58%.
This increase was primarily attributable to the increase in the revenue
generated from the Company's year 2000 program, which began in 1997. The year
2000 program revenue increased to $29.3 million in 1998 from $6.6 million in
1997.
Cost of Revenues
Software License. Software license costs were $23.3 million and $19.9 million
in 1998 and 1997, respectively, representing 25% and 31% of software license
fees for each respective period. The increase in dollar amount was primarily due
to an increase in sales volume. The percentage decrease was primarily due to the
shift in the mix of third party products sold, including those developed by SAG.
The royalty rates on third party products generally vary from 24% to 40%. The
decrease in the percentage was also attributable to an increase in the sale of
23
<PAGE>
the Company owned products compared to the prior year.
Maintenance. Maintenance costs were $30.0 million and $28.8 million in 1998
and 1997, respectively, representing 36% and 40% of maintenance fees for each
respective period. The increase in dollar amount was primarily attributable to
the increase in sale of software license and maintenance fees. The percentage
decrease was primarily attributable to the shift in the mix of third party
products sold, including those developed by SAG, and improved utilization of
existing resources.
Professional Services. Professional services costs were $52.8 million and
$37.6 million in 1998 and 1997, respectively, representing 75% and 85% of
professional services fees for each respective period. The increase in the
dollar amount was primarily due to an increase in sales volume. The decrease in
percentage was primarily attributable to improved performance on fixed price
contracts combined with improved utilization of resources.
Operating Expenses
Software Product Development. Software product development costs were $5.5
million and $1.1 million in 1998 and 1997, respectively. The increase was
primarily due to expenses incurred in support of the Company's product in
development, Sagavista, during this period. The total number of developers
increased to 54 in 1998 from 8 in 1997.
Sales and Marketing. Sales and marketing expenses were $47.6 million and $38.3
million in 1998 and 1997, respectively, representing 19% and 21% of total
revenues for each respective period. The increased dollar amount was mainly
attributable to several new marketing programs implemented in 1998 combined with
increased commissions associated with higher revenues compared to the prior
year. Additionally, the increase in the dollar amount was due to the incremental
sales and marketing expenses recorded since the R.D. Nickel acquisition in
September 1997. The decrease in percentage was primarily due to a higher
percentage increase in revenue than the percentage increase in sales and
marketing expenses over the prior year.
Administrative and General. Administrative and general expenses were $47.6
million and $35.8 million in 1998 and 1997, respectively, representing 19% and
20% of total revenues for each respective period. The increased dollar amount
was primarily attributable to increases in personnel related expenses and
infrastructure required to support an independent and growing company (prior to
the Recapitalization, the Company's ability to market and grow its business was
limited by the business of its then parent company, SAG), amortization expenses
relating to the goodwill and the Cooperation Agreement resulting from the
Recapitalization on March 31, 1997 and amortization expenses relating to the
goodwill associated with the R.D. Nickel acquisition completed in September
1997.
Write-Off of Acquired In-Process Research and Development Costs. The write-off
of acquired in-process research and development costs in 1997 was attributable
to certain of the products acquired in the acquisition of R. D. Nickel. See Note
4 of Notes to Consolidated Financial Statements.
Other
Other Income and Expense, Net. Other income and expense, net, was $4.0
million and $2.0 million in 1998 and 1997, respectively. This increase was
primarily attributable to the increase in the interest income from cash, cash
equivalents and the short-term investments in 1998.
Income Tax Provision. The income tax provision was $18.4 million and $9.0
million in 1998 and 1997, respectively, resulting in effective tax rates of
39.9% and 41.5% (exclusive of the write-off of acquired in process research and
development costs in 1997), respectively. The higher effective tax rate in 1997
was primarily due to the non-deductible expenses incurred as a result of the
Recapitalization.
24
<PAGE>
Selected Unaudited Quarterly Information
The following table sets forth certain unaudited quarterly statement of
operations data for each of the eight most recent quarters. In the opinion of
management, this information has been prepared on the same basis as the audited
financial statements, and all necessary adjustments, consisting only of normal
recurring adjustments, have been included in the amounts stated below to present
fairly the unaudited quarterly results when read in conjunction with the audited
Consolidated Financial Statements and Notes thereto. The operating results for
any quarters are not necessarily indicative of results for any future periods.
<TABLE>
<CAPTION>
Three months ended,
------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31,
1999 1999 1999 1999
----------- ---------- ----------- ----------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Revenue..................................... $ 53,606 $ 55,938 $ 51,768 $ 51,971
Gross profit................................ 28,457 30,973 29,676 30,269
Net income.................................. 5,414 5,108 3,961 2,592
Net income per share........................ 0.18 0.17 0.13 0.09
Net income per share-assuming dilution...... $ 0.17 $ 0.16 $ 0.13 $ 0.09
</TABLE>
<TABLE>
<CAPTION>
Three months ended,
-------------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31,
1998 1998 1998 1998
------------ ------------ ------------ ------------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Revenue.............................................. $ 55,863 $ 60,352 $ 62,923 $ 69,851
Gross profit......................................... 31,635 36,211 35,041 39,884
Net income........................................... 5,390 6,145 6,823 9,352
Net income per share................................. 0.18 0.21 0.23 0.31
Net income per share-assuming dilution.......... $ 0.17 $ 0.19 $ 0.21 $ 0.29
</TABLE>
The Company's results of operations have historically fluctuated on a
quarterly basis and although future results are uncertain, they are expected to
be subject to quarterly fluctuations in the future. Historically, although not
true for every year, the Company's software license fees have tended to increase
through each successive quarter of the year, with software license fees in the
first quarter of a year being lower than those in the immediately preceding
fourth quarter of the prior year. Third quarter results have been favorably
affected by increased end of the year spending by the Company's government
customers. Fourth quarter results benefit from those customers who operate on a
calendar year basis, combined with the Company's sales compensation plans which
include incentives for achieving annual targets. In addition, the signing of a
large contract in one quarter may not be replicated in any subsequent quarter.
Software license costs have varied from period to period and can be expected
to fluctuate in the future primarily due to shifts in the mix of products sold
since royalty rates on third party products generally vary from 24% to 40% and
there are no royalty obligations on the sale of Company owned products.
Although past results may not be indicative of future results, maintenance
fees generally have not fluctuated on a quarterly basis to the same degree as
software license revenue due to the large percentage of maintenance fees
generated from renewals of annual maintenance contracts which are recognized
ratably over the contract period.
Revenues from professional services are influenced by the number of personnel
providing such services, the utilization rates of such personnel and the number
of billable days in a quarter. Other factors being equal, a quarter ending
December 31 will generally reflect lower professional services revenues than
other quarters due to the relatively large number of holidays falling in that
quarter. In addition, the completion or commencement of significant professional
services projects may affect the revenues from professional services in a
particular quarter.
Historically, sales and marketing expenses have varied from quarter to quarter
in absolute dollar terms and as a percentage of revenues, as a result of the
size and timing of marketing programs. A significant portion of marketing
program costs are variable in nature and subject to management discretion as to
their timing and amount. The Company expects that sales and marketing expenses
as a percentage of total revenue will increase due to various new marketing
programs initiated for the marketing of its new e-business integration product
suite, Sagavista.
25
<PAGE>
The Company's quarterly operating results may continue to fluctuate due to
numerous factors, including the demand for the Company's products and services,
the timing and cost of new product and service introductions and product
enhancements by the Company or its competitors, changes in the mix of products
and services sold by the Company and in the mix of sales by distribution
channels, commencement or conclusion of significant service contracts, timing of
any acquisitions and associated costs, the size, timing and terms of customer
orders, including delays in significant orders, changes in pricing policies by
the Company or its competitors, the timing of collection of accounts receivable,
changes in foreign currency exchange rates, increased competition from existing
and new competitors and competitive conditions in the industry and general
economic conditions. The Company's expenses are generally fixed and do not vary
significantly in the short term with revenues. As a result, operating and net
income in a given quarter may be disproportionately affected by a reduction in
revenues.
Liquidity and Capital Resources
The Company has financed its operations principally through cash flow from
operating activities. However, the Company has periodically sold long-term
customer receivable contracts in order to meet its short-term cash needs. In
recent years, the Company sold long-term customer receivable contracts in order
to meet obligations to SAG, to buy back the Company's stocks from SAG in
connection with the Recapitalization and to fund the R.D. Nickel acquisition in
1997. Net cash provided by operating activities was $18.6 million, $21.8 million
and $13.3 million for 1999, 1998 and 1997, respectively, primarily from net
income for each respective period and the net proceeds from sales of accounts
receivable in the amount of $18.1 million and $24.3 million for 1998 and 1997,
respectively.
Investing activities used net cash of $17.5 million, $14.4 million and $33.2
million during 1999, 1998 and 1997, respectively, primarily to fund the
acquisition of Blue Lobster in 1999, to purchase short-term investments in 1999
and 1998, to purchase the Cooperation Agreement from SAG and to acquire R.D.
Nickel in 1997, as well as to fund capital expenditures for each respective
period.
During 1999, financing activities used net cash of $28.1 million, primarily
for the repurchase of Common Stock, pursuant to a stock repurchase program,
which commenced in June 1999. For 1998 and 1997, financing activities provided
net cash of $2.7 million and $44.6 million, respectively, primarily from the
proceeds from stock options exercised and stock sold under the Employee Stock
Purchase Plan in 1998, and the sale of the Company's Common Stock from the
initial public offering in 1997.
The Company had $48.2 million and $70.9 million in cash, cash equivalents and
short-term investments as of December 31, 1999 and 1998, respectively. The
decrease in cash, cash equivalents and short-term investments was primarily the
result of the Company's use of cash to fund the acquisition of Blue Lobster for
approximately $12.0 million in June 1999 (see Note 4 of the Notes to
Consolidated Financial Statements) and the Company's repurchase, pursuant to the
stock repurchase program, of 2,414,600 shares of Common Stock as of December 31,
1999 for approximately $29.7 million (see Note 12 of the Notes to Consolidated
Financial Statements). The decrease in cash, cash equivalents and short-term
investments was offset by the net cash provided by the operating activities of
$18.6 million in 1999.
The Company currently has relationships with two third parties whereby the
Company may sell long-term receivable contracts in which control over and the
economic interest in the contract is transferred to the buyer. As of December
31, 1999 and 1998, the Company remained contingently liable under the recourse
provisions associated with the sales made prior to 1998 in the amount of $7.3
million and $24.7 million, respectively. The sale of accounts receivable which
occurred in 1998 does not carry the recourse provision. The Company's accounts
receivable days sales outstanding at December 31, 1999 and 1998 were 65 and 64,
respectively.
The Company traditionally leases all major equipment, and has no investment in
inventory or facilities other than leasehold improvements.
As fully described in Note 11 of the Notes to Consolidated Financial
Statements, on October 15, 1999, the Company entered into 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
stock repurchase programs. The commitments made under the Revolving Credit
Agreement expire November
26
<PAGE>
1, 2002. The Company has agreed to pay commitment fees of 0.125% per annum on
the unused commitment amount on a quarterly basis. The Company has not borrowed
any funds under the Revolving Credit Agreement as of December 31, 1999.
Capital expenditures will be necessary in order for the Company to expand its
distribution channels internationally. Currently, the Company intends to open
one branch office in western Europe in late 2000. There can be no assurance that
the Company's operating income and/or capital resources will be adequate to
support the opening of additional offices, expand its distribution channels, or
support its international business operations. In addition, there can be no
assurance that even if the Company does open additional offices, expand its
distribution channels or expand its international business operations, that any
of the foregoing efforts will ultimately prove successful.
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 on commercially reasonable
terms. The Company had no significant capital commitments or planned
expenditures as of December 31, 1999. The Company believes that inflation did
not have a material effect on its results of operations in 1999.
Year 2000 Compliance
As of March 20, 2000, the Company has not experienced any significant year
2000 related problems for its internal hardware and software systems. Also, the
Company is not aware of any material problems related to the year 2000 with
respect to its products sold and remediation services provided prior to the year
2000. However, there can be no assurances that the Company will not encounter
any year 2000 related problems in the future which may have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Year 2000 Compliance" in the Company's Quarterly Report on Form 10-Q filed
with the SEC on November 12, 1999.
ITEM 7A. Quantitative and Qualitative Disclosures 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 SAG under the Cooperation Agreement are in U.S. dollars. The Company's
Mexican operations commenced in 1996 and represented approximately 3% of total
revenues each in 1999, 1998 and 1997, respectively. With the acquisition of R.D.
Nickel, the Company began direct sales in Canada effective October 1, 1997.
Revenues from this source were approximately 7% and 5% of the total revenues in
1999 and 1998, respectively, and 4% of total revenues in the fourth quarter of
1997. 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.
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 December 31, 1999 was $14.5 million, which
approximates the fair value.
27
<PAGE>
The Company also maintains depository relationships with several banks in the
United States, Canada and Mexico. The majority of these cash balances represent
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 in 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
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 or short-term investments are not exposed to any
significant market risk.
