<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) November 30, 1994
-------------------------
Sterling Software, Inc.
---------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 1-8465 75-1873956
- ------------------------------ ----------- ------------------
(State or other jurisdiction (Commission (IRS Employer
of incorporation File Number) Identification No.)
8080 N. Central Expwy., Suite 1100, Dallas, Texas 75206
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (214) 891-8600
---------------------------
<PAGE>
Item 2. Acquisition or Disposition of Assets
General
On November 30, 1994, pursuant to an Amended and Restated Agreement and
Plan of Merger dated as of August 31, 1994 (as amended, the "Merger Agreement"),
among Sterling Software, Inc., a Delaware corporation ("Sterling"), SSI
Corporation, a Georgia corporation and a wholly owned subsidiary of Sterling
("Merger Sub"), and KnowledgeWare, Inc., a Georgia corporation
("KnowledgeWare"), Merger Sub was merged with and into KnowledgeWare and
KnowledgeWare became a wholly owned subsidiary of Sterling (the "Merger").
Pursuant to the terms of the Merger Agreement, each outstanding share of the
common stock, without par value, of KnowledgeWare (the "KnowledgeWare Common
Stock") (other than (a) shares owned by Sterling, Merger Sub or any other
subsidiary of Sterling and (b) shares held in KnowledgeWare's treasury
immediately prior to the effective time of the Merger) was converted into the
right to receive up to .1653 of a share of common stock, par value $.10 per
share ("Sterling Common Stock"), of Sterling (the "Exchange Ratio"). Promptly
after the Merger, KnowledgeWare common stockholders became entitled to receive
.1322 of a share of Sterling Common Stock for each share of KnowledgeWare Common
Stock, or approximately 2,421,000 shares; the remaining 20% of the number of
shares of Sterling Common Stock issuable upon effectiveness of the Merger
(approximately 484,800 shares) were placed in escrow pursuant to the terms of an
escrow agreement and will be distributed to KnowledgeWare common stockholders
only if and to the extent that such shares are not necessary to cover certain
losses, claims, liabilities, judgments, costs and expenses that may be incurred
by Sterling, Merger Sub or KnowledgeWare in connection with any pending or
threatened litigation, action, claim, proceeding, dispute or investigation
(including amounts paid in settlement) to which Sterling, Merger Sub or
KnowledgeWare is or may become a party and with respect to which Sterling is
entitled to indemnification pursuant to the terms of the Merger Agreement. In
addition, pursuant to the terms of the Merger Agreement, options outstanding
under the stock option plans of KnowledgeWare and KnowledgeWare's outstanding
warrants to purchase an aggregate of 500,000 shares of KnowledgeWare Common
Stock at a price of $17.50 per share (the "Warrants") were assumed by Sterling;
provided that (a) each such option or Warrant became exercisable for that whole
number of shares of Sterling Common Stock (to the nearer whole share) equal to
the product of the number of shares of KnowledgeWare Common Stock issuable upon
exercise of such option or Warrant immediately prior to the effective time of
the Merger times the Exchange Ratio and (b) the exercise price of such option or
Warrant became equal to the quotient given by dividing the exercise price of
such option or Warrant in effect immediately prior to the effective time of the
Merger by the Exchange Ratio. The terms of the Merger Agreement, including the
Exchange Ratio, and the related agreements were the result of arm's-length
negotiations between the managements of Sterling and KnowledgeWare.
Management's Discussion and Analysis of the Effects of the Merger on the Future
Financial Condition and Results of Operations of Sterling
Sterling believes that the Merger creates one of the leading software and
services companies in the world, which will provide its customers with a broad
range of products and excellent customer support and assist their movement
toward enterprise-wide computing. Specifically,
2
<PAGE>
Sterling believes that the combined company has a greatly expanded
presence in the visual application software and services market, including
integrated computer-aided software engineering and application development tools
and products for client/server, midrange and mainframe computing environments.
Additionally, Sterling continues to be a leading provider of electronic
commerce software and services in North America, provides a broad offering of
enterprise-wide systems management software tools and has a strong presence
in the complex federal systems market. The combined company is expected to be a
leading vendor of application development tools, and has a substantial
worldwide customer base, a broad global distribution network, a workforce of
approximately 3,500 skilled employees and a high level of recurring
revenue, all of which Sterling believes position the combined company for
significant future growth.
Substantial costs will occur as a result of the combination of the two
companies, including costs with respect to the elimination of duplicate
facilities, severance costs related to the termination of certain employees,
transaction costs, and write-off of costs related to certain software products
which will not be actively marketed by the combined company. Such costs directly
related to the acquisition of KnowledgeWare are expected to be approximately $25
to $30 million and are included in the aggregate cost of the Merger. Such costs
related to Sterling are expected to be approximately $12 to $18 million and will
be charged to the future results of operations of the combined company in the
first quarter of 1995 and are excluded from the pro forma combined results of
operations. The pro forma combined results of operations also exclude
approximately $55 million of purchased research and development costs which will
be charged to expense in the first quarter of 1995.
Because the enterprise software industry is highly competitive and because
of the inherent uncertainties associated with merging two large companies, there
can be no assurance that the combined entity will be able to realize the
economies of scale and operating efficiencies that Sterling currently expects to
realize as a result of the consolidation of its operations with KnowledgeWare.
Furthermore, any difficulties encountered in the transition process could have
an adverse impact on the revenues and operating results of the combined company.
Item 7. Financial Statements and Exhibits.
a. Financial Statements of KnowledgeWare.
The following audited consolidated financial statements, and the notes
thereto, of KnowledgeWare have been previously filed by Sterling at pages A-1 to
A-19 of Sterling's Current Report on Form 8-K dated November 3, 1994 and filed
November 3, 1994 and are incorporated herein by reference: (i) Consolidated
Balance Sheets as of June 30, 1994 and 1993; (ii) Consolidated Statements of
Operations for the years ended June 30, 1994, 1993 and 1992; (iii) Consolidated
Statements of Shareholders' Equity for the years ended June 30, 1994, 1993 and
1992; (iv) Consolidated Statements of Cash Flows for the years ended June 30,
1994, 1993 and 1992; and (v) the related notes thereto.
The following condensed consolidated financial statements of KnowledgeWare
have been previously filed by Sterling at pages A-1 to A-8 of Sterling's Current
Report on Form 8-K dated November 14, 1994 and filed November 14, 1994 and are
incorporated herein by reference:
3
<PAGE>
(i) the unaudited Condensed Consolidated Statements of Operations for the three
months ended September 30, 1994 and 1993; (ii) the unaudited Condensed
Consolidated Balance Sheet as of September 30, 1994 and the audited Condensed
Consolidated Balance Sheet as of June 30, 1994; (iii) the unaudited Condensed
Consolidated Statements of Cash Flows for the three months ended September 30,
1994 and 1993; and (iv) the related notes thereto.
b. Pro Forma Financial Information.
Included on pages A-1 to A-5 of this Current Report on Form 8-K are the
following unaudited pro forma combined condensed financial statements assuming a
business combination between Sterling and KnowledgeWare accounted for as a
purchase of KnowledgeWare by Sterling: (i) the unaudited Pro Forma Combined
Condensed Balance Sheet of Sterling and KnowledgeWare as of September 30, 1994;
(ii) the unaudited Pro Forma Combined Condensed Statements of Operations of
Sterling and KnowledgeWare for the year ended September 30, 1994; and (iii) the
related notes thereto. The pro forma combined condensed balance sheet assumes
the Merger had been consummated on September 30, 1994. The pro forma combined
condensed statement of operations assumes the Merger had been consummated as of
October 1, 1993.
c. Exhibits.
The following is a list of exhibits filed as part of this Current Report on
Form 8-K.
Exhibit
Number Description of Exhibit
------ ----------------------
2.1 Amended and Restated Agreement and Plan of Merger dated as of August
31, 1994 among the Registrant, KnowledgeWare, Inc. and SSI Corporation
(1)
2.2 Agreement dated October 11, 1994 among the Registrant, KnowledgeWare,
Inc. and SSI Corporation (1)
2.3 First Amendment to Amended and Restated Agreement and Plan of Merger
dated as of October 24, 1994 among the Registrant, KnowledgeWare, Inc.
and SSI Corporation (1)
4.1 Certificate of Incorporation of the Registrant (2)
4.2 Certificate of Amendment of Certificate of Incorporation of the
Registrant (3)
4.3 Certificate of Amendment of Certificate of Incorporation of the
Registrant (4)
4.4 Restated Bylaws of the Registrant (5)
4.5 Form of Common Stock Certificate (6)
4
<PAGE>
23 Consent of Coopers & Lybrand L.L.P. (7)
99.1 Audited Consolidated Financial Statements of KnowledgeWare, Inc. (7)
99.2 Condensed Consolidated Financial Statements of KnowledgeWare, Inc. (7)
- ------------------------------------------
(1) Previously filed as an exhibit to the Registrant's Registration Statement
No. 33-56185 on Form S-4 and incorporated herein by reference.
(2) Previously filed as an exhibit to the Registrant's Registration Statement
No. 2-82506 on Form S-1 and incorporated herein by reference.
(3) Previously filed as an exhibit to the Registrant's Annual Report on Form
10-K for the fiscal year ended September 30, 1993 and incorporated herein
by reference.
(4) Previously filed as an exhibit to the Registrant's Registration Statement
No. 33-69926 on Form S-8 and incorporated herein by reference.
(5) Previously filed as an exhibit to the Registrant's Registration Statement
No. 33-47131 on Form S-8 and incorporated herein by reference.
(6) Previously filed as an exhibit to the Registrant's Registration Statement
No. 2-86825 on Form S-1 and incorporated herein by reference.
(7) Filed herewith.