28
<PAGE>
ITEM 8. Consolidated Financial Statements and Supplementary Data
INDEPENDENT AUDITORS' REPORT
Board of Directors
SAGA SYSTEMS, Inc.:
We have audited the accompanying consolidated balance sheets of SAGA SYSTEMS,
Inc. (formerly known as Software AG Systems, Inc.) and subsidiaries as of
December 31, 1999 and 1998, and the related consolidated statements of
operations, stockholders' equity and cash flows for the years ended December 31,
1999, 1998 and the period from April 1, 1997 to December 31, 1997 (Successor
periods), and the consolidated statements of operations, stockholders' equity
and cash flows of SAGA SYSTEMS, Inc. and subsidiaries (a wholly owned subsidiary
of Software AG, a German software company) (Predecessor), for the period from
January 1, 1997 to March 31, 1997 (Predecessor periods). In connection with our
audits of the consolidated financial statements, we have also audited the
accompanying financial statement Schedule II - Valuation and Qualifying
Accounts. These consolidated financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the aforementioned Successor consolidated financial statements
present fairly, in all material respects, the financial position of SAGA
SYSTEMS, Inc. and subsidiaries as of December 31, 1999 and 1998 and the results
of their operations and their cash flows for the Successor periods, in
conformity with generally accepted accounting principles. Further, in our
opinion, the aforementioned Predecessor consolidated financial statements
present fairly, in all material respects, the results of operations and cash
flows of SAGA SYSTEMS, Inc. and subsidiaries (a wholly owned subsidiary of
Software AG, a German software company) for the Predecessor periods, in
conformity with generally accepted accounting principles. Also in our opinion,
the related financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly, in
all material respects, the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, effective
April 1, 1997, SAGA SYSTEMS, Inc. consummated a Recapitalization under which a
majority of the Company's common stock changed control. The change in control of
the Company's common stock was accounted for as a purchase business combination.
As a result of the Recapitalization, the consolidated financial information for
the periods after the Recapitalization is presented on a different cost basis
than that for the periods before the Recapitalization and, therefore, is not
comparable.
KPMG LLP
Washington, D.C.
February 1, 2000
29
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-------------------------
1999 1998
----------- -----------
(in thousands)
<S> <C> <C>
Assets
Current:
Cash and cash equivalents..................................................... $ 33,701 $ 60,298
Short-term investments........................................................ 14,500 10,600
Accounts receivable:
Invoiced and currently due.................................................. 36,486 50,110
Advanced billings on maintenance............................................ 9,355 11,899
Unbilled services........................................................... 1,792 8,771
Installment................................................................. 42,672 32,016
Other....................................................................... 2,131 1,231
Less: allowance for doubtful accounts....................................... (2,884) (5,042)
------------- -----------
Total accounts receivable................................................ 89,552 98,985
Prepaid expenses.............................................................. 3,186 2,265
Current portion of deferred income taxes...................................... 2,175 5,392
Other current assets.......................................................... 939 1,855
------------- -----------
Total current assets..................................................... 144,053 179,395
Installment accounts receivable, net of current portion........................... 35,510 30,248
Goodwill and other intangible assets, net of accumulated amortization............. 22,674 9,720
Cooperation agreement, net of accumulated amortization............................ 17,037 19,387
Property, equipment and leasehold improvements, net of accumulated depreciation
and amortization................................................................ 8,423 10,176
Purchased software costs, net of accumulated amortization......................... 861 ---
Deferred income taxes............................................................. 883 4,136
Other assets...................................................................... 1,303 703
------------- ------------
Total assets............................................................. $ 230,744 $ 253,765
============= ============
</TABLE>
See accompanying notes to consolidated financial statements.
30
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-------------------------
1999 1998
----------- -----------
(in thousands, except share data)
<S> <C> <C>
Liabilities and Stockholders' Equity
Current:
Current portion of long-term obligations........................................ $ 649 $ 478
Accounts payable................................................................ 6,640 9,675
Accrued payroll and employee benefits........................................... 6,044 12,181
Payable to SAG.................................................................. 8,427 10,884
Income taxes payable............................................................ 1,376 3,991
Other current liabilities....................................................... 6,481 7,912
Current portion of deferred revenues, net of deferred royalties of $12,507 in
1999 and $12,683 in 1998...................................................... 47,882 48,328
------------ ------------
Total current liabilities................................................. 77,499 93,449
Long-term obligations, net of current portion....................................... 680 635
Deferred revenues, net of deferred royalties of $8,626 in 1999 and $9,966 in
1998.......................................................................... 33,110 31,773
------------ ------------
Total liabilities......................................................... 111,289 125,857
Commitments and contingencies
Stockholders' equity:
Common stock ($0.01 par value; 75,000,000 shares authorized; 30,882,422 shares
issued in 1999; 30,516,946 shares issued and outstanding in 1998)............. 309 305
Additional paid-in capital...................................................... 98,936 95,474
Retained earnings............................................................... 50,123 33,048
Accumulated other comprehensive income.......................................... (225) (919)
------------ ------------
149,143 127,908
Treasury stock, at cost, 2,414,600 shares in 1999 and no shares in 1998......... (29,688) ---
------------ ------------
Total stockholders' equity................................................. 119,455 127,908
------------ ------------
Total liabilities and stockholders' equity................................. $ 230,744 $ 253,765
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
31
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Successor Predecessor
---------------------------------------------- -------------
Year Year Nine months Three months
ended ended ended ended
Dec. 31, Dec. 31, Dec. 31, Mar. 31,
1999 1998 1997 1997
----------- ----------- ----------- -------------
(in thousands, except per share dollar amounts)
<S> <C> <C> <C> <C>
Revenues:
Software license fees........................... $ 64,974 $ 94,899 $ 56,796 | $ 7,341
Maintenance fees................................ 82,958 83,817 55,337 | 17,352
Professional services fees...................... 65,351 70,273 34,450 | 9,948
---------- ----------- ----------- | ------------
Total revenues............................... 213,283 248,989 146,583 | 34,641
---------- ----------- ----------- | ------------
Cost of revenues: |
Software license................................ 15,115 23,329 17,811 | 2,098
Maintenance..................................... 27,677 30,042 22,559 | 6,205
Professional services........................... 51,116 52,847 28,356 | 9,211
---------- ----------- ----------- | ------------
Total cost of revenues....................... 93,908 106,218 68,726 | 17,514
---------- ----------- ----------- | ------------
Gross profit....................................... 119,375 142,771 77,857 | 17,127
---------- ----------- ----------- | ------------
Operating expenses: |
Software product development.................... 10,157 5,492 1,093 | ---
Sales and marketing............................. 45,698 47,635 31,003 | 7,317
Administrative and general...................... 41,111 47,563 27,258 | 8,500
Write-off of acquired in-process R&D costs...... --- --- 6,051 | ---
---------- ----------- ------------- | ------------
Total operating expenses..................... 96,966 100,690 65,405 | 15,817
---------- ----------- ------------- | ------------
Income from operations............................. 22,409 42,081 12,452 | 1,310
Other income and expense, net................... 5,451 4,003 1,017 | 978
---------- ----------- ------------- | ------------
Income before income taxes......................... 27,860 46,084 13,469 | 2,288
Income tax provision............................ 10,785 18,374 8,131 | 915
---------- ----------- ------------- | ------------
Net income......................................... 17,075 27,710 5,338 | 1,373
Other comprehensive income (loss): |
Foreign currency translation adjustments........ 694 (919) --- | ---
---------- ----------- ------------- | ------------
Comprehensive income............................... $ 17,769 $ 26,791 $ 5,338 | $ 1,373
========== =========== ============= | ============
Net income per common share........................ $ 0.57 $ 0.93 $ 0.21 | $ 0.06
========== =========== ============= | ============
Net income per common share-assuming dilution...... $ 0.55 $ 0.87 $ 0.20 | $ 0.05
========== =========== ============= | ============
Shares used in computing net income per common |
share: |
Net income per common share..................... 29,864 29,950 25,119 | 24,338
Net income per common share-assuming dilution... 31,131 31,864 26,685 | 25,894
</TABLE>
See accompanying notes to consolidated financial statements.
32
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Common Stock Accumulated
$0.01 par value Additional Other Total
----------------------- Paid-in Retained Comprehensive Treasury Stockholders'
Predecessor: Shares Amount Capital Earnings Income Stock Equity
---------- ----------- ----------- ----------- ------------- ----------- ------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1996... 27,500 $ 275 $ 11,877 $ 17,656 $ -- $ -- $ 29,808
Net income...................... -- -- -- 1,373 -- -- 1,373
--------- --------- --------- --------- ----------- ---------- ---------
Balances at March 31, 1997...... 27,500 $ 275 $ 11,877 $ 19,029 $ -- $ -- $ 31,181
========= ========= ========= ========= =========== ========== =========
- -----------------------------------------------------------------------------------------------------------------------------
Successor:
Initial capitalization.......... 27,500 $ 275 $ 37,108 $ -- $ -- $ (32) $ 37,351
Amortization of deferred
compensation expense.......... -- -- 323 -- -- -- 323
Net proceeds from Initial Public
offering...................... 5,178 52 46,754 -- -- -- 46,806
Net income...................... -- -- -- 5,338 -- -- 5,338
--------- --------- --------- --------- ----------- ---------- ---------
Balances at December 31, 1997... 32,678 327 84,185 5,338 -- (32) 89,818
Retirement of treasury stock.... (3,163) (32) -- -- -- 32 --
Amortization of deferred
compensation expense.......... -- -- 776 -- -- -- 776
Stock options exercised......... 933 9 2,260 -- -- -- 2,269
Costs incurred relating to public
Offering...................... -- -- (371) -- -- -- (371)
Stock issued through Employee
Stock Purchase Plan........ 69 1 1,112 -- -- -- 1,113
Tax benefit on stock options
exercised.................. -- -- 7,512 -- -- -- 7,512
Net income ..................... -- -- -- 27,710 -- -- 27,710
Foreign currency
translation adjustment ......... -- -- -- -- (919) -- (919)
--------- --------- --------- --------- ----------- ---------- ---------
Balances at December 31, 1998... 30,517 305 95,474 33,048 (919) -- 127,908
Amortization of deferred
compensation expense.......... -- -- 502 -- -- -- 502
Stock options exercised......... 171 2 293 -- -- -- 295
Stock issued through Employee
Stock Purchase Plan........ 194 2 1,859 -- -- -- 1,861
Stock repurchased............... -- -- -- -- -- (29,688) (29,688)
Tax benefit on stock options
exercised.................. -- -- 808 -- -- -- 808
Net income...................... -- -- -- 17,075 -- -- 17,075
Foreign currency translation
adjustment................. -- -- -- -- 694 -- 694
--------- --------- --------- --------- ----------- ---------- ---------
Balances at December 31, 1999... 30,882 $ 309 $ 98,936 $ 50,123 $ (225) $ (29,688) $ 119,455
========= ========= ========= ========= =========== ========== =========
</TABLE>
See accompanying notes to consolidated financial statements.
33
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Successor Predecessor
----------------------------------------- ---------------
Year Year Nine Three
ended ended months ended months ended
Dec. 31, Dec. 31, Dec. 31, Mar. 31,
1999 1998 1997 1997
------------- ------------ ------------ ---------------
Cash flows from operating activities: (in thousands)
<S> <C> <C> <C> <C>
Net income......................................................... $ 17,075 $ 27,710 $ 5,338 | $ 1,373
Adjustments to reconcile net income to net cash provided by |
operating activities: |
Depreciation and amortization.................................. 9,150 7,992 6,205 | 941
Loss (gain) on disposal of property and equipment.............. 72 236 (5) | --
Deferred income taxes.......................................... 3,546 (463) (3,041) | (1,143)
Deferred gain.................................................. -- -- -- | (36)
Net proceeds from sales of accounts receivable................. -- 18,119 24,314 | --
Write-off of acquired in-process R&D costs..................... -- -- 6,051 | --
Write-off of long-term investment.............................. -- 848 1,529 | --
Amortization of deferred compensation expense.................. 502 776 323 | --
Change in: |
Accounts receivable, excluding net proceeds from sales....... 4,527 (54,434) (43,074) | 10,996
Prepaid expenses............................................. (417) (899) 4,313 | (3,894)
Other current and long-term assets........................... 316 947 (2,988) | 3,083
Accounts payable............................................. (4,529) 1,285 779 | 673
Accrued payroll and employee benefits ....................... (6,164) 2,037 2,059 | (3,632)
Payable to SAG............................................... (2,457) 834 (1,336) | 6,265
Other current liabilities.................................... (1,741) (1,766) (558) | (927)
Income taxes payable......................................... (1,836) 9,768 (1,542) | (568)
Deferred revenues, net....................................... 604 8,825 4,476 | (2,705)
----------- -------- -------- | ----------
Net cash provided by operating activities................ 18,648 21,815 2,843 | 10,426
----------- -------- -------- | ----------
Cash flows from investing activities |
Additions to property, equipment and leasehold improvements........ (1,477) (3,817) (4,084) | (208)
Purchase of short-term investments................................. (12,535) (10,600) -- | --
Proceeds from sales of short-term investments...................... 8,600 -- -- | --
Proceeds from sales of property and equipment...................... 4 35 2 | --
Purchase of Cooperation Agreement.................................. -- -- (22,612) | --
Acquisition, net of cash received.................................. (12,092) -- (6,325) | --
----------- -------- -------- | ----------
Net cash used in investing activities.................... (17,500) (14,382) (33,019) | (208)
----------- -------- -------- | ----------
Cash flows from financing activities: |
Proceeds from stock options exercised ............................. 295 2,269 -- | --
Proceeds from Employee Stock Purchase Plan ........................ 1,861 1,113 -- | --
Expenses relating to public offerings ............................. -- (371) -- | --
Payment made on capital leases .................................... (518) (286) -- | --
Net proceeds from Initial Public Offering ......................... -- -- 46,806 | --
Repurchase of common stock ........................................ (29,688) -- (33,919) | --
Issuance of common stock .......................................... -- -- 31,727 | --
----------- -------- -------- | ----------
Net cash provided by (used in) financing activities...... (28,050) 2,725 44,614 | --
----------- -------- -------- | ----------
Effect of exchange rate changes on cash and cash equivalents ........ 305 (289) -- | --
Net increase in cash and cash equivalents ........................... (26,597) 9,869 14,438 | 10,218
Cash and cash equivalents, beginning ................................ 60,298 50,429 35,991 | 25,773
----------- -------- -------- | ----------
Cash and cash equivalents, ending ................................... $ 33,701 $ 60,298 $ 50,429 | $ 35,991
=========== ======== ======== | ==========
Non-cash investing and financing activity: |
Tax benefit on stock options exercised............................. $ 808 $ 7,512 $ -- | $ --
Acquired capital lease assets and software......................... 1,941 1,195 -- | --
Supplemental disclosures: |
Interest paid...................................................... $ 117 $ 128 $ 14 | $ --
Income taxes paid, net of refunds.................................. 7,401 9,547 11,056 | 3,630
</TABLE>
See accompanying notes to consolidated
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Description of Operations and Summary of Significant Accounting Policies
Reporting Entity and Principles of Consolidation
Prior to March 31, 1997, SAGA SYSTEMS, Inc. (formerly known as Software AG
Systems, Inc.) and subsidiaries (the "Company") was a wholly owned subsidiary of
Software AG, a German software company ("SAG"). As is more fully described in
Note 2, on March 31, 1997, the Company consummated a recapitalization pursuant
to which the senior management of the Company and Thayer Equity Investors III,
L.P. ("Thayer") acquired approximately 89% of the Company's then outstanding
common stock, par value $0.01 per share ("Common Stock") ("Recapitalization").
The Company and certain stockholders consummated an initial public offering in
November 1997 and a secondary offering in May 1998.
The consolidated financial statements include the accounts of SAGA SYSTEMS,
Inc. and its wholly owned subsidiaries. All inter-company balances and
transactions between the Company and its wholly owned subsidiaries have been
eliminated.
Description of Operations
The Company is an enterprise solutions company that provides robust
software products and related professional services to large organizations with
complex computing requirements. The Company's products are used to build,
enhance and integrate mission critical applications that require reliability,
scalability and security, such as customer billing systems, financial accounting
systems and inventory management systems. The Company also has comprehensive
professional services offerings, including consulting, software integration,
systems implementation and large project management services. The Company
markets and sells the Company owned products and related services through direct
and indirect channels worldwide. With third party owned products, the Company
markets and sells through direct and indirect channels in North America, South
America, Japan and Israel. The Company operates in one reportable segment,
enterprise solutions, that provides software and related professional services.
Financial Statement Presentation
The historical financial information set forth in these consolidated
financial statements for the periods ended, or as of the dates prior to March
31, 1997 reflect the results of operations of the Company prior to the
Recapitalization when the Company was a wholly owned subsidiary of SAG and is
captioned as "Predecessor." The historical financial information subsequent to
March 31, 1997 reflects the consolidated financial position and results of
operations subsequent to the Recapitalization and is captioned as "Successor."
As a result of the Recapitalization, the consolidated financial information for
the periods after the Recapitalization is presented on a different cost basis
than that for the periods before the Recapitalization and, therefore, is not
comparable.
Cash Equivalents
The Company considers all highly liquid instruments with a maturity of
three months or less at time of purchase to be cash equivalents. Cash
equivalents generally consist of commercial paper and institutional money market
funds.
Short-Term Investments
The Company's short-term marketable debt securities at December 31, 1999
and 1998 have been categorized as available-for-sale and are carried at carrying
value, which approximates fair value. Unrealized holding gains and losses are
included as a separate component of stockholders' equity until realized. All of
the Company's investment holdings have been classified in the consolidated
balance sheet as current assets, as they are available to be used for current
operations.
35
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to credit risk
include accounts receivable, cash, cash equivalents and short-term investments.
For the installment accounts receivable that are sold, the Company continues to
service the receivables sold, including invoicing and collection. In addition,
the Company remains contingently liable under the recourse provisions associated
with the installment accounts receivable sold prior to 1998. Management believes
that credit risk related to the Company's accounts receivable is limited due to
a large number of customers in differing industries and geographic areas. The
Company does not require collateral for accounts receivable. Historically, the
Company has not experienced significant losses on accounts receivable, including
the installment accounts receivables sold, except in isolated situations. The
Company maintains depository relationships with several banks. At times, the
Company's cash deposits may exceed federally insured limits. The Company invests
excess cash in highly liquid short-term investments, such as high grade
corporate and United States government debt securities and commercial paper. The
Company has not experienced any losses in its depository accounts or short-term
investments and management believes that the Company is not exposed to
significant credit risks.
Fair Value of Financial Instruments
The carrying amounts of cash, cash equivalents, short-term investments,
accounts receivable, accounts payable, payable to SAG, and amounts included in
other current assets and current liabilities that meet the definition of a
financial instrument, approximate fair value because of the short-term nature of
these amounts.
The carrying amount of installment accounts receivable, net of related
deferred revenues, approximates the fair value.
Goodwill and Other Intangible Assets
Goodwill represents the excess of purchase price over fair market value of
net assets acquired and has been recorded in conjunction with the Blue Lobster
Software, Inc. ("Blue Lobster") acquisition in June 1999, the R.D. Nickel and
Associates, Inc. ("R.D. Nickel") acquisition in September 1997 and the
Recapitalization in March 1997. Goodwill is being amortized on a straight-line
basis over the expected periods to be benefited, between seven and ten years.
Other intangible assets consist of acquired intellectual property and a
favorable contract resulting from the Blue Lobster acquisition and are being
amortized on a straight-line basis over seven years and one year, respectively.
Property, Equipment and Leasehold Improvements
Property, equipment and leasehold improvements are recorded at cost.
Computer equipment and software are depreciated on a straight-line basis over
three years. Leasehold improvements and assets recorded under capital leases are
amortized over the shorter of the respective lease term or estimated useful
asset lives. Furniture and other equipment are depreciated on a straight-line
basis over five years.
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" software development costs are expensed 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.
The Company expenses costs incurred related to the development of its
products. For products where technological feasibility has been reached,
software purchased to be used in the development of those products has been
capitalized. Such costs amounted to $861,000 of purchased software costs as of
December 31, 1999.
36
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Capitalized purchased software is recorded at the lower of cost or net
realizable value and is being amortized over the estimated useful life of three
years beginning at the point in which the product becomes available for general
release to customers. None of the products for which these costs were
capitalized were available for general release at December 31, 1999. Therefore,
there was no amortization expense.
Impairment of Long-Lived Assets
The Company accounts for long-lived assets in accordance with the
provisions of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of." This statement requires that long-
lived assets and certain identifiable intangibles be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. The Company assesses the recoverability of its
long-lived assets, including goodwill and other intangible assets by determining
whether the remaining carrying amount of the assets can be recovered through
undiscounted future operating cash flows. If such assets are considered to be
impaired, the amount of impairment is measured based on projected discounted
future operating cash flows. The assessment of the recoverability of long-lived
assets will be impacted if estimated future operating cash flows are not
achieved.
Revenue Recognition
As of January 1, 1998, the Company adopted Statement of Position 97-2,
"Software Revenue Recognition" ("SOP 97-2"), as amended by SOP 98-4 and SOP 98-
9. SOP 97-2 focuses on when and in what amounts revenue should be recognized for
licensing, selling, leasing, or otherwise marketing computer software. SOP 98-4
and SOP 98-9 defer certain portion of SOP 97-2 until the Company's fiscal year
2000. Management of the Company believes that the impact of adopting the
provisions of SOP 97-2 that become effective during the fiscal year 2000 will
result in application of the "residual method" (as defined in SOP 98-9) in the
accounting for certain products of the Company. Application of the residual
method may result in a significant decrease in product revenues and a
significant increase in maintenance revenues. However, the amount of impact on
future financial statements is not reasonably estimable at this time.
Software license revenues for an arrangement to deliver software that does
not require significant production, modification or customization of software
are recognized when there is an executed license agreement, the software and
authorization code, where applicable, have been delivered, the fee is fixed and
collectibility is probable.
Maintenance revenues, which include unspecified when-and-if deliverable
software upgrades, user documentation, and technical support for software
products, are deferred and recognized on a straight-line basis over the term of
the maintenance agreement, generally one year.
Customer training revenues and revenues from time and material type
professional consulting and custom application contracts are recognized as the
services are provided and the work is performed. Revenues from long-term fixed
price professional consulting and custom application contracts are accounted for
under the percentage of completion method. When estimates of costs, on long-term
fixed price contracts, indicate a loss, such a loss is provided for currently.
Sales of enterprise license agreements generally bundle a combination of
products, technical services and professional consulting services. In accordance
with SOP 97-2, these elements are unbundled for revenue recognition purposes,
and are accounted for based on the fair value of their component parts using the
criteria described above.
Advertising Costs
The Company expenses all advertising costs as period costs when incurred.
Advertising expense was $1,724,000, $1,976,000 and $329,000 in 1999, 1998 and
1997, respectively.
37
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Income Taxes
The Company uses the asset and liability method to account for income
taxes. Under the asset and liability method, deferred income taxes are
recognized for the future tax consequences attributable to future years for
differences between the financial statement carrying amounts and the tax bases
of existing assets and liabilities. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred taxes of a change in tax rates is recognized in
income in the period that includes the enactment date.
Foreign Currency Translation
The local currencies of the Company's foreign subsidiaries are the
functional currencies. The assets and liabilities of foreign subsidiaries are
translated into U.S. dollars at current exchange rates, and the resulting
translation gains and losses are included as an adjustment to stockholders'
equity. Revenue and expense accounts of these operations are translated at
monthly average exchange rates prevailing during the year. Foreign currency
adjustments are disclosed as a separate component of stockholders' equity and
comprehensive income.
Comprehensive Income (Loss)
The Company adopted SFAS No. 130 "Reporting Comprehensive Income" ("SFAS
No. 130") as of January 1, 1998. SFAS No. 130 establishes standards for the
reporting of comprehensive income (loss) and its components in the financial
statements. This statement requires only additional disclosures in the
consolidated financial statements, and does not affect the Company's financial
position or results of operations. The Company's comprehensive income (loss)
includes net income and foreign currency translation adjustments. The Company
has not recorded the foreign currency translation net of an income tax benefit,
since management does not believe that it is probable that the Company will
ultimately realize the benefit.
Net Income per Common Share
The Company reports earnings per share under SFAS No. 128, "Earnings Per
Share" ("SFAS No. 128"). In accordance with SFAS No. 128 requirements, the
Company presents basic and diluted earnings per share. Basic earnings per share
is based on income available to common shareholders divided by the weighted
average number of common shares outstanding. Diluted earnings per share is based
on income available to common shareholders divided by the sum of the weighted
average number of common shares outstanding and all potential common stock.
Stock Option Plan
The Company accounts for issuance of stock options in accordance with SFAS
No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). SFAS No.
123 permits entities to recognize as expense over the vesting period the fair
value of all stock-based awards on the date of grant. Alternatively, SFAS No.
123 also allows entities to continue to apply the provisions of Accounting
Principles Board Opinion No. 25 ("APB Opinion No. 25") and provide pro forma net
income and pro forma earnings per share disclosures for employee stock option
grants made as if the fair value based method defined in SFAS No. 123 had been
applied. Under APB Opinion No. 25, compensation expense would be recorded only
if the current market price of the underlying stock on the date of the grant
exceeded the exercise price. The Company has elected to continue to apply the
provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions
of SFAS No. 123.
Transfers and Servicing of Financial Assets
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS No.