5
<PAGE>
PRO FORMA COMBINED CONDENSED FINANCIAL INFORMATION
The accompanying unaudited pro forma combined condensed financial
statements assume the Merger is accounted for as a purchase of KnowledgeWare by
Sterling. The pro forma combined condensed financial statements are based on the
historical financial statements of Sterling and KnowledgeWare. The pro forma
combined condensed balance sheet assumes the Merger had been consummated on
September 30, 1994. The pro forma combined condensed statement of operations
assumes the Merger had been consummated as of October 1, 1993.
The pro forma information is presented for illustrative purposes only and
is not necessarily indicative of the operating results or financial position
that would have occurred if the Merger had been consummated as presented in the
accompanying unaudited pro forma combined condensed financial statements, nor is
it necessarily indicative of the future results of operations. The pro forma
adjustments and the assumptions on which they are based are described in the
accompanying Notes to Unaudited Pro Forma Combined Condensed Financial
Statements.
These pro forma combined condensed financial statements should be read in
conjunction with the historical consolidated financial statements and the
related notes thereto of Sterling and KnowledgeWare.
A-1
<PAGE>
STERLING SOFTWARE, INC.
PRO FORMA COMBINED CONDENSED BALANCE SHEET
SEPTEMBER 30, 1994
(IN THOUSANDS)
<TABLE>
<CAPTION>
PURCHASE
ACCOUNTING
STERLING KNOWLEDGEWARE ADJUSTMENTS PRO FORMA
HISTORICAL HISTORICAL (NOTE 2) COMBINED
---------- ------------- ----------- ---------
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents... $101,893 $ 5,846 ($700)(e) $107,039
Marketable securities....... 41,847 0 41,847
Accounts and notes
receivable, net............ 132,166 24,536 156,702
Deferred income tax asset... 11,294 3,356 6,000 (f) 20,650
Prepaid expenses and other
current assets............. 9,978 3,685 13,663
-------- -------- -------- --------
Total current assets...... 297,178 37,423 5,300 339,901
Property and equipment, net... 33,526 20,419 (5,000)(c) 48,945
Computer software, net........ 61,304 28,039 (3,039)(c) 80,304
(6,000)(f)
Excess cost over net assets
acquired, net................ 54,504 14,266 16,452 (c) 85,222
Noncurrent deferred income
taxes........................ 2,216 2,216
Other assets.................. 21,779 1,663 23,442
Investment in and advances to
KWI.......................... 18,266 0 99,443 (a) 0
(63,413)(c)
(18,266)(d)
(36,030)(b)
-------- -------- -------- --------
Total assets.................. $488,773 $101,810 $(10,553) $580,030
======== ======== ======== ========
Current liabilities:
Notes payable and current
portion of long-term debt.. $7,257 $19,111 $(18,266)(d) $ 8,102
Accounts payable and accrued
liabilities................ 87,164 23,554 25,000 (a) 144,718
9,000 (f)
Deferred revenue............ 77,598 18,740 96,338
-------- -------- -------- --------
Total current liabilities. 172,019 61,405 15,734 249,158
Long-term debt................ 115,932 854 116,786
Other noncurrent liabilities.. 25,018 3,521 28,539
Stockholders' equity:
Preferred stock............. 20 0 20
Common stock................ 2,238 72,579 242 (a) 2,480
(72,579)(b)
Additional paid-in capital.. 192,064 0 56,096 (a) 247,460
(700)(e)
Retained earnings (deficit). 572 (36,549) (55,000)(c) (63,428)
(9,000)(f)
36,549 (b)
Less: Treasury stock........ (19,090) 0 18,105 (a) (985)
-------- -------- -------- --------
Total stockholders'
equity................... 175,804 36,030 (26,287) 185,547
-------- -------- -------- --------
Total liabilities and
stockholders' equity......... $488,773 $101,810 $(10,553) $580,030
======== ======== ======== ========
Shares of common stock
outstanding.................. 20,585 2,421 23,006
======== ======== ========
</TABLE>
See accompanying notes.
A-2
<PAGE>
STERLING SOFTWARE, INC.
PRO FORMA COMBINED CONDENSED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED SEPTEMBER 30, 1994
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
KNOWLEDGEWARE
STERLING ---------------------------------------------------------------------- PURCHASE
HISTORICAL HISTORICAL DEDUCT HISTORICAL ADD HISTORICAL PRO FORMA ACCOUNTING
YEAR ENDED YEAR ENDED THREE MONTHS ENDED THREE MONTHS ENDED YEAR ENDED ADJUSTMENTS PRO FORMA
SEPTEMBER 30,1994 JUNE 30, 1994 SEPTEMBER 30, 1993 SEPTEMBER 30, 1994 SEPTEMBER 30, 1994 (NOTE 3) COMBINED
----------------- ------------- ------------------ ------------------ ------------------ ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Products.......... $178,233 $ 71,294 $19,147 $ 7,298 $ 59,445 $237,678
Product support... 133,752 39,698 9,472 9,240 39,466 173,218
Services.......... 161,408 21,499 4,605 5,253 22,147 183,555
-------- -------- ------- ------- -------- --------
473,393 132,491 33,224 21,791 121,058 594,451
Costs and expenses:
Cost of sales:
Products and
product support.. 64,123 22,259 4,767 4,269 21,761 $(2,303) (a) 84,007
426 (b)
Services.......... 107,622 18,389 3,683 4,826 19,532 95 (b) 127,249
Selling, general
and
administrative... 173,112 86,743 16,899 17,778 87,622 260,734
Product
development and
enhancement...... 33,002 24,196 6,155 4,678 22,719 55,721
Restructuring
charges.. 6,205 6,205 6,205
-------- -------- ------- -------- ------ ------- --------
Total costs and
expenses....... 377,859 151,587 31,504 37,756 157,839 (1,782) 533,916
-------- -------- ------- ------- -------- ------- --------
Income (loss)
before other
income (expense)
and income taxes.. 95,534 (19,096) 1,720 (15,965) (36,781) 1,782 60,535
Other income
(expense)......... (2,933) 66 (185) 140 391 595 (c) (1,947)
-------- -------- ------- ------- -------- ------- --------
Income (loss)
before
income taxes...... 92,601 (19,030) 1,535 (15,825) (36,390) 2,377 58,588
Provision (benefit)
for income taxes.. 34,262 0 153 0 (153) 843 34,952
-------- -------- ------- ------- -------- ------- --------
Net income (loss).. $ 58,339 $(19,030) $ 1,382 (15,825) $(36,237) $ 1,534 $ 23,636
======== ======== ======= ======= ======== ======= ========
Net income per
common share
(Note 4):
Primary........... $ 2.54 $ 0.94
======== ========
Fully diluted..... $ 2.31 $ 0.94
======== ========
Shares used to
compute per share
data (Note 4):
Primary........... 22,923 2,292 25,215
======== ======= ========
Fully diluted..... 26,979 (1,764) 25,215
======== ======= ========
</TABLE>
See accompanying notes.
A-3
<PAGE>
STERLING SOFTWARE
NOTES TO PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS
1.GENERAL
The Merger will be accounted for as a purchase. The pro forma combined
condensed financial statements reflect the issuance of 2,420,926 shares of
Sterling Common Stock for an aggregate 14,645,649 shares of KnowledgeWare
Common Stock (KnowledgeWare Common Stock outstanding as of November 30, 1994)
based on an Exchange Ratio of .1653 shares of Sterling Common Stock for each
share of KnowledgeWare Common Stock. Total shares reflected as issued and
outstanding include the Escrowed Shares. The actual number of shares of
Sterling Common Stock issued of 2,420,926 shares was determined at the
Effective Time of the Merger based on the Exchange Ratio and the number of
shares of KnowledgeWare Common Stock then outstanding. The purchase price of
the Merger reflected in the accompanying pro forma financial statements is
$99.4 million which represents the value of the Sterling Common Stock issued
(based on a price of $30.75 per share), plus costs related to the combination
described below.
Substantial costs are expected to occur as a result of the combination of
the two companies. The costs directly related to the acquisition of
KnowledgeWare are included in the aggregate cost of the Merger and are
expected to consist of the following (in thousands):
<TABLE>
<S> <C>
Investment advisor, legal, accounting and other professional
fees............................................................ $ 2,800
Out of pocket costs related to due diligence and acquisition
evaluation...................................................... 2,000
KnowledgeWare employee severance and benefits.................... 8,100
Elimination of duplicate facilities and leases of KnowledgeWare.. 8,000
Other merger related liabilities................................. 4,100
-------
$25,000
=======
</TABLE>
Sterling's costs expected to occur as a result of the combination of the two
companies, including the write-off of costs related to certain software
products which will not be actively marketed by the combined company, are
expected to be approximately $12 to $18 million and will be charged to the
future results of operations of the combined company in the first quarter of
1995.
The purchase price has been allocated to the consolidated assets and
liabilities of KnowledgeWare for purposes of the Pro Forma Combined Balance
Sheet based on preliminary estimates of fair values. These estimates were
determined by Sterling management based primarily on information furnished
by management of KnowledgeWare and a preliminary valuation of acquired
software and research and development prepared by Burton Grad Associates,
Inc. The final allocation of the purchase price will be based on a complete
evaluation of the assets and liabilities of KnowledgeWare. Accordingly, the
information presented herein may differ from the actual purchase price
allocation.