125"). SFAS No. 125 is effective for transfers and servicing of financial assets
and extinguishments of liabilities occurring after December 31, 1996 and is to
be applied
38
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
prospectively. SFAS No. 125 provides accounting and reporting standards for
transfers and servicing of financial assets and extinguishments of liabilities
based on consistent application of a financial-components approach that focuses
on control. It distinguishes transfers of financial assets that are sales from
those transfers that are secured borrowings.
Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Reclassifications
Certain amounts in 1997 and 1998 have been reclassified to conform to the
1999 presentation.
(2) Recapitalization of the Company
On March 31, 1997, the Company consummated the Recapitalization under which
the Company repurchased from its former parent, SAG, 24,750,000 shares of common
stock and sold 21,450,000 shares of Common Stock to Thayer and certain of the
Company's senior managers for approximately $31,500,000. As a result of this
change in control, the acquisition by Thayer and such managers was accounted for
as a purchase business combination, and as such the fair value of the Company's
assets and liabilities was recorded as of April 1, 1997.
Prior to the consummation of the Recapitalization, the Company entered into
a perpetual cooperation agreement, dated March 31, 1997 ("Original Cooperation
Agreement") with SAG that terminated and superseded the license agreement dated
January 1, 1995. As consideration for the Original Cooperation Agreement, the
Company paid SAG approximately $22,600,000.
In connection with the Recapitalization, the determination of fair value
allocated to the identifiable assets and liabilities of the Company has been
made by management based on the nature of the assets and liabilities acquired,
and general economic factors. Based on this allocation, the fair value of the
Original Cooperation Agreement to the Company has been recorded at $23,500,000,
based on an independent appraisal. The amortization period for the value of the
Original Cooperation Agreement is ten years. The Company recorded these
remaining assets and liabilities at book value, which approximate the fair value
at the date of the acquisition. Based on allocation of the purchase price to the
net assets and liabilities, an excess of purchase price over net assets acquired
(goodwill) of $6,402,000 was recorded. Such goodwill is being amortized on a
straight-line basis over ten years. Accumulated amortization on the goodwill was
$1,761,000 and $1,120,000, respectively, at December 31, 1999 and 1998.
(3) Cooperation Agreement
On September 30, 1999, the Company amended and restated the Original
Cooperation Agreement. The amended Original Cooperation Agreement will be
referred to hereinafter as the "Cooperation Agreement." The Cooperation
Agreement allows, among other things, the Company and SAG to expand their
respective distribution channels. The Cooperation Agreement removes certain
distribution exclusivity provisions, which were part of the Original Cooperation
Agreement, allowing both companies to sell new products in geographic
territories that were previously restricted to the other.
The Original Cooperation Agreement, among other things, provided (i) the
Company the exclusive and perpetual right to license and service in North
America, South America, Japan and Israel (collectively, the "Territory") both
existing and future products developed or acquired by SAG and (ii) SAG the
exclusive and perpetual right to license and service outside the Territory both
existing and future products developed or acquired by the Company.
39
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Under the Cooperation Agreement, the Company has retained, with the exception
of the Company's Construct product, the exclusive right to license and service
on a worldwide basis the products that it develops or acquires. Additionally,
the Company retained the exclusive and perpetual right to license and service
the core SAG product lines, including Adabas, Natural and the existing core
Entire family products, but exclusive of EntireX, to current Company customers
in the United States, Canada and Mexico ("North America"). The Company also
retained the exclusive right to license and service EntireX in North America,
except under certain circumstances, to current Company customers through June
2000, and a non-exclusive right to license and service EntireX in North America
after June 2000. In addition, excluding North America, the Company retained the
exclusive and perpetual right to license and service all current and future SAG
products within the Territory.
The Company has non-exclusive and perpetual rights under the Cooperation
Agreement to license and service the SAG products Bolero and Tamino, as well as
SAG's future database and software development tools, if any, to current Company
customers in North America. The Company also has non-exclusive rights to license
and service certain new SAG products other than the core SAG products, the
EntireX, Bolero and Tamino products and future database and software development
tools to current Company customers in North America. This right terminates on
December 31, 2005, although it may continue under certain circumstances. In
addition, the Company has the non-exclusive and perpetual right to license and
service the core SAG product lines, including Adabas, Natural and the existing
core products in the Entire family, including EntireX, to new Company customers
in North America.
The Company has no rights to license or service new SAG products to new SAGA
customers in North America.
Under the Cooperation Agreement, SAG has the non-exclusive, perpetual right
to license the Company's Construct products outside of the Territory. SAG has no
right to license any other Company product anywhere else in the world.
Under the Original Cooperation Agreement, each of the Company and SAG had to
pay the other 24% of the net revenues derived from licenses granted. This 24%
royalty rate was fixed for 20 years. Except under certain circumstances, the
Company's minimum annual royalty payment to SAG under the Original Cooperation
Agreement through the year 2000 was required to equal at least $21.0 million.
Under the Cooperation Agreement, each of the Company and SAG must still pay
the other 24% of the net revenues derived from the distribution of the other
party's products and the provision of maintenance within the Territory, in the
case of the Company, and outside of the Territory, in the case of SAG. This
royalty rate shall be effective through the year 2017 and thereafter unless the
parties agree otherwise. Additional payments may be made by the Company if the
Company grants certain discounts.
Except under certain circumstances, the Company's minimum annual royalty
payment to SAG under the Cooperation Agreement, must equal at least $21.0
million for year 1999, $23.0 million for each of years 2000, 2001 and 2002,
$21.0 million for year 2003, $20.0 million for year 2004 and $17.0 million for
year 2005. The Company made royalty payments of $32,408,000, $39,601,000 and
$29,278,000 to SAG in 1999, 1998 and 1997, respectively.
Management of the Company believes that the amendments to the Original
Cooperation Agreement did not impair its carrying value nor impact its remaining
useful life. As a result, no adjustment to the carrying value of the Original
Cooperation Agreement has been reflected in these financial statements as a
result of the amendments. The accumulated amortization on the Cooperation
Agreement at December 31, 1999 and 1998 was $6,463,000 and $4,113,000,
respectively. Amortization expense on the Cooperation Agreement for the years
ended December 31, 1999 and 1998, and the nine months ended December 31, 1997
was $2,350,000, $2,350,000 and $1,763,000, respectively.
40
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(4) Acquisitions
Effective June 9, 1999, the Company acquired 100% of the issued and
outstanding stock of a privately-owned enterprise software development company
based in San Jose, California, Blue Lobster, for approximately $12,000,000. The
acquisition was funded through cash on hand.
The acquisition was accounted for using the purchase method of accounting
and the operating results of the acquired business have been included in the
consolidated financial statements since the acquisition date. The purchase price
has been allocated based on estimated fair values at the date of acquisition. Of
the total purchase price, $11,844,000 was allocated to acquired intellectual
property rights and an assembled workforce, $500,000 to a favorable contract,
$1,814,000 to a deferred tax asset, $4,738,000 to deferred tax liability and
$344,000 of other liabilities assumed. The excess of the purchase price over net
assets acquired of $2,924,000 represented goodwill. The acquired intellectual
property rights, assembled workforce and the goodwill are being amortized over
their estimated useful lives of seven years. The favorable contract is being
amortized over one year. At December 31, 1999, the accumulated amortization of
the goodwill and other acquired intangible assets was $237,000 and $1,133,000,
respectively.
On September 30, 1997, the Company acquired 100% of the issued and
outstanding shares of the common stock of R.D. Nickel. R.D. Nickel now operates
as SAGA SOFTWARE (CANADA) Inc. ("SAGA CANADA"). R.D. Nickel, located in Ontario,
Canada, was a software company that had a family of application development
products and had been the exclusive distributor of SAG's products in Canada
since 1973. The transaction was accounted for using the purchase method of
accounting for a business combination. The aggregate purchase price of
Cdn$14,000,000 (US$10,130,000) was funded through a cash payment of
Cdn$7,000,000 (US$5,065,000) and a note payable of Cdn$7,000,000 (US$5,065,000).
The note payable was paid in November 1997 with the proceeds from the initial
public offering in November 1997.
In connection with the transaction, the Company recorded a $6,051,000 non-
recurring charge against earnings for in-process research and development costs.
The remaining excess purchase price of Cdn$6,944,000 (US$4,960,000) represented
goodwill on SAGA CANADA's books. The related amortization period for the
goodwill is ten years. At December 31, 1999 and 1998, accumulated amortization
on the goodwill was approximately Cdn$1,567,000 (US$1,085,000) and Cdn$873,000
(US$570,000), respectively.
The Company accounted for the acquisition effective September 30, 1997, and
as such, the operating results of R.D. Nickel have been consolidated with the
Company's operating results as of October 1, 1997.
Neither the Blue Lobster acquisition nor the R.D. Nickel acquisition was
determined to be significant to the operations or financial position of the
Company; accordingly, pro forma financial information has not been presented.
(5) Short-Term Investments
The following is a summary of the carrying value of available-for-sale
securities held by the Company:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1999 1998
------------- ------------
(in thousands)
<S> <C> <C>
Commercial paper......................................................... $ 1,500 $ 5,100
Debt securities.......................................................... 13,000 5,500
---------- -----------
$ 14,500 $ 10,600
=========== ===========
</TABLE>
The carrying value of these securities approximates fair market value. As
such, there were no unrealized holding gains or losses for the years ended
December 31, 1999 and 1998. There were no realized gains and losses for the
years ended December 31, 1999, 1998 and 1997. Short-term investments are
comprised of fixed rate securities with contractual maturities that are less
than 24 months.
41
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(6) Accounts Receivable
Total current and non-current accounts receivable (including installment
accounts receivable) consist of the following:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1999 1998
------------- -------------
(in thousands)
<S> <C> <C>
Domestic................................................................... $ 115,831 $ 120,262
International.............................................................. 12,115 14,013
Less: allowance for doubtful accounts..................................... 2,884 5,042
------------- -------------
$ 125,062 $ 129,233
============ ============
</TABLE>
Installment Accounts Receivable
Installment accounts receivable represent unbilled receivables from
enterprise license agreements and other long-term and short-term contracts with
deferred invoicing terms.
Installment accounts receivable include:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1999 1998
------------- -------------
(in thousands)
<S> <C> <C>
Gross installment accounts receivable................................. $ 82,678 $ 65,480
Less: unearned interest............................................... 4,496 3,216
------------- -------------
78,182 62,264
Less: current portion................................................. 42,672 32,016
------------- -------------
$ 35,510 $ 30,248
============= =============
</TABLE>
The effective interest rate on the installment accounts receivable, net of
related deferred revenues, at December 31, 1999 and 1998 was approximately 9%.
At December 31, 1999, installment accounts receivable are scheduled to be
invoiced as follows:
<TABLE>
<CAPTION>
Years ending December 31, Amount
------------------------- -------------
(in thousands)
<S> <C>
2000........................................................................................ $ 45,040
2001........................................................................................ 22,855
2002........................................................................................ 10,690
2003........................................................................................ 4,093
----------
$ 82,678
==========
</TABLE>
In 1998 and 1997, the Company sold installment accounts receivable relating
to certain enterprise license agreements and other long-term contracts to
unrelated financing companies. The Company received net proceeds of $18,119,000
and $24,314,000 from sales of the installment accounts receivable in 1998 and
1997, respectively. The installment accounts receivable sold include those
relating to software license fees, maintenance services, and professional
consulting services. Under SFAS No. 125, the sales of the receivables during
1998 and 1997 have been reflected as a reduction of the accounts receivable.
Under the terms of the agreements with the financing companies, the Company
continues to service the receivables sold, including invoicing and collection,
and makes payments to the financing companies under pre-determined amortization
schedules based on the scheduled invoicing dates of the receivables sold. The
Company has determined that there is no servicing asset or liability to record
under SFAS No. 125 as a result of the sales. The amortization schedules provide
rates of return to the financing companies ranging from 8.5% to 8.9%.
42
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The agreements allow for substitution of contracts for early terminations
and require the Company to repurchase contracts that cease to meet eligibility
requirements, such as those contracts that become 90 days past due. At December
31, 1999 and 1998, the Company remained contingently liable under the recourse
provisions for the installment accounts receivable sold prior to 1998 in the
amount of $7,264,000 and $24,723,000, respectively. Management has determined
that the fair value of the recourse liabilities on the sales are not material to
the financial statements, and as a result, believes that the allowance for
doubtful accounts is maintained at a level that is sufficient to cover potential
losses under the recourse provisions on the receivables sold prior to 1998.
Under the terms of the agreements, the Company is required to maintain
specified amounts of net worth and cash availability, and a debt to equity ratio
that does not exceed a specified amount. If the Company fails to maintain these
specified amounts, the financing companies may assume the servicing rights on
receivables sold. The Company is in compliance with the requirements as required
by the agreements at December 31, 1999.
Unbilled Services
Unbilled services relate primarily to long-term professional consulting
services and custom application contracts accounted for using the percentage of
completion method. Billings on these contracts generally are tied to achieving
specific milestones.
<TABLE>
<CAPTION>
Unbilled services include: Dec. 31, Dec. 31,
1999 1998
-------------- --------------
(in thousands)
<S> <C> <C>
Unbilled work in process....................... $ 1,240 $ 10,777
Retainage...................................... 552 1,409
---------- -----------
1,792 12,186
Less: advance billings and prepayments......... -- 3,415
---------- -----------
$ 1,792 $ 8,771
========== ===========
</TABLE>
(7) Goodwill and Other Intangible Assets
Goodwill and other intangible assets included in the accompanying balance
sheets are summarized as follows:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1999 1998
-------------- --------------
(in thousands)
<S> <C> <C>
Goodwill............................................. $ 15,016 $ 11,823
Other intangible assets.............................. 12,344 --
----------- -----------
27,360 11,823
Less: accumulated amortization...................... 4,686 2,103
----------- -----------
$ 22,674 $ 9,720
=========== ===========
</TABLE>
As fully discribed in Note 4, the increase in goodwill and other intangible
assets was a result of the Blue Lobster acquisition in June 1999. Amortization
expense of goodwill and other intangible assets for the years ended December 31,
1999 and 1998, the nine months ended December 31, 1997 and the three months
ended March 31, 1997 was $2,538,000, $1,159,000, $650,000 and $15,000,
respectively.
43
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(8) Property, Equipment and Leasehold Improvements
Property, equipment and leasehold improvements included in the
accompanying balance sheets are summarized as follows:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1999 1998
------------ ------------
(in thousands)
<S> <C> <C>
Leasehold improvements .................................. $ 10,884 $ 10,486
Computer equipment and software ......................... 10,669 16,834
Furniture and other equipment ........................... 9,596 8,891
---------- ----------
31,149 36,211
Less: accumulated depreciation and amortization.......... 22,726 26,035
---------- ----------
$ 8,423 $ 10,176
========== ==========
</TABLE>
Depreciation and amortization expense for property, equipment and
leasehold improvements for the years ended December 31, 1999 and 1998, the nine
months ended December 31, 1997 and the three months ended March 31, 1997 was
$4,263,000 and $4,540,000, $2,952,000 and $896,000, respectively.
(9) Other Current Liabilities
Other current liabilities are comprised of the following amounts:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1999 1998
------------ -----------
(in thousands)
<S> <C> <C>
Reserve for losses on long-term contracts................ $ 250 $ 2,427
Other accrued expenses .................................. 6,231 5,485
---------- ----------
$ 6,481 $ 7,912
========== ==========
</TABLE>
(10) Lease Commitments
The Company leases certain computer and other equipment under agreements,
which are classified as capital leases. Lease terms range between 36 months and
60 months. Assets under capital leases are included in the consolidated balance
sheets as follows:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1999 1998
----------- ----------
(in thousands)
<S> <C> <C>
Computer equipment and software................................ $ 1,556 $ 1,512
Furniture and other equipment.................................. 436 --
---------- ----------
1,992 1,512
Less: accumulated amortization................................. 889 428
---------- -----------
$ 1,103 $ 1,084
========== ===========
</TABLE>
In addition, the Company leases office space and equipment under operating
lease agreements that expire at various dates through 2015. Facility rent
expense for the years ended December 31, 1999 and 1998, the nine months ended
December 31, 1997 and the three months ended March 31, 1997 was $6,855,000,
$6,658,000, $5,179,000 and $1,772,000, respectively. Rent expense includes the
current year effect of determinable scheduled rent increases and initial rent
abatement periods contained in certain of the Company's facility lease
agreements. Equipment lease expense for the years ended December 31, 1999 and
1998, the nine months ended December 31, 1997 and the three months ended March
31, 1997 was $2,915,000, $2,002,000, $1,018,000 and $339,000, respectively.
44
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Future minimum rent payments under the aforementioned leases, net of
aggregate rents of $3,520,000 expected to be received from subleasing of a
portion of the customer support facility and another facility, at December 31,
1999 are:
<TABLE>
<CAPTION>
Years ending December 31, Capital Leases Operating Leases
- ------------------------- -------------- -------------------------------------------
Facilities Equipment Total
------------- ----------- ----------
(in thousands)
<S> <C> <C> <C> <C>
2000....................................... $ 629 $ 5,940 $ 1,732 $ 7,672
2001....................................... 380 5,617 249 5,866
2002....................................... 80 4,926 90 5,016
2003....................................... 64 4,162 34 4,196
2004....................................... 64 4,464 -- 4,464
Thereafter................................. -- 14,357 -- 14,357
------------ ------------ ----------- -----------
Total minimum lease payments............... 1,217 $ 39,466 $ 2,105 $ 41,571
============ =========== ===========
Less: amount representing interest......... 141
------------
Present value of net minimum lease payments 1,076
Less: current portion...................... 562
------------
$ 514
============
</TABLE>
The Company's operating lease agreement for its customer support facility
requires the Company to maintain minimum amounts of net worth and retained
earnings. If the minimum amounts are not maintained, the Company will be
required to post a $500,000 irrevocable letter of credit for each $2,000,000
shortfall, to be applied by the lessor in the event of default under the lease.
At December 31, 1999, the Company is in compliance with the minimum net worth
and retained earnings requirements.
(11) Line of Credit
On October 15, 1999, the Company entered into a three-year revolving credit
loan agreement ("Revolving Credit Agreement"), which provides an unsecured
recourse revolving credit loan for borrowing in the aggregate principal amount
of up to $25.0 million. The funds available under the Revolving Credit Agreement
may be used for general corporate purposes including future potential
acquisitions, if any, but excluding stock repurchase programs. The commitments
made under the Revolving Credit Agreement expire November 1, 2002. The Company
has agreed to pay commitment fees of 0.125% per annum on the unused commitment
amount on a quarterly basis.
Under the Revolving Credit Agreement, financial covenants include minimum
current ratio, maximum cash flow leverage ratio and no net losses for any two
consecutive quarters, or at any fiscal year end. The Revolving Credit Agreement
also contains other customary limitations and events of default, and the failure
to comply with such limitations, or occurrence of any events of default, would
prevent any further borrowings and would generally require the repayment of any
outstanding borrowings under the Revolving Credit Agreement. The Company was in
compliance with the financial covenants set forth in the Revolving Credit
Agreement at December 31, 1999.
Interest on borrowings under the Revolving Credit Agreement would be
determined, at the Company's option, by either (a) a Eurodollar rate option or
(b) a base rate option. The Eurodollar rate option is a LIBO rate plus an
applicable margin. The base rate option is the lender's prime rate plus an
applicable margin. Applicable margin can vary according to the Company's cash
flow leverage ratio. The Company has not borrowed any funds under the Revolving
Credit Agreement as of December 31, 1999.
45
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(12) Treasury Stock
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 "Tender Offer"). The Tender Offer
expired on May 25, 1999 and 200 shares of Common Stock were tendered at $8.00
per share. In addition, the Company incurred $160,000 of expenses relating to
the Tender Offer, which were expensed as period costs. These expenses included
printing fees, legal fees, depositary fees, information agent fees, filing fees
and other miscellaneous expenses.
On June 14, 1999, the Company announced that it would begin acquiring
shares of its Common Stock in connection with a stock repurchase program ("Stock
Repurchase Program"). At that time, the Stock Repurchase Program authorized the
Company to repurchase up to 2,000,000 shares of its Common Stock from time to
time on the open market starting on June 14, 1999 and to continue over an
indefinite period. Then on September 29, 1999, the Company announced that it
would repurchase up to an additional 2,000,000 shares of its Common Stock for an
indefinite period. As of December 31, 1999, the Company has repurchased
2,414,400 shares of Common Stock under the Stock Repurchase Program at an
aggregate cost of $29,687,000.
(13) Transactions with Related Party
Royalties
During the three months ended March 31, 1997, the Company and SAG operated
under a license agreement whereby the Company was required to pay royalties of
24% of the net sales amounts for licenses of and technical services on SAG's
products. For the three months ended March 31, 1997, royalty expense related to
SAG's products was $5,683,000. Under this license agreement, SAG also paid 24%
royalties to the Company on sales of the Company's products under the same
terms. For the three months ended March 31, 1997, the Company received royalty
revenues from SAG of $339,000.
In connection with the Recapitalization (Note 2), the Company entered into
the Original Cooperation Agreement in March 1997, which was subsequently amended
in September 1999. Under both the Original Cooperation Agreement and the
Cooperation Agreement, the Company paid $32,408,000, $39,601,000 and $23,595,000
of royalties to SAG for the years ended December 31, 1999 and 1998 and the nine
months ended December 31, 1997, respectively. SAG paid royalties of $437,000,
$997,000 and $300,000 to the Company for the years ended December 31, 1999 and
1998 and the nine months ended December 31, 1997, respectively.
Cost Reimbursements
Under the terms of an Administrative Services Agreement ("ASA") between the
Company and SAG, the Company has housed certain of SAG's product development and
quality assurance personnel. SAG reimbursed the Company for the costs incurred
related to such product development and quality assurance activities. All
intellectual property resulting from this work was the sole property of SAG. The
reimbursements from SAG were netted against costs incurred. Reimbursements for
the years ended December 31, 1999 and 1998, the nine months ended December 31,
1997 and the three months ended March 31, 1997 were $10,125,000, $8,454,000,
$7,406,000 and $3,416,000, respectively. The ASA was terminated effective
December 31, 1999. The Company does not expect to incur any additional costs
under the ASA subsequent to March 31, 2000.
Notes Payable
The payable to SAG of $8,427,000 and $10,884,000 at December 31, 1999 and
1998, respectively, includes royalties due under the Cooperation Agreement on
sales of both product licenses and maintenance services, as well as net amounts
due on other transactions between the Company and SAG. In accordance with the
Cooperation Agreement, royalty payments are made 90 days after invoicing. Any
payments resulting from other transactions between the Company and SAG are made
monthly as expenses are incurred. These amounts are non-interest bearing.
46
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(14) Other Income and Expense, Net
Other income and expense, net, on the consolidated statements of operations
primarily consists of interest earned on cash, cash equivalent, short-term
investments, long-term customer contracts carried by the Company and
miscellaneous income. Interest income earned on cash, cash equivalent, short-
term investments and long-term customer contracts was $4,432,000, $3,550,000,
$728,000 and $779,000 for the years ended December 31, 1999 and 1998, the nine
months ended December 31, 1997 and the three months ended March 31, 1997.
(15) Income Taxes
Income tax expense consisted of:
<TABLE>
<CAPTION>
Successor Predecessor
------------------------------------------- --------------
Year Year Nine months Three months
ended ended ended ended
Dec. 31, Dec. 31, Dec. 31, Mar. 31,
1999 1998 1997 1997
------------ ------------- ------------- --------------
Current expense: (in thousands)
<S> <C> <C> <C> <C>
Federal.............................. $ 949 $ 14,047 $ 6,226 | $ 1,196
State................................ 52 1,894 1,551 | 258
Foreign.............................. 6,431 2,896 3,395 | 604
---------- ----------- ----------- | ------------
7,432 18,837 11,172 | 2,058
---------- ----------- ----------- | ------------
Deferred expense (benefit): |
Federal.............................. 3,398 (421) (2,560)| (959)
State................................ (45) (42) (481)| (184)
---------- ----------- ----------- | ------------
3,353 (463) (3,041)| (1,143)
---------- ----------- ----------- | ------------
$ 10,785 $ 18,374 $ 8,131 | $ 915
========== =========== =========== | ============
</TABLE>
Income tax expense for the years ended December 31, 1999 and 1998, the nine
months ended December 31, 1997 and the three months ended March 31, 1997
differed from the amounts computed by applying the U.S. federal income tax rate
of 35% to pretax income as a result of the following:
<TABLE>
<CAPTION>
Successor Predecessor
------------------------------------------- --------------
Year Year Nine months Three months
ended ended ended ended
Dec. 31, Dec. 31, Dec. 31, Mar. 31,
1999 1998 1997 1997
------------ ------------- ------------- -------------
(in thousands)
<S> <C> <C> <C> <C>
Computed "expected" tax expense.................. $ 9,749 $ 16,129 $ 4,714 | $ 801
Increase (reduction) in income taxes resulting |
from: |
State income taxes, net of federal benefit.... 5 1,204 696 | 48
Expenses, principally meals and entertainment, |
not deductible............................. 294 262 209 | 6
Amortization and write-off of intangibles.... 598 369 2,439 | 49
Other, net................................... 139 410 73 | 11
---------- ----------- ----------- | -----------
$ 10,785 $ 18,374 $ 8,131 | $ 915
========== =========== =========== | ===========
</TABLE>
47
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of December 31, 1999, the Company had tax credit carryforwards of
$2,719,000 and federal and state net operating loss carryforwards (tax effected)
of $3,234,000. Of these amounts, $104,000 of the credit carryforwards and
$1,746,000 of the net operating loss carryforwards were attributable to acquired
tax benefits, which reduced goodwill related to the acquisition of Blue Lobster.