Since August 30, 1994, a number of lawsuits have been filed against
KnowledgeWare and certain of its former officers and directors alleging
violations of securities laws. Sterling cannot presently estimate the amount
of losses that will result in connection with such actions because such
actions have only recently been filed and discovery has just commenced in some
matters and has not commenced in others. If these actions result in losses,
claims, liabilities, judgments, costs or expenses (including amounts paid in
settlement) to KnowledgeWare or Sterling, such losses, claims, liabilities,
judgments, costs or expenses will result in a claim for indemnification to be
satisfied from the Escrowed Shares. In the event that all of the Escrowed
Shares are used to cover losses, claims, liabilities, judgments, costs or
expenses incurred by KnowledgeWare or Sterling, no Escrowed Shares will be
distributed to the former KnowledgeWare common stockholders. If the ultimate
loss from such actions exceeds the proceeds from applicable insurance and the
value of the Escrowed Shares, such excess will be included in Sterling's cost
of acquiring KnowledgeWare to the extent such excess can be reasonably
estimated within one year of the date of acquisition.
2.PRO FORMA COMBINED CONDENSED BALANCE SHEET
The accompanying pro forma combined condensed balance sheet assumes the
Merger was consummated on September 30, 1994 and reflects the following pro
forma adjustments:
(a) To record the aggregate cost of the Merger, reflecting the value of
Sterling Common Stock issued and costs related to the combination
described in Note 1 above.
(b) To eliminate KnowledgeWare's historical stockholders' equity balances.
A-4
<PAGE>
(c) To record the aggregate cost of the Merger of $99.4 million as follows (in
thousands):
<TABLE>
<S> <C>
Working capital (deficit). $(23,982)
Property and equipment.... 15,419
Software.................. 25,000
Purchased research and
development costs charged
to expense............... 55,000
Other assets.............. 1,663
Other liabilities......... (4,375)
Excess cost over net
assets acquired.......... 30,718
--------
$ 99,443
========
</TABLE>
(d) To eliminate the repayment of all amounts outstanding under
KnowledgeWare's line of credit agreement with Sterling.
(e) To record direct costs associated with registering the shares of
Sterling Common Stock.
(f) To record costs associated with Sterling's elimination of duplicate
facilities, severance costs relating to termination of certain
employees and the write-off of costs relating to certain software
products which will not be actively marketed by the combined company,
net of related deferred income tax benefit.
3.PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
The pro forma combined condensed statement of operations has been prepared
as if the Merger was consummated as of October 1, 1993 and reflects the
following pro forma adjustments:
(a) To record amortization of purchased software computed using the
straight-line method over the remaining estimated economic life (five
years).
(b) To record the amortization of excess cost of net assets acquired over
fifteen years.
(c) To record the reduction of interest expense to reflect repayment of the
Sterling line of credit, partially offset by the reduction of
investment income to reflect the reduction of cash investments.
4.PRO FORMA COMBINED EARNINGS PER COMMON SHARE
The pro forma combined primary earnings per common share data is computed by
dividing combined pro forma net income per share, adjusted for preferred stock
dividend requirements, by the weighted average number of common shares and
common share equivalents represented by stock options and warrants, if such
stock options and warrants have a dilutive effect in the aggregate. For
purposes of this computation, income applicable to common stockholders is
adjusted to reflect use of net cash proceeds on the assumed exercise of stock
options and warrants to purchase outstanding long-term debt or government
securities, if such stock options and warrants have a dilutive effect.
Additionally, pro forma combined net income applicable to common stockholders
has been reduced to reflect combined pro forma preferred dividends of $.2
million for the year ended September 30, 1994.
The pro forma combined fully diluted earnings per common share computations
assume, in addition, the conversion of Sterling's 5 3/4% Convertible
Subordinated Debentures due 2003 (the "5 3/4% Debentures") if such conversion
has a dilutive effect. Upon assumed conversion of the 5 3/4% Debentures,
income applicable to common stockholders is adjusted to reflect the
elimination of after tax interest expense related to such debentures. For
purposes of this computation, pro forma combined net income applicable to
common stockholders is also adjusted to reflect use of net cash proceeds on
the assumed exercise of stock options and warrants to purchase outstanding
long-term debt or government securities, if such stock options and warrants
have a dilutive effect.
A-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
STERLING SOFTWARE, INC.
Date: December 15, 1994
By: /s/ George H. Ellis
---------------------------------------
Its: Executive Vice President and
Chief Financial Officer
---------------------------------------
6
<PAGE>
INDEX TO EXHIBITS
Exhibit
Number Description of Exhibit
------ ----------------------
2.1 Amended and Restated Agreement and Plan of Merger dated as of August
31, 1994 among the Registrant, KnowledgeWare, Inc. and SSI Corporation
(1)
2.2 Agreement dated October 11, 1994 among the Registrant, KnowledgeWare,
Inc. and SSI Corporation (1)
2.3 First Amendment to Amended and Restated Agreement and Plan of Merger
dated as of October 24, 1994 among the Registrant, KnowledgeWare, Inc.
and SSI Corporation (1)
4.1 Certificate of Incorporation of the Registrant (2)
4.2 Certificate of Amendment of Certificate of Incorporation of the
Registrant (3)
4.3 Certificate of Amendment of Certificate of Incorporation of the
Registrant (4)
4.4 Restated Bylaws of the Registrant (5)
4.5 Form of Common Stock Certificate (6)
23 Consent of Coopers & Lybrand L.L.P. (7)
99.1 Audited Consolidated Financial Statements of KnowledgeWare, Inc. (7)
99.2 Condensed Consolidated Financial Statements of KnowledgeWare, Inc. (7)
- ------------------------------------------
(1) Previously filed as an exhibit to the Registrant's Registration Statement
No. 33-56185 on Form S-4 and incorporated herein by reference.
(2) Previously filed as an exhibit to the Registrant's Registration Statement
No. 2-82506 on Form S-1 and incorporated herein by reference.
(3) Previously filed as an exhibit to the Registrant's Annual Report on Form
10-K for the fiscal year ended September 30, 1993 and incorporated herein
by reference.
(4) Previously filed as an exhibit to the Registrant's Registration Statement
No. 33-69926 on Form S-8 and incorporated herein by reference.
(5) Previously filed as an exhibit to the Registrant's Registration Statement
No. 33-47131 on Form S-8 and incorporated herein by reference.
(6) Previously filed as an exhibit to the Registrant's Registration Statement
No. 2-86825 on Form S-1 and incorporated herein by reference.
(7) Filed herewith.
<PAGE>
Exhibit 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
of Sterling Software, Inc. on Form S-3 (No. 33-2644, No. 33-13490, No. 33-32699,
No. 33-35433, No. 33-48553, No. 33-55954, No. 33-57428, No. 33-71706, No. 33-
53831, No. 33-53837, No. 33-54961, No. 33-56685, No. 33-56683, No. 33-56677 and
No. 33-56679), and on Form S-8 (No. 33-65402, No. 33-69926, No. 33-47131,
No. 33-13532, No. 33-8828, No. 2-95216, No. 2-95215, No. 33-53833 and No. 33-
56681), and in the related Prospectuses, of our report, which included an
explanatory paragraph about KnowledgeWare, Inc.'s ability to continue as a going
concern, dated August 31, 1994, on our audits of the consolidated financial
statements of KnowledgeWare, Inc. and Subsidiaries as of June 30, 1994 and 1993,
and for each of the three years in the period ended June 30, 1994, included in
this Current Report on Form 8-K.
Atlanta, Georgia /s/ Coopers & Lybrand L.L.P.
December 15, 1994
<PAGE>
Exhibit 99.1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of
KnowledgeWare, Inc. and Subsidiaries
We have audited the consolidated balance sheets of KnowledgeWare, Inc. and
Subsidiaries as of June 30, 1994 and 1993, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
three years in the period ended June 30, 1994. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements 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.
On July 1, 1994 the Company announced that it anticipated it would have a
significant loss from operations during the quarter ended June 30, 1994 and
that it would restructure operations in the first quarter of fiscal 1995 as
described in Note 15 to the financial statements. The Company also modified its
accounting policy for revenue recognition and restated financial results for
the first three quarters of fiscal year 1994 as described in Note 12 to the
financial statements.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of KnowledgeWare,
Inc. and Subsidiaries as of June 30, 1994 and 1993, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended June 30, 1994, in conformity with generally accepted
accounting principles.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in
Note 16 to the financial statements, the Company has suffered recurring losses
from operations and violated financial covenants in the line of credit
agreement with IBM Credit Corporation, that raise substantial doubt about its
ability to continue as a going concern. Management's plans to enter into a
merger agreement with Sterling Software were announced on August 1, 1994, and
an Amended and Restated Merger Agreement was executed as of August 31, 1994,
and are also described in Note 16. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
Coopers & Lybrand, L.L.P.
Atlanta, Georgia
August 31, 1994
1
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 1994 AND 1993
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
1994 1993
-------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $ 8,519 $ 16,816
Trade accounts receivable:
Receivable from related parties........................ 250 -0-
Trade, less allowance of $3,368 and $2,428 in 1994 and
1993, respectively.................................... 37,282 36,894
Escrow, prepaid expenses and other....................... 3,577 7,229
Prepaid income taxes and income taxes receivable......... 199 2,479
Deferred income tax benefits............................. 3,356 3,374
-------- --------
Total current assets................................. 53,183 66,792
-------- --------
Property and equipment:
Leasehold improvements................................... 5,567 4,621
Furniture and fixtures................................... 17,539 16,976
Computers and related equipment and software............. 29,802 25,062
-------- --------
52,908 46,659
Less: accumulated depreciation and amortization.......... 31,083 22,896
-------- --------
21,825 23,763
-------- --------
Other assets:
Acquired and developed software, less accumulated
amortization of $11,294 and $6,491 in 1994 and 1993,
respectively............................................ 28,382 22,458
Goodwill, less accumulated amortization of $1,812 and
$383 in 1994 and 1993, respectively..................... 14,616 11,369
Other long-term assets................................... 1,638 1,299
-------- --------
44,636 35,126
-------- --------
$119,644 $125,681
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Note payable to related party............................ $ 15,766 $ 2,000
Trade accounts payable................................... 7,670 8,863
Deferred revenues........................................ 22,734 26,932
Accrued expenses and other current liabilities........... 8,732 15,253
Accrued compensation and payroll taxes................... 6,407 6,753
Current portion of long-term debt........................ 1,627 5,902
-------- --------
Total current liabilities............................ 62,936 65,703
Commitments and contingencies (Note 5)
Long-term debt............................................. 836 3,624
Deferred income taxes...................................... 3,521 2,622
Shareholders' equity:
Common Stock, without par value--100,000,000 shares
authorized; 14,562,381 and 13,046,906 shares issued and
outstanding in 1994 and 1993, respectively.............. 72,548 54,124
Accumulated deficit...................................... (19,639) (609)
Cumulative translation adjustments....................... (558) 217
-------- --------
Total shareholders' equity........................... 52,351 53,732
-------- --------
$119,644 $125,681
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30, 1994, 1993 AND 1992
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1994 1993 1992
--------- -------- -------
<S> <C> <C> <C>
Revenues:
Software product license, including revenue
from related parties.......................... $ 71,294 $ 80,307 $83,243
Service agreement, including revenue from
related parties............................... 39,698 35,256 26,247
Consulting and education....................... 19,550 11,861 5,926
Other.......................................... 1,949 1,337 1,126
--------- -------- -------
132,491 128,761 116,542
--------- -------- -------
Costs and expenses:
Cost of software product license revenues...... 9,516 4,875 5,072
Cost of service agreement revenues............. 12,743 12,176 6,261
Cost of consulting and education revenues...... 18,389 7,487 4,265
Selling and marketing.......................... 67,162 66,570 62,373
General and administrative..................... 19,581 14,349 15,845
Research and development....................... 24,196 28,867 23,672
Corporate restructuring charge................. -0- 21,976 -0-
--------- -------- -------
151,587 156,300 117,488
--------- -------- -------
Loss from operations......................... (19,096) (27,539) (946)
Foreign currency transaction gain................ 850 -0- -0-
Interest income (expense), net................... (784) 340 1,959
--------- -------- -------
Income (loss) before income taxes............ (19,030) (27,199) 1,013
--------- -------- -------
Provision (benefit) for income taxes:
Current........................................ -0- (1,277) (1,468)
Deferred....................................... -0- (123) 2,125
--------- -------- -------
-0- (1,400) 657
--------- -------- -------
Net income (loss)............................ $ (19,030) $(25,799) $ 356
========= ======== =======
Net income (loss) per common share............... $ (1.34) $ (1.94) $ .03
========= ======== =======
Weighted average number of common and common
equivalent shares outstanding................... 14,178 13,283 13,110
========= ======== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED JUNE 30, 1994, 1993 AND 1992
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK RETAINED CUMULATIVE
-------------- EARNINGS TRANSLATION
SHARES AMOUNT (DEFICIT) ADJUSTMENTS TOTAL
------ ------- --------- ----------- --------
<S> <C> <C> <C> <C> <C>
Balance at July 1, 1991......... 12,558 $50,065 $ 24,834 $ -0- $ 74,899
Issuance of common stock
pursuant to stock option and
employee stock purchase
plans........................ 157 361 361
Tax benefits arising from
exercise of stock options.... 2,010 2,010
Net income for the year ended
June 30, 1992................ 356 356
------ ------- -------- ----- --------
Balance at June 30, 1992........ 12,715 52,436 25,190 -0- 77,626
Issuance of common stock
pursuant to stock option and
employee stock purchase
plans........................ 332 1,688 1,688
Net loss for the year ended
June 30, 1993................ (25,799) (25,799)
Cumulative translation
adjustments.................. 217 217
------ ------- -------- ----- --------
Balance at June 30, 1993........ 13,047 54,124 (609) 217 53,732
Issuance of common stock
pursuant to stock option and
employee stock purchase
plans........................ 309 1,557 1,557
Issuance of common stock in a
private placement............ 1,000 14,667 14,667
Issuance of common stock for
business acquisition......... 206 2,200 2,200
Net loss for the year ended
June 30, 1994................ (19,030) (19,030)
Cumulative translation
adjustments.................. (775) (775)
------ ------- -------- ----- --------
14,562 $72,548 $(19,639) $(558) $ 52,351
====== ======= ======== ===== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30, 1994, 1993 AND 1992
<TABLE>
<CAPTION>
1994 1993 1992
-------- -------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Operating activities:
Net income (loss)................................ $(19,030) $(25,799) $ 356
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization................... 14,410 11,693 9,512
Capitalization of software development costs.... (7,480) (5,161) (4,400)
Provision for uncollectible accounts receivable. 3,301 2,414 1,000
Foreign currency gain........................... (850) -0- -0-
Write-down of capitalized software development
costs.......................................... -0- 2,948 -0-
Termination of certain European distribution
rights......................................... -0- 7,000 -0-
Deferred income taxes........................... 917 (160) 2,125
Changes in operating assets and liabilities, net
of effect of acquisitions:
Trade accounts receivable...................... (4,271) (6,942) 16,300
Inventories and escrow, prepaid expenses and
other......................................... 3,090 773 (226)
Trade accounts payable, accrued expenses and
other current liabilities and accrued
compensation and payroll taxes................ (9,079) 2,199 (4,399)
Deferred revenues.............................. (6,518) (1,682) 3,095
Commissions payable to related parties......... -0- (878) (352)
Income taxes................................... 2,280 1,424 (7,014)
-------- -------- -------
Net cash provided by (used in) operating
activities................................... (23,230) (12,171) 15,997
-------- -------- -------
Investing activities:
Acquisitions, net of cash acquired............... (25) (10,985) (11,487)
Purchases of property and equipment.............. (6,407) (4,429) (8,603)
Disposals of property and equipment, net......... 590 702 -0-
Other non-current assets......................... (170) (658) 652
-------- -------- -------
Net cash used in investing activities......... (6,012) (15,370) (19,438)
-------- -------- -------
Financing activities:
Proceeds from note payable to related party...... 19,766 2,000 -0-
Payments on note payable to related party........ (6,000) -0- -0-
Payments on debt................................. (9,102) -0- -0-
Proceeds from sale of Common Stock and exercise
of stock options................................ 16,224 1,688 361
Tax benefits arising from exercise of stock
options......................................... -0- -0- 2,010
-------- -------- -------
Net cash provided by financing activities..... 20,888 3,688 2,371
-------- -------- -------
Effect of exchange rate changes on cash and cash
equivalents...................................... 57 217 -0-
-------- -------- -------
Decrease in cash and cash equivalents............. (8,297) (23,636) (1,070)
Cash and cash equivalents at beginning of year.... 16,816 40,452 41,522
-------- -------- -------
Cash and cash equivalents at year-end......... $ 8,519 $ 16,816 $40,452
======== ======== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its subsidiaries, all of which are wholly owned. Significant intercompany
accounts and transactions have been eliminated in consolidation.
Revenue Recognition
Revenues are derived from the licensing and development of computer software
products, sale of software service agreements, licensing of technology and on-
going consulting and education activities. Revenues from sales of software
product licenses to end users are recognized at the time of software delivery
if collection is probable and there are no significant vendor obligations. The
Company recognizes software product license revenue from resellers upon cash
collection unless shipment has been made to the end user and there is a
reasonable basis for estimating the degree of collectibility of the receivable.
Revenues from sales of service agreements are deferred and recognized ratably
over the lives of the agreements. Other revenues are recognized as services are
performed or technology rights transferred.
Income (Loss) Per Common Share
Income (loss) per common share is based on the Company's Common Stock and is
computed using the weighted average number of common and dilutive common
equivalent shares outstanding during the period. Dilutive common equivalent
shares consist principally of stock options calculated using the treasury stock
method.
Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. Cash and cash equivalents
exceeding the Company's ongoing operational requirements are held on deposit in
a bank.
Inventories
Inventories included in prepaid expenses in the balance sheet are stated at
the lower of cost (first-in, first-out method) or market. At June 30, 1994 and
1993, inventories consisted of assembled product kits totalling approximately
$296,000 and $158,000, respectively, and product media, documentation and
packaging totalling approximately $112,000 and $137,000, respectively.
Property and Equipment
Property and equipment is stated on the basis of cost. Depreciation and
amortization are provided using accelerated and straight-line methods over the
estimated useful lives of the assets. When property and equipment is retired,
or otherwise disposed of, the cost and related accumulated depreciation are
removed from the accounts, and the resulting gain or loss is credited or
charged to operations.
Acquired and Developed Computer Software
Costs related to the development of computer software internally are
capitalized in accordance with Statement of Financial Accounting Standards No.
86 ("SFAS 86"). Additionally, the costs of acquired technologies which meet the
provisions for capitalization under SFAS 86, approximating $3,248,000 and
6
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
$16,557,000 in 1994 and 1992, respectively, are also capitalized. Capitalized
costs are amortized over five years, the estimated lives of the products, with
amortization expense of approximately $4,803,000, $3,683,000 and $2,387,000 in
1994, 1993 and 1992, respectively.
Goodwill
The Company has recorded goodwill related to certain acquisitions and is
amortizing it over 10 to 12 years using the straight line method. The Company
assesses the recoverability of goodwill through analysis of discounted cash
flows.
Reclassifications
Certain changes in the presentation of 1993 and 1992 amounts have been made
to conform to the 1994 presentation.
2. SUPPLEMENTAL CASH FLOW INFORMATION:
<TABLE>
<CAPTION>
1994 1993 1992
------ ------- -------
<S> <C> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid for:
Interest........................................... $ 880 $ 352 $ 125
====== ======= =======
Income taxes....................................... $ 5 $ 487 $ 5,710
====== ======= =======
Supplemental schedule of noncash investing and
financing activities:
Fair value of assets acquired........................ $2,783 $26,456 $17,900
Cash paid............................................ 100 11,056 8,000
------ ------- -------
Liabilities assumed.................................. $2,683 $15,400 $ 9,900
====== ======= =======
</TABLE>
Additional common stock was issued during fiscal 1994 to acquire the assets
of ClearAccess Corporation, consisting primarily of intellectual property
rights. The purchase price $2,200,000 was recorded as capitalized software.