These acquired benefits are subject to the ownership change limitations under
Section 382 of the Internal Revenue Code. The ownership change limitations
generally limit the amount of acquired tax benefits that may be used on an
annual basis. The tax credit carryforwards, if unused, will begin to expire in
2004. Likewise, unused net operating losses will begin to expire in 2011.
The components of deferred tax assets and liabilities at December 31,
1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31,
1999 1998
------------ ------------
(in thousands)
<S> <C> <C>
Deferred tax assets arising from deductible temporary differences:
Accrued compensation costs and other expenses.................. $ 3,308 $ 2,884
Net operating loss and credit carryforwards.................... 5,953 --
Allowance for doubtful accounts................................ 1,234 2,849
Depreciation and amortization.................................. 2,690 2,004
Deferred gain.................................................. 766 1,031
Investments.................................................... -- 956
---------- ----------
13,951 9,724
Deferred tax liabilities arising from taxable temporary differences:
Leases of product licenses..................................... 168 196
Acquired intangibles........................................... 4,423 --
Net deferred royalties......................................... 6,302 --
---------- ----------
10,893 196
---------- ----------
Net deferred income taxes........................................... 3,058 9,528
Less: current portion, deferred tax assets.......................... 2,175 5,392
---------- ----------
Non-current portion, deferred tax assets............................ $ 883 $ 4,136
========== ==========
</TABLE>
In assessing the realization of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Based upon the level of
historical taxable income and projections for future taxable income over the
periods for which the deferred tax assets are deductible, management believes
that it is more likely than not that the Company will realize the benefits of
these deductible differences. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of future
taxable income are reduced.
48
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(16) Net Income per Share
The following is a reconciliation of the number of shares used in the
earnings per share calculations:
<TABLE>
<CAPTION>
Successor Predecessor
------------------------------------------- -------------
Year Year Nine months Three months
ended ended ended ended
Dec. 31, Dec. 31, Dec. 31, Mar. 31,
1999 1998 1997 1997
------------ ------------ ------------- -------------
(in thousands, except for per share dollar amounts)
<S> <C> <C> <C> <C>
Numerator:
Net income............................... $ 17,075 $ 27,710 $ 5,338 | $ 1,373
=========== ========== ========== | =========
|
Denominator: |
Basic weighted average shares outstanding 29,864 29,950 25,119 | 24,338
Effect of dilutive securities: |
Stock options............................ 1,267 1,914 1,566 | 1,556
----------- ---------- ---------- | ----------
Diluted weighted average shares outstanding... 31,131 31,864 26,685 | 25,894
=========== ========== ========== | ==========
EPS: |
Net income per common share.............. $ 0.57 $ 0.93 $ 0.21 | $ 0.06
Net income per common share - assuming |
dilution.............................. $ 0.55 $ 0.87 $ 0.20 | $ 0.05
</TABLE>
49
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(17) Retirement Plans
The Company has a retirement plan covering substantially all of its
employees. This plan meets the requirements of Section 401(k) of the Internal
Revenue Code. The Company matches employee contributions and may make additional
contributions based on the Company's profitability. For the years ended December
31, 1999 and 1998, the nine months ended December 31, 1997 and the three months
ended March 31, 1997, the Company's matching (and total) contributions were
$3,028,000, $2,391,000, $1,190,000 and $696,000, respectively.
The Company also had deferred compensation agreements with certain key
executives, which were fully paid out on January 1, 1999. Under these
agreements, the executives were credited with annual pre-determined amounts and
amounts based on bonuses received, and earned interest on the deferred amounts.
Total deferrals were included in accrued payroll and employee benefits, net of
any outstanding loans. Total deferrals were $1,755,000 (net of $363,000 loan
balance) at December 31, 1998. The expense for these agreements was $450,000,
$160,000 and $150,000 for the year ended December 31, 1998, the nine months
ended December 31, 1997 and the three months ended March 31, 1997, respectively.
There was no expense for the year ended December 31, 1999 as the liabilities
under these agreements were fully paid out on January 1, 1999. To assist in the
funding of these agreements, the Company has purchased corporate-owned life
insurance policies on certain of these executives. However, these insurance
policies were not redeemed at the time of the pay out on January 1, 1999 as the
Company paid the liabilities with cash on hand. The cash surrender value of
these policies, which is included in other assets, was approximately $700,000 at
December 31, 1999 and 1998.
(18) Stock Option Plan and Employee Stock Purchase Plan
The Company adopted the SAGA SYSTEMS, Inc. 1997 Stock Option Plan (the
"Stock Option Plan") on April 29, 1997. The Stock Option Plan currently permits
a maximum of 6,875,000 shares of Common Stock to be issued pursuant to grants of
stock options. The Board of Directors approved an amendment to the Stock Option
Plan to increase the number of shares of Common Stock reserved for issuance
thereunder by 2,000,000 shares to 8,875,000 shares. This amendment will be
presented to the Company's stockholders for approval at the Company's Annual
Meeting of Stockholders scheduled to be held on May 17, 2000. Unless sooner
terminated by the Company's Board of Directors, the Stock Option Plan will
terminate on April 11, 2007. Under the Stock Option Plan, options are granted
with an exercise price that is equal to the fair market value of each share at
the date of grant. All options issued generally have vesting periods of zero to
four years from the grant date and expire after the seventh anniversary from the
date of grant. At December 31, 1999 and 1998, 1,079,939 shares and 1,761,776
shares, respectively, were available for grant under the Stock Option Plan.
Following is a summary of activity under the Stock Option Plan for the
years ended December 31, 1999, 1998 and 1997:
<TABLE>
<CAPTION>
1999 1998 1997
---------------------------- ---------------------------- ------------------------
Weighted Weighted Weighted
average Average Average
exercise exercise Exercise
Shares price Shares price Shares Price
------------- ------------ -------------- ----------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, January 1,.. 4,179,964 $ 6.97 5,043,225 $ 5.02 -- $ --
Granted ................. 880,250 12.39 450,500 19.50 5,069,900 4.66
Exercised ............... 171,144 1.72 933,260 2.43 -- --
Forfeited/Expired ....... 198,413 11.12 380,501 7.27 26,675 2.90
------------- ------------ -------------- ----------- ------------ ---------
Outstanding, December 31, 4,690,657 $ 8.00 4,179,964 $ 6.97 5,043,225 $ 5.02
============= ============ ============== =========== ============ =========
</TABLE>
50
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table summarizes information about the Stock Option Plan at
December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------------------------------------- ----------------------------------
Weighted average
Actual range of remaining Weighted Weighted
exercise prices in Shares contractual average Shares average exercise
150% increments outstanding life years exercise price exercisable price
---------------------- --------------- ------------------ ---------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C>
$ 1.47 - 1.47 1,906,829 4.3 $ 1.47 918,127 $ 1.47
7.38 - 11.06 1,086,978 5.3 9.56 598,916 9.64
11.25 - 15.88 1,316,350 5.9 12.70 642,649 12.13
17.00 - 24.44 302,500 5.8 18.55 44,672 18.22
25.75 - 30.19 78,000 5.3 26.00 20,250 25.99
---------------------- --------------- ------------------ ---------------- ---------------- ----------------
$ 1.47 - 30.19 4,690,657 5.1 $ 8.01 2,224,614 $ 7.31
====================== =============== ================== ================ ================ ================
</TABLE>
At December 31, 1998 and 1997, there were 1,033,230 and 593,725 shares
exercisable, respectively, with weighted average exercise price of $9.00 and
$9.58, respectively.
In 1998, the Company's Board of Directors and the shareholders approved a
qualified employee stock purchase plan ("ESPP") and authorized the issuance of
1,500,000 shares of Common Stock, for purchase pursuant to the ESPP. The ESPP
commenced on June 1, 1998. Under the terms of the ESPP, employees may
contribute, through payroll deduction, up to 15% of eligible compensation to
purchase stock with the limitation of $25,000 annually in fair market value of
the shares. Employees may elect to withdraw from the ESPP at any time during the
two separate offering periods which run from December to May and June to
November and have their contributions for the period returned to them. Also,
employees may elect to change the rate of contribution only once during the
offering periods. The price at which employees may purchase shares is 85% of the
lower of the fair market value of the stock at the beginning or end of the six-
month offering period. The ESPP is qualified under Section 423 of the Internal
Revenue Code of 1986, as amended. Employees purchased 194,242 shares and 68,686
shares at weighted average prices of $9.56 and $16.20 in 1999 and 1998,
respectively. At December 31, 1999 and 1998, 1,237,072 shares and 1,431,000
shares, respectively, are remaining for future issuance.
The Company applies APB Opinion No. 25 in accounting for its stock options
granted and stock issued through the ESPP, under which compensation cost is
recognized to the extent that the fair value of the underlying stock exceeds the
exercise price of the stock options granted or stock issued through the ESPP.
Under SFAS No. 123, the Company is required to provide pro forma disclosure of
the net income and earnings per share that would have resulted had the Company
adopted the fair value method for recognition purposes. The following
information is presented as if the Company had adopted SFAS No. 123 and restated
its results for the years ended December 31, 1999 and 1998 and the nine months
ended December 31, 1997:
<TABLE>
<CAPTION>
Dec. 31, Dec. 31, Dec. 31,
1999 1998 1997
----------- ------------ ------------
(in thousands, except per share data)
<S> <C> <C> <C>
Net income - as reported ............................. $ 17,075 $ 27,710 $ 5,338
Net income - pro forma ............................... 13,910 25,501 4,741
Earnings per share - as reported ..................... 0.57 0.93 0.21
Earnings per share (assuming dilution) - as reported.. 0.55 0.87 0.20
Earnings per share - pro forma ....................... 0.47 0.85 0.19
Earnings per share (assuming dilution) - pro forma.... 0.45 0.80 0.18
</TABLE>
For the above information, the fair value of each stock option grant was
estimated on the date of grant using the Black-Scholes option pricing model with
the following weighted average assumptions used for grants in 1999, 1998 and
1997: dividend yield of zero percent each; risk-free interest rate of 5.4%, 5.2%
and 6.0%; expected volatility of 76.0%, 73.9% and 40.0%; and expected lives of
4.5 years, 4.5 years and 2 to 6 years, respectively. The weighted average fair
value of options granted during the years ended December 31, 1999 and 1998 and
the nine months ended December 31, 1997 was $7.71, $11.90 and $1.97,
respectively.
51
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In addition, the fair value of each share of Common Stock purchased through
the ESPP was estimated on the purchase date using the Black-Scholes pricing
model with the following assumptions in 1999 and 1998: dividend yield of zero
percent each; risk free interest rate of 4.8% and 5.3%; expected volatility of
76.0% and 73.9%; and expected lives of 0.5 years each, respectively. The
weighted average fair value of stocks purchased through the ESPP during the
years ended December 31, 1999 and 1998 was $5.07 and $8.31, respectively.
The full impact of calculating cost for stock options under SFAS No. 123 is
not reflected in the pro forma net income amounts presented above because
compensation cost is reflected over the options vesting period of four years.
(19) Geographic, Product and Services Revenue Information
Net revenue, operating income, and identifiable assets by geographic area
were as follows:
<TABLE>
<CAPTION>
Successor Predecessor
--------------------------------------------- --------------
Year Year Nine months Three monhs
ended ended ended ended
Dec. 31, Dec. 31, Dec. 31, Mar. 31,
1999 1998 1997 1997
-------------- ------------- ------------- --------------
Revenue:.......................................... (in thousands)
<S> <C> <C> <C> <C>
U.S. operations................................. $ 171,628 $ 209,838 $ 116,378 | $ 30,424
Canadian operations............................. 17,427 15,062 3,861 | --
Mexican operations.............................. 6,346 6,209 4,507 | --
Other operations................................ 21,843 25,845 23,329 | 4,217
Intercompany elimination........................ (3,961) (7,965) (1,492) | --
--------- --------- --------- | ---------
Total revenue................................ $ 213,283 $ 248,989 $ 146,583 | $ 34,641
========= ========= ========= | =========
Income (loss) from operations: |
U.S. operations................................. $ 4,505 $ 25,109 $ 5,956 | $ (240)
Canadian operations............................. 4,157 3,046 (5,129) | --
Mexican operations.............................. 504 (22) (1,151) | --
Other operations................... ............ 11,740 13,766 12,776 | 1,550
Intercompany elimination........................ 1,503 182 -- | --
--------- --------- --------- | ---------
Total operating income........................ $ 22,409 $ 42,081 $ 12,452 | $ 1,310
========= ========= ========= | =========
Identifiable assets (including long-lived assets): |
U.S. operations................................. $ 225,188 $ 253,199 $ 193,503 | $ 127,749
Canadian operations............................. 7,494 11,158 9,143 | --
Mexican operations.............................. 2,910 302 1,538 | --
Other operations................................ -- -- -- | --
Intercompany elimination........................ (4,848) (10,894) (2,447) | --
--------- --------- --------- | ---------
Total identifiable assets..................... $ 230,744 $ 253,765 $ 201,737 | $ 127,749
========= ========= ========= | =========
</TABLE>
Canadian operations consist of one subsidiary, SAGA CANADA (formerly R.D.
Nickel), which was acquired in September 1997. Mexican operations consist of one
subsidiary located in Mexico. The Company's Mexican operations commenced in 1996
and operated as a branch office until it became a wholly owned subsidiary in May
1997. Other operations include royalty revenue from international distributors.
52
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Royalty revenues from international distributors are as follows:
<TABLE>
<CAPTION>
Successor Predecessor
-------------------------------------------- ------------
Nine Three
Year Year months months
ended ended ended ended
Dec. 31, Dec. 31, Dec. 31, Mar. 31,
1999 1998 1997 1997
------------ ------------ ------------ -------------
(in thousands)
<S> <C> <C> <C> <C>
Brazil.............................................. $ 9,000 $ 7,777 $ 7,500 | $ 1,500
Japan............................................... 7,587 12,469 10,481 | 971
Canada.............................................. --- --- 2,026 | 805
Other............................................... 5,256 5,599 3,322 | 941
------------ ------------ ------------ | -------------
Total royalty revenues from international distributors $ 21,843 $ 25,845 $ 23,329 | $ 4,217
============ ============ ============ | =============
</TABLE>
Royalty revenues from international distributors included in software
license fees and maintenance fees on the consolidated statements of operations
were $16,232,000 and $5,611,000, respectively, for the year ended December 31,
1999; $18,696,000 and $7,149,000, respectively, for the year ended December 31,
1998; $16,105,000 and $7,224,000, respectively, for the nine months ended
December 31, 1997; and $2,331,000 and $1,886,000, respectively, for the three
months ended March 31, 1997. Royalties from Canada include royalties received
from R.D. Nickel prior to the acquisition in September 1997.
Sales and transfers between geographic areas are accounted for at prices
which the Company believes are arm's length, and in accordance with the rules
and regulations of the respective governing tax authorities.
The Company's software license fees are derived primarily from the
licensing of the Company's enterprise systems and e-business integration
products. In 1999, 1998 and 1997, revenues from the sale of enterprise systems
products (including year 2000 products) represented 82%, 84% and 81%,
respectively, and revenues from sale of e-business integration products
represented 18%, 16% and 19%, respectively, of the total software license fees.
The Company's professional services fees are derived primarily from
services provided with the implementation and deployment of the Company's
enterprise systems and e-business integration products and through educational
services. The Company's professional services offerings include software
integration, system implementation, large project management, year 2000 analysis
and remediation and consulting. In 1999, 1998 and 1997, software integration,
system implementation and large project management services contributed 59%, 44%
and 64%, respectively; year 2000 analysis and remediation services contributed
24%, 42% and 15%, respectively; educational services contributed 4%, 4% and 7%,
respectively; and consulting and other services contributed approximately 13%,
10% and 14%, respectively, of the total professional services revenue.
(20) Contingencies
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) and May 20 and May 27, 1999 in the United States
District Court for the Eastern District of Virginia, alleging violations of the
federal securities laws. Civil action number 99-496-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.;
civil action number 99-545-A was filed by Adele Brody, et. al.; civil action
number 99-721-A was filed by Caroline Teitelbaum, et. al.; and civil action
number 99-751-A was filed by Harold Smith, et. al. In general, the lawsuits
claim, among other things, that the Company's accounting policies artificially
inflated revenues and earnings and that defendants caused or permitted the
Company to issue a series of materially false and misleading public statements
about the Company's operations and financial results while, at the same time,
selling the Company's Common Stock at artificially inflated prices while in
possession of material non-public information. Plaintiffs seek recission or
compensatory damages with interest, attorneys and expert witness fees, other
costs and other relief awarded at the discretion of the Court. On July 19, 1999,
the shareholder class
53
<PAGE>
SAGA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
action lawsuits were consolidated and an amended complaint, civil action number
99-496-A, "In re: Software AG Systems, Inc. Securities Litigation," was filed.
On August 18, 1999, the Company filed a motion to dismiss the consolidated and
amended shareholder class action lawsuit. The motion to dismiss was denied on
October 1, 1999. Fact discovery closed December 31, 1999. The class was
certified on January 28, 2000. The trial is currently scheduled for May 15,
2000. It is not possible at this time to predict the outcome of the litigation
or the amount or nature of any loss. The Company believes that the allegations
in the lawsuit are without merit and intends to vigorously defend the charges.
However, there are no assurances that the resolution of the lawsuit may not
materially adversely affect the Company's financial condition or results of
operations.
The Company is involved in various other claims and legal proceedings of a
nature considered normal to its business, primarily relating to product and
contract performance issues, and employee termination matters. While 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.
(21) Quarterly Financial Data (Unaudited)
Summarized financial data by quarters is as follows:
<TABLE>
<CAPTION>
Three months ended,
----------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31,
1999 1999 1999 1999
------------ ----------- ----------- -----------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Revenue .............................. $ 53,606 $ 55,938 $ 51,768 $ 51,971
Gross profit ......................... 28,457 30,973 29,676 30,269
Net income ........................... 5,414 5,108 3,961 2,592
Net income per share ................. 0.18 0.17 0.13 0.09
Net income per share-assuming dilution $ 0.17 $ 0.16 $ 0.13 $ 0.09
<CAPTION>
Three months ended,
----------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31,
1998 1998 1998 1998
------------ ----------- ----------- -----------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Revenue .............................. $ 55,863 $ 60,352 $ 62,923 $ 69,851
Gross profit ......................... 31,635 36,211 35,041 39,884
Net income ........................... 5,390 6,145 6,823 9,352
Net income per share ................. 0.18 0.21 0.23 0.31
Net income per share-assuming dilution $ 0.17 $ 0.19 $ 0.21 $ 0.29
</TABLE>
Net income for the fourth quarter ended December 31, 1999 includes a
reduction in bad debt reserve of approximately $1.6 million as a result of a
lower accounts receivable balance and an overall improvement aging of accounts
receivables as of December 31, 1999 compared to December 31, 1998.
54
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
Information with respect to the directors and executive officers of the
Company is set forth in the Company's definitive proxy statement for its annual
stockholders' meeting to be held on May 17, 2000 (the "Proxy Statement") under
the captions "Election of Directors" and "Executive Officers," which information
is incorporated herein by reference. Information concerning compliance with
Section 16 of the Securities Exchange Act of 1934, as amended, by persons
subject to such section is set forth in the Proxy Statement under the heading
"Section 16 (a) Beneficial Ownership Reporting Compliance," which information is
incorporated herein by reference.
Item 11. Executive Compensation.
The information required by Item 11 is incorporated herein by reference from
the Proxy Statement under the caption "Election of Directors." Information
contained in the Proxy Statement under the captions "Report of the Compensation
Committee of the Board of Directors on Executive Compensation" and "Stock
Performance Graph" is not incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by Item 12 is incorporated herein by reference from
the Proxy Statement under the caption "Security Ownership of Certain Beneficial
Owners and Management."
Item 13. Certain Relationships and Related Transactions.
The information required by Item 13 is incorporated herein by reference from
the Proxy Statement under the caption "Certain Relationships and Transactions."
55
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1. The following consolidated financial statements are included in Part
II, Item 8 of this report: Report of Independent Auditors
Consolidated Balance Sheets - December 31, 1999 and 1998
Consolidated Statements of Operations - For the years ended December
31, 1999 and 1998, for the nine months ended December 31, 1997
and for the three months ended March 31, 1997.
Consolidated Statements of Stockholders' Equity - For the years ended
December 31, 1999 and 1998, for the nine months ended December
31, 1997 and for the three months ended March 31, 1997.
Consolidated Statements of Cash Flows - For the years ended December
31, 1999 and 1998, for the nine months ended December 31, 1997
and for the three months ended March 31, 1997.
Supplementary Financial Information
2. The following financial statement schedule is filed as a part of this
Annual Report:
Financial statement schedule covered by report of Independent
Auditors: Schedule II - Valuation and Qualifying Accounts as of
and for the three years in the period ended December 31, 1999.
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission
are omitted because they are not required under the related
instructions or are not applicable.
3. Exhibits
3.1 (1) Second Amended and Restated Certificate of Incorporation of
the Registrant
3.2 (2) Third Amended and Restated Bylaws of the Registrant
4 (1) Specimen Common Stock Certificate of the Registrant
10.1 (1) Recapitalization Agreement among Software AG, Software AG
Systems, Inc., Thayer Equity Investors III, L.P. and
certain Managers of Software AG Systems, Inc. (dated as of
March 18, 1997)
10.2 (1) Cooperation Agreement between Software AG and Software AG
Americas, Inc. (dated as of March 31, 1997)
10.2.1(5) Amended and Restated Cooperation Agreement among SAGA
SYSTEMS, Inc., SAGA
SOFTWARE, Inc. and Software AG (dated as of September 30,
1999)
10.3 (1) Memorandum of Understanding between Daniel F. Gillis and
Software AG Systems, Inc. (dated as of April 24, 1997) *
10.4 (1) Memorandum of Understanding between Harry K. McCreery and
Software AG Americas, Inc. (dated as of December 16, 1996) *
10.5 (3) Softwarre AG Systems, Inc. 1997 Stock Option Plan, as
amended *
10.6 (4) Software AG Systems, Inc. Employee Stock Purchase Plan, as
amended *
10.7(1) Management and Consulting Agreement between TC Management
LLC and Software AG Americas, Inc. (dated as of April 1,
1997)
10.8 (1) Deferred Compensation Agreement between Daniel F. Gillis and
Software AG Americas, Inc.
(dated as of July 1, 1995), as amended *
10.9 (1) Deferred Compensation Agreement between Harry K. McCreery
and Software AG Americas,
Inc. (dated as of January 1, 1991), as amended *
10.10 (1) Administrative Services Agreement between Software AG and
Software AG Americas, Inc. (dated as of March 31, 1997), as
amended
10.11 (1) Registration Rights Agreement between Software AG Systems,
Inc. and Thayer Equity Investors III, L.P. (dated as of
September 26, 1997)
10.12 (1) Subscription Agreement between Timothy L. Hill and Software
AG Systems, Inc., (dated as of August 22, 1997), as amended
10.13 (1) Shareholders Agreement among Software AG Systems, Inc.,
Thayer Equity Investors III, L.P.
and certain shareholders of Software AG Systems, Inc. (dated
as of April 1, 1997)
56
<PAGE>
3. Exhibits (continued)
10.14 (5) Revolving Credit Loan Agreement between SAGA SOFTWARE,
Inc. and The Chase Manhattan Bank (dated as of October 15,
1999)
21 (6) Subsidiaries of the Registrant
23 (6) Consent of KPMG LLP
24 (6) Powers of Attorney
27 (6) Financial Data Schedule
_________________
(1) Previously filed as an exhibit to the Company's Registration Statement
on Form S-1 (File No. 333-36567) and incorporated herein by reference.
(2) Previously filed as an exhibit to the Company's Registration Statement
on Form S-1 (File No. 333-50645) and incorporated herein by reference.
(3) Previously filed as an exhibit to the Company's Registration Statement
on Form S-8 (File No. 333-44687) and incorporated herein by reference.
(4) Previously filed as an exhibit to the Company's Registration Statement
on Form S-8 (File No. 333-49221) and incorporated herein by reference.
(5) Previously filed as an exhibit to the Company's Quarterly Report on Form
10-Q for the quarterly period ended September 30, 1999 and incorporated
herein by reference.
(6) Filed herewith.
* Indicates management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on October 1 and
October 8, 1999 to report, respectively, execution of the Amended and
Restated Cooperation Agreement among SAGA SYSTEMS, Inc., SAGA SOFTWARE,
Inc. and Software AG, and the resignation of Dr. Erwin Koenigs from the
Company's Board of Directors effective October 7, 1999.
57
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SAGA SYSTEMS, INC.