Approximately $1,048,000 was recorded as capitalized software in relation to
certain technology received in a non-monetary transaction.
3. NOTE PAYABLE:
In June 1994, the Company entered into a loan agreement with IBM Credit
Corporation, a related party, which provides up to $22,233,500 of operating
capital based on eligible accounts receivable and a $2,767,500 term loan
payable in February 1995. Upon payment of the term loan the line of credit for
operating capital increases to $25,000,000. The loan bears interest at 1 1/4%
above the prime rate and is collateralized by the Company's domestic trade
receivables, domestic furniture and equipment and all of the Company's
intellectual property. The outstanding balance on June 30, 1994 consists of
$13,000,000 on the line of credit and $2,766,500 on the term loan.
On July 1, 1994 the Company announced a loss for the fourth quarter of 1994
which would cause the Company to be in violation of certain financial covenants
dealing with net income, net worth and working capital. The Company has
received a waiver of these violations through September 30, 1994. In exchange
for the waiver, the Company has agreed to increase its interest rate to 2 1/4%
above the prime rate and to provide more frequent reporting.
7
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In May 1993, the Company entered into a loan agreement with International
Business Machines Corporation, a related party, which provides up to $8,000,000
of operating capital collateralized by certain of the Company's trade accounts
receivable. At June 30, 1993, the amount outstanding under the line of credit
was $2,000,000 at an interest rate of 7%. Additional borrowings were made in
the amount of $2,000,000 in August 1993 and $2,000,000 in October 1993. The
loan was repaid in June 1994 from proceeds of the loan agreement with IBM
Credit Corporation.
4. LONG-TERM DEBT:
The Company incurred certain long-term debt obligations in relation to the
acquisition of certain of its European distributors, the acquisition of its
Australian distributor and the acquisitions of Computer and Engineering
Consultants, Ltd. (CEC) and Viewpoint Systems, Inc. The minimum amounts payable
under the purchase agreement for the European Distributors is $1,000,000 in
September 1996, including interest imputed at 8% per annum. The amount due on
Viewpoint Systems, Inc. has been paid subsequent to June 30, 1994. Other long-
term debt consists of various obligations which were assumed from acquired
entities. At June 30, 1994 long-term debt is summarized as follows (in
thousands):
<TABLE>
<CAPTION>
6/30/94 6/30/93
------- -------
<S> <C> <C>
Long-term debt:
European Distributors................................... $ 836 $7,886
Australian Distributor.................................. 820 -0-
ViewPoint............................................... 736 928
Other................................................... 71 712
------ ------
2,463 9,526
Less current maturities................................... 1,627 5,902
------ ------
$ 836 $3,624
====== ======
</TABLE>
5. COMMITMENTS AND CONTINGENCIES:
Leases
The Company leases office space and various office equipment under
noncancellable operating leases. Total rent expense for all operating leases
approximated $13,820,000, $13,442,000 and $11,830,000 for the years ended June
30, 1994, 1993 and 1992, respectively.
Future minimum lease payments, by year and in the aggregate, under
noncancellable operating leases with initial or remaining terms of one year or
more consisted of the following at June 30, 1994 (in thousands):
<TABLE>
<CAPTION>
YEARS ENDING
JUNE 30,
------------
<S> <C>
1995............................................................ $12,424
1996............................................................ 8,521
1997............................................................ 4,262
1998............................................................ 3,139
1999............................................................ 2,276
Thereafter...................................................... 498
-------
Total minimum lease payments................................ $31,120
=======
</TABLE>
8
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Legal Proceedings
On December 18, 1991, a complaint was filed in the United States District
Court for the Northern District of Georgia, Atlanta Division which consolidated
and amended several class action lawsuits previously filed against
KnowledgeWare in October 1991. This action was a class action lawsuit alleging
violations of Sections 20 and 10(b) of the Exchange Act and Rule 10b-5 of the
Commission. In summary, the complaint alleged KnowledgeWare misrepresented or
failed to disclose material facts which would have a material adverse impact on
KnowledgeWare or approved such misrepresentations and omissions. The complaint
sought compensatory damages and reimbursements for the plaintiffs' fees and
expenses.
On January 26, 1994, KnowledgeWare entered into and the District Court
preliminarily approved a stipulation of settlement in this lawsuit. By entering
into the settlement, KnowledgeWare did not admit the allegations in the suit
and, to the contrary, denied any wrongdoing. The settlement, which received
final court approval in April, 1994, required a cash payment of $1,750,000, all
of which was paid by KnowledgeWare's insurance carrier, and the issuance by
KnowledgeWare of the Warrants, which allow the holders to acquire an aggregate
of 500,000 shares of KnowledgeWare's Common Stock at a price of $17.50 per
share. The Warrants are exercisable for a period of three years from June 9,
1994 (the date of issuance). The Company expensed $100,000 related to the
settlement in the quarter ending March 31, 1994.
Employment Agreements
The Company has entered into employment agreements with certain of its
executive officers. These agreements provide for the payment of significant
benefits to these executives under most conditions of employment termination or
change in control.
6. INCOME TAXES:
Effective July 1, 1991, the Company adopted Statement of Financial Accounting
Standards No. 109, "Accounting For Income Taxes" which bases the measurement of
deferred tax assets and liabilities on the provisions of enacted tax law and
forecasts of future taxable income. The Company's deferred tax expense
(benefit) for fiscal 1994 and 1993 represents the change in the net deferred
tax asset from the beginning to the end of the year.
The provision (benefit) for income taxes consists of (in thousands):
<TABLE>
<CAPTION>
1994 1993 1992
----- ------- -------
<S> <C> <C> <C>
Federal:
Current............................................ $ -0- $(1,498) $(2,494)
Deferred........................................... -0- 27 1,722
----- ------- -------
-0- (1,471) (772)
State:
Current............................................ -0- (385) (40)
Deferred........................................... (150) 403
----- ------- -------
-0- (535) 363
Foreign:
Current............................................ -0- 606 1,066
----- ------- -------
$ -0- $(1,400) $ 657
===== ======= =======
</TABLE>
9
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The difference between the tax bases of assets and liabilities and their
carrying amounts for financial reporting purposes are referred to as temporary
differences. Significant temporary differences include the treatment of
software service agreement revenue, amortization of capitalized software
development costs under SFAS No. 86, corporate restructuring charge, and
depreciation of property and equipment. Income tax credits are accounted for by
the flow-through method as realized. At June 30, 1994, the following
carryforwards are available to reduce future federal income taxes for financial
reporting purposes: net operating loss (regular tax) of $38,276,000 expiring in
fiscal 2008 and 2009, net operating loss (alternative minimum tax) of
$31,927,000 expiring in fiscal 2008 and 2009, foreign tax credit of $3,039,000
expiring in fiscal 1995 through 1998, research & development credit of
$3,068,000 expiring in fiscal 1997 through 2008, investment tax credit of
$53,000 expiring in fiscal 1996 through 2001, and alternative minimum tax
credit of $710,000 which has no expiration date.
A reconciliation of income tax expense (benefit) computed at the statutory
federal income tax rates with the Company's effective income tax rates follows
(in thousands):
<TABLE>
<CAPTION>
1994 1993 1992
------- ------- -------
<S> <C> <C> <C>
Federal income tax at statutory rate (34%)....... $(6,470) $(9,248) $ 344
State income taxes, net of federal tax........... -0- (535) 469
Foreign income taxes............................. -0- 606 1,066
Tax benefits of foreign sales corporation........ -0- -0- (156)
Utilization of foreign tax credits and
carryforwards................................... -0- -0- (1,066)
Limitations on the utilization of net operating
losses and tax credits.......................... 6,470 7,777 -0-
------- ------- -------
Provision for income taxes....................... $ -0- $(1,400) $ 657
======= ======= =======
</TABLE>
The net deferred tax asset (liability) presented in the balance sheet is
$(165,000) and $752,000 at June 30, 1994 and 1993, respectively. The asset
(liability) is presented net of a valuation allowance of $20,229,000 and
$10,791,000 at June 30, 1994 and 1993, respectively.
7. STOCK PLANS AND OPTIONS:
The Company has established the Incentive Stock Option Plan of 1984 and the
Second Incentive Stock Option Plan of 1984 ("1984 Plans") and the 1988 Stock
Incentive Plan ("1988 Plan"). The 1984 Plans and the 1988 Plan are administered
by the Employee Incentive Stock Committee ("Committee") appointed by the Board
of Directors. Under the 1984 Plans, the Committee has the authority to
determine all terms and provisions under which options are granted, including
the persons to whom options are granted, the number of shares of Common Stock
to be covered by each option, the exercise price per share covered by the
option and the time or times at which options shall be exercisable. The
Committee as administrator of the 1988 Plan, in its discretion, may select the
participants and determine the prices at which restricted shares may be sold to
participants, may award shares of Common Stock to participants thereunder
without cash consideration and may grant options to purchase shares at prices
determined by the Board. Options have historically been granted based on the
fair value of the shares at date of grant. Since no quoted market price was
available prior to the Company's initial public offering in October 1989, the
best estimate of the fair value of the stock was determined by the Board of
Directors. Options granted under the 1984 Plans and the 1988 Plan expire on
various dates from November 1994 through January 2001 and February 1999 through
April 2003, respectively. At June 30, 1994, there were 19 and 78 participants
in the 1984 Plans and the 1988 Plan, respectively.
On August 29, 1989, shareholders of the Company approved the 1989 Non-
Employee Director Stock Option Plan ("Director Plan") pursuant to which options
to acquire 9,000 shares of Common Stock were
10
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
granted to three of the Company's non-employee directors, of which 3,000 shares
have lapsed. Under the terms of the Director Plan, each of these directors was
granted options to acquire 3,000 shares of Common Stock. The options became
100% vested on March 31, 1992.
On December 3, 1993, shareholders of the Company approved the 1993 Non-
Employee Director Stock Option Plan pursuant to which 50,000 shares of Common
Stock, without par value, were authorized for issuance. Two of the outside
directors were each granted options to acquire 5,000 shares of Common Stock and
the third was granted options to acquire 7,500 shares of Common Stock. The
options vest 50% on December 3, 1994 and 50% on December 3, 1995.
Information regarding the Plans at June 30, 1994 is summarized as follows:
<TABLE>
<CAPTION>
1984 DIRECTOR
PLANS 1988 PLAN PLANS TOTAL
------ --------- -------- ---------
<S> <C> <C> <C> <C>
Shares reserved for issuance............ 55,621 3,238,523 56,000 3,350,144
Shares under outstanding options........ 35,308 1,752,488 23,500 1,811,296
Shares available for future grants,
awards or sales........................ 20,313 1,486,035 32,500 1,538,848
Shares subject to options which are
currently exercisable.................. 14,308 573,027 6,000 593,335
</TABLE>
A summary of stock option activity for the years ended June 30, 1992, 1993
and 1994 is as follows:
<TABLE>
<CAPTION>
OPTION
SHARES RANGE
--------- -----------
<S> <C> <C>
Shares under option July 1, 1991...................... 1,623,198 1.84-39.00
Options granted..................................... 560,500 11.50-28.38
Options exercised................................... (158,529) 1.84-10.35
Options canceled.................................... (168,781) 2.28-39.00
---------
Shares under option June 30, 1992..................... 1,856,388 1.84-39.00
Options granted..................................... 441,900 9.25-12.50
Options exercised................................... (184,844) 1.84-10.35
Options canceled.................................... (332,695) 2.28-24.75
---------
Shares under option June 30, 1993..................... 1,780,749 1.84-39.00
Options granted..................................... 1,106,000 10.25-17.25
Options exercised................................... (89,688) 1.84-13.63
Options canceled.................................... (985,765) 8.25-39.00
---------
Shares under option June 30, 1994..................... 1,811,296 2.28-24.75
=========
</TABLE>
On August 29, 1989, shareholders of the Company approved the establishment of
an employee stock purchase plan ("Purchase Plan") which allows eligible
employees to purchase Common Stock of the Company through payroll deductions at
85% of the lesser of fair market value on the first or last day of the offering
period. An employee's payroll deductions which are applied toward the purchase
of Common Stock are limited to the lesser of 10% of the employee's compensation
or $25,000. The current offering period began on April 15, 1994 and will
conclude on October 14, 1994. The rights to purchase shares were granted on
April 15, 1994. The Company has reserved 352,510 shares of Common Stock for
issuance under the Purchase Plan.
8. CAPITAL STOCK:
The Company's Board of Directors has the authority, without further action of
the shareholders of the Company, to issue up to 50,000,000 shares of Preferred
Stock in one or more series and to fix or alter the
11
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
designations, preferences, rights and any qualifications, limitations or
restrictions of the shares of each such series thereof, including the dividend
rights, dividend rates, conversion rights, voting rights, terms and redemption
(including sinking fund provisions), redemption price or prices, liquidation
preferences and the number of shares constituting any series or the
designations of such series. The issuance of Preferred Stock may have the
effect of delaying, deferring or preventing a change in control of the Company.
Through June 30, 1994, no Preferred Stock had been issued.
On August 18, 1989, the Company and International Business Machines
Corporation (IBM) entered into a common stock purchase agreement pursuant to
which IBM acquired 1,091,931 shares of the Company's Common Stock for
$10,500,000. As provided in this agreement, IBM has the right of refusal on any
private sale of securities by the Company and/or certain significant
shareholders to a competitor of IBM if such sale would result in such
competitor owning more than 5% of the Company. IBM has both demand and
"piggyback" registration rights with respect to its Company shares. Also, so
long as IBM maintains a 5% or greater interest in the voting power of the
Company, IBM has the right to nominate an individual to serve as a Director or
to designate an individual to attend Board of Directors meetings as a nonvoting
observer. Two of the Company's significant shareholders entered into a
shareholders agreement with the Company and IBM to implement certain of the
above provisions, and have agreed to vote their shares for any nominee to the
Board of Directors by IBM. However, IBM notified the Company in January 1994
that it is no longer exercising its right under the shareholder agreement to
have an IBM designee on the Company's Board of Directors.
The Company has outstanding 500,000 warrants to purchase common stock at a
price of $17.50 per share which expire June 9, 1997.
9. INTERNATIONAL DISTRIBUTORS:
Commencing in July 1989, the Company entered into individual, territory
specific, multi-year marketing agreements with certain member firms of Ernst &
Young International (collectively, "Distributors") whereby the Distributors
have rights to distribute the Company's products in their respective countries
outside of the United States. The marketing agreements provide for rebates of
up to 25% of gross sales to the Distributors and are based upon the attainment
by the Distributors of territorial sales quotas. Total revenues from the
Distributors in 1994, 1993 and 1992 were approximately $4,820,000, $16,415,000
and $29,613,000, respectively, and are net of rebates of approximately
$1,084,000, $4,090,000 and $7,675,000, respectively. Included in trade accounts
receivable at June 30, 1994 and 1993 were approximately $1,085,000 and
$2,154,000, respectively, of net receivables related to such sales. The
activity for fiscal year 1993 includes the European territory through March 4,
1993, the date on which the Company acquired certain of the European
Distributors. The activity for fiscal year 1994 includes the Australian
territory through November 9, 1993, and the Switzerland and Austrian
distributors through December 31, 1993, the dates on which the Company acquired
the distributors.
In addition to the foregoing rebates arrangement, effective as of July 1,
1990 the Company entered into agreements with certain of the Distributors
whereby the Distributors are reimbursed by the Company for a portion of the
commissions which the Distributors pay to IBM on sales of certain products of
the Company to end-users. The reimbursement is limited to 7.5% of the net
purchase price which the Distributors paid to the Company for such products. In
fiscal years 1994, 1993 and 1992 the Company accrued reimbursements of such
commissions totalling approximately $0, $470,000 and $1,117,000, respectively.
On June 29, 1990, the Company and a Japanese affiliate of Ernst & Young
International executed a product development agreement and an addendum to the
above described international marketing agreement
12
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
with the Japanese affiliate. The product development agreement granted the
Japanese affiliate a license to develop Japanese language versions of certain
products of the Company ("J-Versions") for a total consideration of $2,000,000
payable over ten calendar quarters beginning September 30, 1990, reflecting a
net present value of $1,850,000 of which the Company recognized revenues of
$185,000 and $1,665,000 in fiscal years 1991 and 1990, respectively. The
Japanese addendum grants the Japanese affiliate a license to market, distribute
and support J-Versions in Japan with the right to sublicense J-Versions to
customers through December 31, 1997 and provides for certain royalty
arrangements between the Company and the Japanese affiliate upon the occurrence
of specified events. The J-Versions were completed and commercially released in
fiscal 1992. The Company recognized revenues of $952,000 and $665,000 in fiscal
1994 and 1993, respectively. Royalties payable to the Company at June 30, 1994
are $145,000. In March, 1994 the Company reached agreement to transfer the
distribution rights for the ADW product from the Ernst & Young affiliate to IBM
Japan.
On March 18, 1992, the Company and a Korean affiliate of Ernst & Young
International executed a product development agreement and an addendum to the
above described international marketing agreement with the Korean affiliate.
The product development agreement provides the Korean affiliate a license to
use J-Versions for the development of Korean versions ("K-Versions") of certain
of the Company's products. The Korean addendum grants the Korean affiliate a
license to market, distribute and support K-Versions in Korea with the right to
sublicense K-Versions to customers through June 30, 1998 and provides for
certain royalty arrangements between the Company and the Korean affiliate upon
the occurrence of specified events. The K-Versions were completed and
commercially released in fiscal 1993. Revenues of $394,000 and $45,000 were
recognized by the Company in fiscal 1994 and 1993, respectively. Royalties
payable to the Company at June 30, 1994 are $88,000.
10. RELATED PARTY TRANSACTIONS:
Since 1989, the Company and IBM have entered into various joint-marketing
agreements in which IBM was granted a license to market the Company's products.
Under the domestic portion of the agreement the Company was obligated to pay
IBM commissions equal to 7.5% of the sales of certain of the Company's
products. In fiscal years 1994 and 1993 the Company incurred approximately
$122,000 and $447,000 respectively, of such commissions. The agreement was
revised by mutual consent to eliminate commissions payable under the agreement
effective September 30, 1992.
The Company also sells directly to IBM, which is the largest end-user
customer of the Company. Such sales are not subject to the domestic joint-
marketing agreement described above. Product license revenues from IBM in
fiscal years 1994, 1993 and 1992 totalled approximately $1,000,000, $9,500,000
and $11,615,000 respectively, of which approximately $250,000 remained in trade
accounts receivable from related parties at June 30, 1994.
On June 22, 1989, the Company and IBM entered into a license agreement which
granted IBM licenses and rights in certain existing technology ("Licensed
Works") of the Company. The license agreement provides for certain royalty
arrangements between IBM and the Company upon the sale of jointly developed
products and other products of IBM containing all or a significant part of the
Licensed Works or derivatives thereof. Royalties approximating $38,000 and
$102,000 were realized from IBM in fiscal 1993 and 1992, respectively.