By: /s/ Daniel F. Gillis
-------------------------------
Daniel F. Gillis
Date: March 30, 2000 Director, President and Chief
Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
By: /s/ Daniel F. Gillis Director, President and Chief Executive Officer March 30, 2000
---------------------------
Daniel F. Gillis (Principal Executive Officer)
By: /s/ Dale E. Williams Vice President and Chief Financial Officer March 30, 2000
---------------------------
Dale E. Williams (Principal Financial and Accounting Officer)
By: * Chairman of the Board of Directors March 30, 2000
---------------------------
Carl J. Rickertsen
By: * Director March 30, 2000
---------------------------
Paul A. Brands
By: * Director March 30, 2000
---------------------------
John F. Burton
By: * Director March 30, 2000
---------------------------
Dr. Philip S. Dauber
By: * Director March 30, 2000
---------------------------
Edward E. Lucente
By: * Director March 30, 2000
---------------------------
Frederic V. Malek
By: * Director March 30, 2000
---------------------------
Dr. Paul G. Stern
*By: /s/ Dale E. Williams
----------------------
Dale E. Williams
Attorney-In-Fact
</TABLE>
58
<PAGE>
SCHEDULE II
Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Additions
Balance at Charged to Balance
Beginning Costs and Deductions/ at End
Description of Period Expenses Write-offs of Period
----------- --------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Predecessor:
1/1/97 - 3/31/97
Allowance for Doubtful Accounts $3,709,003 $ 204,406 $(138,274) $4,051,683
- ----------------------------------------------------------------------------------------------------------
Successor:
4/1/97 - 12/31/97
Allowance for Doubtful Accounts 4,051,683 1,202,325 1,564,412 3,689,596
1/1/98 - 12/31/98
Allowance for Doubtful Accounts 3,689,596 3,424,222 2,071,216 5,042,602
1/1/99 - 12/31/99
Allowance for Doubtful Accounts $5,042,602 $(1,713,916) $ 444,217 $2,884,469
</TABLE>
59
<PAGE>
Exhibit 21
Subsidiaries of the Registrant
The companies listed below are directly or indirectly owned 100% by
SAGA SYSTEMS, Inc. and are included in its consolidated financial statements.
SAGA SOFTWARE, Inc. (formerly Software AG Americas, Inc.) is a wholly owned
subsidiary of SAGA SYSTEMS, Inc. , Insight Consulting, Inc., Software AG
Professional Services, Inc., SAGA FSC, Inc. (formerly Software AG FSC, Inc.),
SAGA SOFTWARE Venezolana, C.A. (formerly Software AG Venezolana, C.A.), SAGA
SOFTWARE Services, Inc., SAGA SOFTWARE International, Inc., SAGA SOFTWARE
Technologies, Inc. and SAGA SOFTWARE Funding Corporation are wholly owned
subsidiaries of SAGA SOFTWARE, Inc. SAGA SOFTWARE, S.A. de C.V. (formerly
Software AG Americas, Latin America Operations, S.A. de C.V.) and SAGA SYSTEMS
(Canada) Holdings Ltd. (formerly SAG Systems (Canada) Holdings Ltd.) are jointly
owned by SAGA SYSTEMS, Inc. and SAGA SOFTWARE, Inc. SAGA SOFTWARE (CANADA) Inc.
(formerly Software AG Systems (Canada) Inc.) is a wholly owned subsidiary of
SAGA SYSTEMS (Canada) Holdings Ltd. SAGA SOFTWARE Atlantic, L.L.C. is a wholly
owned subsidiary of SAGA SOFTWARE Technologies, Inc.
Name Jurisdiction of Incorporation
SAGA SOFTWARE, Inc. Commonwealth of Virginia
Insight Consulting, Inc. Commonwealth of Virginia
Software AG Professional Services, Inc. Commonwealth of Virginia
SAGA SOFTWARE, S.A. de C.V. Mexico
SAGA SOFTWARE Venezolana, C.A. Venezuela
SAGA SYSTEMS (Canada) Holdings Ltd. Canada
SAGA SOFTWARE (CANADA) Inc. Canada
SAGA FSC, Inc. U. S. Virgin Islands
SAGA SOFTWARE Services, Inc. State of Delaware
SAGA SOFTWARE International, Inc. State of Delaware
SAGA SOFTWARE Technologies, Inc. State of Delaware
SAGA SOFTWARE Atlantic, L.L.C. State of Delaware
SAGA SOFTWARE Funding Corporation State of Delaware
<PAGE>
Exhibit 23
Accountant's Consent
The Board of Directors
SAGA SYSTEMS, Inc.
We consent to incorporation by reference in the registration statement of SAGA
SYSTEMS, Inc. on Form S-8 (Nos. 333-44687 and 333-49221) of our report dated
February 1, 2000, with respect to the consolidated balance sheets of SAGA
SYSTEMS, Inc. and subsidiaries (Successor) as of December 31, 1999 and 1998, and
the related consolidated statements of operations, stockholders' equity, cash
flows, and the related schedule for the years ended December 31, 1999 and 1998
and the period from April 1, 1997 to December 31, 1997 (Successor periods), and
the consolidated statements of operations, stockholders' equity and cash flows
of SAGA SYSTEMS, Inc. and subsidiaries (a wholly owned subsidiary of Software
AG, a German software company) (Predecessor) from January 1, 1997 to March 31,
1997, which report appears in the December 31, 1999, annual report on Form 10-K
of SAGA SYSTEMS, Inc.
KPMG LLP
Washington, D.C.
March 29, 2000
<PAGE>
Exhibit 24
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned director of
SAGA SYSTEMS, Inc., a corporation organized under the laws of the State of
Delaware, hereby constitutes and appoints Daniel F. Gillis, Dale E. Williams and
Katherine E. Butler, and each of them (with full power to each of them to act
alone), his true and lawful attorneys-in-fact and agents for him and on his
behalf and in his name, place and stead, in all cases with full power of
substitution and resubstitution, in any and all capacities, to sign, execute and
affix his seal to and file with the Securities and Exchange Commission (or any
other governmental or regulatory authority) an Annual Report on Form 10-K or any
other appropriate form and all amendments or supplements thereto with all
exhibits and any and all documents required to be filed with respect thereto,
and grants to each of them full power and authority to do and to perform each
and every act and thing requisite and necessary to be done for each in order to
effectuate the same as fully to all intents and purposes as he himself might or
could do if personally present, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned director has hereunto set his hand
and seal, as of the date specified.
/s/ Paul A. Brands
---------------------------
Signature
Paul A. Brands
---------------------------
Name
March 10, 2000
<PAGE>
Exhibit 24
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned director of
SAGA SYSTEMS, Inc., a corporation organized under the laws of the State of
Delaware, hereby constitutes and appoints Daniel F. Gillis, Dale E. Williams and
Katherine E. Butler, and each of them (with full power to each of them to act
alone), his true and lawful attorneys-in-fact and agents for him and on his
behalf and in his name, place and stead, in all cases with full power of
substitution and resubstitution, in any and all capacities, to sign, execute and
affix his seal to and file with the Securities and Exchange Commission (or any
other governmental or regulatory authority) an Annual Report on Form 10-K or any
other appropriate form and all amendments or supplements thereto with all
exhibits and any and all documents required to be filed with respect thereto,
and grants to each of them full power and authority to do and to perform each
and every act and thing requisite and necessary to be done for each in order to
effectuate the same as fully to all intents and purposes as he himself might or
could do if personally present, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned director has hereunto set his hand
and seal, as of the date specified.
/s/ John F. Burton
----------------------------
Signature
John F. Burton
-----------------------------
Name
March 13, 2000
<PAGE>
Exhibit 24
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned director of
SAGA SYSTEMS, Inc., a corporation organized under the laws of the State of
Delaware, hereby constitutes and appoints Daniel F. Gillis, Dale E. Williams and
Katherine E. Butler, and each of them (with full power to each of them to act
alone), his true and lawful attorneys-in-fact and agents for him and on his
behalf and in his name, place and stead, in all cases with full power of
substitution and resubstitution, in any and all capacities, to sign, execute and
affix his seal to and file with the Securities and Exchange Commission (or any
other governmental or regulatory authority) an Annual Report on Form 10-K or any
other appropriate form and all amendments or supplements thereto with all
exhibits and any and all documents required to be filed with respect thereto,
and grants to each of them full power and authority to do and to perform each
and every act and thing requisite and necessary to be done for each in order to
effectuate the same as fully to all intents and purposes as he himself might or
could do if personally present, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned director has hereunto set his hand
and seal, as of the date specified.
/s/ Dr. Philip S. Dauber
---------------------------------
Signature
Dr. Philip S. Dauber
---------------------------------
Name
March 2, 2000
<PAGE>
Exhibit 24
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned director of
SAGA SYSTEMS, Inc., a corporation organized under the laws of the State of
Delaware, hereby constitutes and appoints Daniel F. Gillis, Dale E. Williams and
Katherine E. Butler, and each of them (with full power to each of them to act
alone), his true and lawful attorneys-in-fact and agents for him and on his
behalf and in his name, place and stead, in all cases with full power of
substitution and resubstitution, in any and all capacities, to sign, execute and
affix his seal to and file with the Securities and Exchange Commission (or any
other governmental or regulatory authority) an Annual Report on Form 10-K or any
other appropriate form and all amendments or supplements thereto with all
exhibits and any and all documents required to be filed with respect thereto,
and grants to each of them full power and authority to do and to perform each
and every act and thing requisite and necessary to be done for each in order to
effectuate the same as fully to all intents and purposes as he himself might or
could do if personally present, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned director has hereunto set his hand
and seal, as of the date specified.
/s/ Edward E. Lucente
-----------------------------
Signature
Edward E. Lucente
------------------------------
Name
March 6, 2000
<PAGE>
Exhibit 24
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned director of
SAGA SYSTEMS, Inc., a corporation organized under the laws of the State of
Delaware, hereby constitutes and appoints Daniel F. Gillis, Dale E. Williams and
Katherine E. Butler, and each of them (with full power to each of them to act
alone), his true and lawful attorneys-in-fact and agents for him and on his
behalf and in his name, place and stead, in all cases with full power of
substitution and resubstitution, in any and all capacities, to sign, execute and
affix his seal to and file with the Securities and Exchange Commission (or any
other governmental or regulatory authority) an Annual Report on Form 10-K or any
other appropriate form and all amendments or supplements thereto with all
exhibits and any and all documents required to be filed with respect thereto,
and grants to each of them full power and authority to do and to perform each
and every act and thing requisite and necessary to be done for each in order to
effectuate the same as fully to all intents and purposes as he himself might or
could do if personally present, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned director has hereunto set his hand
and seal, as of the date specified.
/s/ Frederic V. Malek
------------------------------
Signature
Frederic V. Malek
------------------------------
Name
March 6, 2000
<PAGE>
Exhibit 24
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned director of
SAGA SYSTEMS, Inc., a corporation organized under the laws of the State of
Delaware, hereby constitutes and appoints Daniel F. Gillis, Dale E. Williams and
Katherine E. Butler, and each of them (with full power to each of them to act
alone), his true and lawful attorneys-in-fact and agents for him and on his
behalf and in his name, place and stead, in all cases with full power of
substitution and resubstitution, in any and all capacities, to sign, execute and
affix his seal to and file with the Securities and Exchange Commission (or any
other governmental or regulatory authority) an Annual Report on Form 10-K or any
other appropriate form and all amendments or supplements thereto with all
exhibits and any and all documents required to be filed with respect thereto,
and grants to each of them full power and authority to do and to perform each
and every act and thing requisite and necessary to be done for each in order to
effectuate the same as fully to all intents and purposes as he himself might or
could do if personally present, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned director has hereunto set his hand
and seal, as of the date specified.
/s/ Carl J. Rickertsen
--------------------------------
Signature
Carl J. Rickertsen
--------------------------------
Name
March 3, 2000
<PAGE>
Exhibit 24
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned director of
SAGA SYSTEMS, Inc., a corporation organized under the laws of the State of
Delaware, hereby constitutes and appoints Daniel F. Gillis, Dale E. Williams and
Katherine E. Butler, and each of them (with full power to each of them to act
alone), his true and lawful attorneys-in-fact and agents for him and on his
behalf and in his name, place and stead, in all cases with full power of
substitution and resubstitution, in any and all capacities, to sign, execute and
affix his seal to and file with the Securities and Exchange Commission (or any
other governmental or regulatory authority) an Annual Report on Form 10-K or any
other appropriate form and all amendments or supplements thereto with all
exhibits and any and all documents required to be filed with respect thereto,
and grants to each of them full power and authority to do and to perform each
and every act and thing requisite and necessary to be done for each in order to
effectuate the same as fully to all intents and purposes as he himself might or
could do if personally present, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, may lawfully do or cause to be
done by virtue hereof.
IN WITNESS WHEREOF, the undersigned director has hereunto set his hand
and seal, as of the date specified.
/s/ Dr. Paul G. Stern
-------------------------------
Signature
Dr. Paul G. Stern
-------------------------------
Name
March 3, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 33,701
<SECURITIES> 14,500
<RECEIVABLES> 92,436
<ALLOWANCES> 2,884
<INVENTORY> 0
<CURRENT-ASSETS> 144,053
<PP&E> 31,149
<DEPRECIATION> 22,726
<TOTAL-ASSETS> 230,744
<CURRENT-LIABILITIES> 77,499
<BONDS> 0
0
0
<COMMON> 309
<OTHER-SE> 119,146
<TOTAL-LIABILITY-AND-EQUITY> 230,744
<SALES> 213,283
<TOTAL-REVENUES> 213,283
<CGS> 93,908
<TOTAL-COSTS> 93,908
<OTHER-EXPENSES> 96,966
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 27,860
<INCOME-TAX> 10,785
<INCOME-CONTINUING> 17,075
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 17,075
<EPS-BASIC> 0.57
<EPS-DILUTED> 0.55
</TABLE>