On June 18, 1992, the Company entered into a U.S. Enterprise License
agreement ("Enterprise License") with IBM, as amended on June 24, 1992, which
provides IBM the right to produce an unlimited quantity of certain
KnowledgeWare products for IBM's internal use for a fee of $12,000,000. The
Company recognized
13
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
$6,500,000 of the fee in the fourth quarter of fiscal 1992 and $5,500,000 in
the first quarter of fiscal 1993 based on product delivery dates. Although no
assurances exist, future product offerings of the Company may be added to the
Enterprise License at a mutually negotiated fee between IBM and the Company.
The Enterprise License also included purchase commitments for maintenance of
all Company products licensed by IBM. The Company recognized $3,582,000 and
$2,500,000 of revenue under the maintenance agreement in fiscal years 1994 and
1993, respectively.
11. BUSINESS SEGMENT AND GEOGRAPHIC DATA:
The Company is engaged in one business segment: the design, development,
marketing and support of application development products and the delivery of
related maintenance and consulting services. The Company licenses its products
internationally through the Distributors (Note 9) and its direct sales force,
and revenues can be grouped into six main geographic areas as follows (in
thousands):
<TABLE>
<CAPTION>
GEOGRAPHIC AREAS 1994 1993 1992
- ---------------- -------- -------- --------
<S> <C> <C> <C>
North America, United States........................ $ 82,382 $ 92,797 $ 86,929
Export Revenues:
North America, Canada............................... 1,817 2,177 4,821
Europe.............................................. 41,065 28,239 19,687
Australia........................................... 3,262 1,561 1,442
South America....................................... 1,307 2,881 2,331
Asia................................................ 2,658 1,106 1,322
-------- -------- --------
$132,491 $128,761 $116,542
======== ======== ========
</TABLE>
Other segment data is as follows:
<TABLE>
<CAPTION>
1994 1993 1992
-------- -------- ------
<S> <C> <C> <C>
Income (loss) before taxes:
North America..................................... $(15,866) $(28,524) $1,013
European subsidiaries............................. (2,701) 1,330 --
Australia/New Zealand subsidiaries................ (230) -- --
Other international operations.................... (233) (5) --
-------- -------- ------
(19,030) (27,199) 1,013
<CAPTION>
1994 1993
-------- --------
<S> <C> <C>
Identifiable assets:
North America..................................... $ 81,785 $ 95,014
European Subsidiaries............................. 33,629 30,667
Australia/New Zealand subsidiaries................ 3,401 --
Other international operations.................... 829 --
-------- --------
$119,644 $125,681
======== ========
</TABLE>
The income (loss) before taxes in North America includes intercompany transfer
pricing income from foreign subsidiaries of approximately $11,960,000 and
$2,610,000 for the years ended June 30, 1994 and 1993, respectively. The income
(loss) from foreign subsidiaries reflects the corresponding expense.
14
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
12. QUARTERLY FINANCIAL DATA (UNAUDITED):
<TABLE>
<CAPTION>
QUARTERS
------------------------------------
FIRST SECOND THIRD FOURTH
------- ------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
1994
Revenues, as previously reported....... $34,144 $38,178 $ 38,928 $ 30,414
Restatements........................... (920) (2,625) (5,628) --
Revenues, restated..................... 33,224 35,553 33,300 30,414
Gross profit, as previously reported... 25,694 29,052 27,992 18,234
Restatements........................... (920) (2,635) (5,573) --
Gross Profit, restated................. 24,774 26,417 22,419 18,234
Income (loss) before income taxes, as
previously reported................... 1,844 2,442 663 (15,412)
Restatements........................... (309) (2,133) (6,125) --
Income (loss) before income taxes,
restated.............................. 1,535 309 (5,462) (15,412)
Net Income (loss), as previously
reported.............................. 1,566 2,082 807 (15,412)
Restatements........................... (184) (1,804) (6,085) --
Net Income (loss), restated............ 1,382 278 (5,278) (15,412)
Net income (loss) per common share, as
previously reported................... .12 .15 .06 (1.05)
Restatements........................... (.02) (.13) (.42) --
Net Income (loss) per common share,
restated.............................. .10 .02 (.36) (1.05)
1993
Revenues............................... $29,957 $32,581 $ 25,797 $ 40,426
Income (loss) before income taxes...... 1,231 1,337 (32,546) 2,779
Net Income (loss)...................... 794 987 (30,359) 2,779
Net income (loss) per common share..... .06 .07 (2.34) .21
</TABLE>
During the fourth quarter, as a result of an evaluation of credit policies
and collectibility issues related to the Company's North American Reseller
Program, including government integrators, the Company has modified its
accounting policy for revenue recognition related to reseller product license
revenue (See Note 1), and restated financial results to correct the first three
quarters of fiscal year 1994. The fiscal year 1994 transactions are clearly
different in substance from previous experience based on the Company's direct
sales to end-user companies.
The significant loss in the fourth quarter of fiscal 1994 is attributable to
a combination of increased marketing and headcount related expenses in
expectation of significantly increased product license revenues which were not
realized.
13. ACQUISITIONS:
On June 7, 1994 the Company acquired the assets of ClearAccess Corporation,
consisting primarily of intellectual property rights to the ClearAccess and
Clear Manager products, in consideration for 205,906 shares of common stock.
The purchase price of $2,200,000 has been recorded as capitalized software and
will be amortized over five years.
On November 9, 1993, the Company acquired Ernst & Young CASE Technology Pty.,
Ltd. based in Sydney, Australia, from Ernst & Young Australia. The purchase
price was $1,600,000 plus 4% of product sales royalties, as defined, through
November 9, 1996. Of the purchase price $800,000 was paid in January 1994,
$800,000 is scheduled in July 1994 and the 4% payments are made quarterly. The
assets acquired and
15
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
liabilities assumed were recorded based on their fair market values as of the
date of the acquisition. The excess of amounts paid over the fair market values
of assets acquired and liabilities assumed, approximating $2,056,000, was
allocated to goodwill and will be amortized over twelve years using the
straight line method. The acquisition was accounted for under the purchase
method of accounting and the results of operation of the Australia distributor
have been included in the Company's consolidated financial statements since
November 9, 1993.
Pro forma financial results for the acquisitions of ClearAccess Corporation
and the Australian Distributor have not been presented due to immateriality.
On November 13, 1992, the Company acquired all of the assets and assumed
certain liabilities of Computer and Engineering Consultants Ltd. (CEC), a
Michigan-based applications development consulting and methodology company. The
purchase price approximated $1,960,000, of which $1,500,000 was paid at closing
and $460,000 was deferred and subject to adjustment. CEC assets acquired and
liabilities assumed were recorded based on their fair market values as of the
effective date of the acquisition. The excess of amounts paid over the fair
market values of assets acquired and liabilities assumed, approximating
$1,680,000, was allocated to goodwill and will be amortized over 10 years using
the straight line method. The acquisition was accounted for under the purchase
method of accounting and the results of operations of CEC have been included in
the Company's consolidated financial statements since November 13, 1992.
On February 19, 1993, the Company completed the acquisition of Matesys
Mathematic Systems S.A. (Matesys), a French corporation, and its wholly-owned
subsidiary, Matesys Corp., a California corporation. Matesys Corp. develops and
markets ObjectView, an object-oriented development tool for rapidly creating
client/server applications that access multiple databases. Pursuant to the
purchase agreement, the Company issued 900,000 shares of its Common Stock in
exchange for all of the outstanding stock of Matesys. The acquisition has been
accounted for as a pooling of interests and, accordingly, the accounts of the
pooled companies have been retroactively combined for all periods presented in
the accompanying consolidated financial statements.
The separate accounts of the Companies prior to pooling reflect the following
(in thousands):
<TABLE>
<CAPTION>
SIX MONTHS YEAR
ENDED ENDED
DECEMBER 31, JUNE 30,
1992 1992
------------ --------
<S> <C> <C>
Revenues
KnowledgeWare, Inc................................ $61,074 $115,084
Matesys........................................... 1,464 1,458
------- --------
Combined.......................................... $62,538 $116,542
======= ========
Net income (loss)
KnowledgeWare, Inc................................ $ 1,601 $ 260
Matesys........................................... 180 96
------- --------
Combined.......................................... $ 1,781 $ 356
======= ========
</TABLE>
On March 4, 1993, the Company completed the acquisition of its European
Distributors in Belgium, Denmark, Finland, France, Germany, Italy, the
Netherlands, Norway, Portugal, Spain, Sweden and the United Kingdom. Pursuant
to the purchase agreement, the purchase price will range between $17,200,800
and $28,668,000, of which $9,556,000 was paid at closing. Payments over the
four years following closing range from a minimum of $7,644,800 to a maximum of
$19,112,000, depending on revenues in the territories
16
<PAGE>
from products which were offered under the previous distribution agreements.
The foregoing is illustrated by the following table:
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
FY 6/93 FY 6/94 FY 6/95 FY 6/96 12/96
---------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Reporting Period
10% of product sales
in excess of......... $ 0 $23,890,000 $28,668,000 $47,780,000 $28,668,000
7% of maintenance
revenue.............. yes yes yes no no
Minimum payment....... 1,911,200 2,866,800 2,866,800 0 0
Maximum payment....... 1,911,200 4,778,000 7,644,800 4,778,000 1,911,200
Cumulative maximum.... 1,911,200 6,689,200 14,334,000 19,112,000 19,112,000
Calculated payment.... 646,000
</TABLE>
Because of changes in the Company's product mix, including the introduction
of various new products, the Company does not believe that revenues will exceed
the minimum levels in any reporting period. Therefore, the purchase has been
recorded at the minimum amount of $17,200,800. The acquisition was accounted
for under the purchase method of accounting and assets acquired and liabilities
assumed were recorded based on their fair market values as of the effective
date of the acquisition. The excess of the $17,200,800 minimum purchase price
over the fair market values of assets acquired and liabilities assumed,
$12,874,000, has been allocated to goodwill and is being amortized over 12
years using the straight line method. The results of operations of the acquired
businesses have been included in the Company's consolidated financial
statements since March 4, 1993.
On August 9, 1991, the Company acquired all of the capital stock of Language
Technology, Inc. ("LTI"), a developer of computer-aided software engineering
tools for the maintenance and enhancement of existing COBOL systems. On June
11, 1992, the Company acquired all of the capital stock of Viewpoint Systems,
Inc. ("VPS"), a developer and marketer of two personal computer-based software
products for graphical user interface development. The purchase prices of LTI
and VPS approximated $6,000,000 and $4,500,000, respectively. Total assets
acquired, approximating $2,700,000, and liabilities assumed, approximating
$7,400,000, were recorded based on their fair market values as of the dates of
the acquisitions. Approximately $15,200,000 was allocated to the technology
rights acquired relative to the products of LTI and VPS. The amount allocated
to technology rights acquired are amortized over the estimated five-year
economic lives of the products. The acquisitions were accounted for under the
purchase method of accounting.
The pro forma unaudited results of operations for the years ended June 30,
1993 and 1992, assuming the purchases of LTI, VPS, CEC and the European
Distributors had been consummated as of July 1, 1991, are as follows (in
thousands, except per share data):
<TABLE>
<CAPTION>
1993 1992
-------- --------
<S> <C> <C>
Net sales............................................. $145,102 $142,416
Net loss.............................................. (23,259) (10,747)
Net loss per common share............................. (1.75) (.82)
</TABLE>
14. CORPORATE RESTRUCTURING CHARGE:
During the third quarter of fiscal year 1993 the Company recorded a
$21,976,000 restructuring charge related to expansion of the Company's product
line, including the acquisition of Matesys, to the expansion of the Company's
direct distribution network through acquisition of its European distributors,
and to reallocation of personnel to match business objectives including
alternate distribution channels and revised product development goals. The
charge includes approximately $7,000,000 related to the termination of European
distribution rights; $6,700,000 related to consolidation of corporate real
estate; $4,200,000 related
17
<PAGE>
to the reduction and relocation of personnel; $3,500,000 of software
development costs; and $600,000 of direct costs associated with the acquisition
of Matesys. Accrued expenses at June 30, 1994 include approximately $1,700,000
relative to this restructuring charge.
15. SUBSEQUENT EVENTS:
In July, 1994 the Company reduced its work force by 243 people. The Company
is expected to pay out approximately $3,500,000 related to this work force
reduction. Total restructuring charges for the first quarter of fiscal year
1995 are estimated to be between $5,000,000 and $6,000,000.
On August 31, 1994 the Company entered into a revised definitive Agreement
and Plan of Merger with Sterling Software, Inc. ("Sterling") and SSI
Corporation, pursuant to which Sterling will acquire the Company through a
merger of SSI Corporation with and into the Company.
Under the terms of the Merger Agreement, each outstanding share of Common
Stock, without par value, of the Company will be converted into the right to
receive .1653 of a share of the Common Stock, par value $.10 per share, of
Sterling, of which 20% of the shares will be held in escrow for certain
potential liabilities.
Consummation of the proposed merger is subject to the approval of the
Stockholders of the Company and other conditions set forth in the Merger
Agreement.
On August 31, 1994 the Company entered into a revolving and term loan
agreement with Sterling to replace the loan agreement with IBM Credit
Corporation and expand the Company's borrowing capacity. The agreement provides
for maximum borrowings under the loan arrangement of $22,000,000; the issuance
of 70,250 warrants to purchase the Company's common stock at its fair market
value upon the date of issuance (initially $4.50 per share) for each one
million dollars drawn; and interest at 1 1/4% over prime and a maturity date of
August 31, 1995. The Company has reserved a maximum of 1,545,500 shares of its
Common Stock for issuance under the loan agreement with Sterling.
16. LIQUIDITY
The Company has suffered recurring losses from operations. These losses have
resulted in negative working capital and an accumulated deficit. In addition,
current period losses violated financial covenants in the line of credit
agreement with IBM Credit Corporation for which the Company received a waiver
until September 30, 1994. Management believes that existing cash balances must
be supplemented by additional cash from outside sources in order to fund
currently anticipated cash and capital requirements.
Understanding its strategic alternatives, including remaining an independent
company and the impact of financial constraints on its ability to invest in and
execute future plans, management engaged Alex Brown to seek potential
candidates for a business combination. On July 31, 1994 the Board of Directors
approved managements' plans to enter into a merger agreement with Sterling
Software. Management announced on August 1, 1994, it had entered into a Merger
Agreement and an Amended and Restated Merger Agreement was executed as of
August 31, 1994.
The financial statements do not include any adjustments that may be necessary
as a result of this uncertainty.
17. EVENTS (UNAUDITED) SUBSEQUENT TO THE DATE OF THE REPORT OF INDEPENDENT
CERTIFIED PUBLIC ACCOUNTANTS
On August 30, 1994, the plaintiffs in the class action lawsuit described in
Note 5 (the "1991 Class Action") filed a motion alleging that the proposed
business combination between the Company and Sterling and the announcement by
the Company that it modified its accounting policy for revenue recognition and
restated financial results for the first three quarters of fiscal year 1994
resulted in a substantially reduced
18
<PAGE>
value of the Warrants available to the plaintiffs under the stipulation of
settlement. Accordingly, the plaintiffs moved the District Court for a decree
of specific performance of the terms of the stipulation of settlement entailing
the delivery of new warrants of equivalent value to the original value of the
Warrants, and for a preliminary injunction of the consummation of any business
combination between the Company and Sterling, pending compliance by the Company
with the terms of the stipulation of settlement. Alternatively, the plaintiffs
moved for a declaration that the warrant agreement set forth in the stipulation
of settlement was the product of fraud and for an award to the plaintiffs of
the appropriate measure of damages.
On August 30 and 31 and September 12, 22 and 23, 1994, a total of eight
lawsuits were filed against the Company in the United States District Court for
the Northern District of Georgia, Atlanta Division (the "1994 Class Action
Suits"). Each of the 1994 Class Action Suits is purportedly a class action
lawsuit on behalf of the Company's shareholders alleging violations of Sections
20 and 10(b) of the Exchange Act, and Rule 10b-5 under the Exchange Act. The
alleged factual basis underlying the 1994 Class Action Suits and the relief
sought therein is the plaintiffs' allegations that the Company and the
individual defendants actively misrepresented or failed to disclose the actual
financial condition of the Company throughout fiscal year 1994 and that the
value of the Company's Common Stock was artificially inflated as a result of
such misrepresentations or failures to disclose. Each of the 1994 Class Action
Suits seeks compensatory damages and reimbursement for the plaintiffs' fees and
expenses.
On September 9, 1994, a lawsuit styled Ecta Corporation and Fairfield
Development, Inc. v. KnowledgeWare, Inc., Donald P. Addington and Francis A.
Tarkenton, Civil Action File No. 4-94-CV-80587, was filed against the Company
in the Southern District of Iowa, Central Division (the "Ecta Suit"). The Ecta
Suit is a lawsuit alleging violations of Section 10(b) of the Exchange Act,
Rule 10b-5 under the Exchange Act, Section 12(2) of the Securities Act,
violation of the Iowa Blue Sky Laws (Iowa Stat. Ann. (S)502.502), fraud and
breach of contract. The alleged factual basis underlying the Ecta Suit arises
in connection with the purchase by the Company of substantially all of the
assets of ClearAccess Corporation (now known as Ecta Corporation) and Fairfield
Software, Inc. (now known as Fairfield Development, Inc.) pursuant to an Asset
Purchase Agreement dated May 26, 1994 (the "Acquisition Agreement"). The
plaintiffs allege that the Company and the individual defendants misrepresented
or failed to disclose the actual financial condition of the Company, that the
value of the Company's Common Stock was artificially inflated as a result of
such misrepresentations or failures to disclose and that the Company has
breached certain warranties, representations and covenants made in the
Acquisition Agreement. The Ecta Suit seeks compensatory damages, rescission of
the Acquisition Agreement and/or the sale of the Company's securities issued
pursuant thereto, punitive damages, prejudgment interest, and reimbursement of
attorneys' fees and costs.
None of these actions was served on the Company prior to the date of the
Report of Independent Certified Public Accountants dated August 31, 1994 and
the filing of the Company's Annual Report on Form 10-K on September 1, 1994.
The plaintiffs in the above described actions seek unspecified compensatory
damages, legal fees and litigation costs. The Company is unable to predict the
outcome or the potential financial impact of this litigation either as an
amount or range of amounts. For the 12 month period ended September 30, 1994,
KnowledgeWare maintained directors and officers liability insurance policies
with a maximum aggregate loss amount of $4.0 million. Losses, claims, judgement
costs and expenses of KnowledgeWare and Sterling resulting from the above-
described actions will also result in claims for indemnification to be
satisfied from the escrowed shares provided for in the Amended Merger
Agreement. As of October 26, 1994, KnowledgeWare estimates that approximately
$55,000 of costs and expenses have been incurred since August 31, 1994 with
respect to the above-described sections.
KnowledgeWare has received informal requests for information from the Staff
of the Commission as to which persons and entities had knowledge of the
negotiations between KnowledgeWare and Sterling prior to the public
announcement of the Merger Agreement on August 1, 1994, and as to the
circumstances with respect to KnowledgeWare's restatement of financial results
for the first three quarters of fiscal 1994.
19
<PAGE>
EXHIBIT 99.2
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data) (unaudited)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Three Months Ended
September 30,
-------------
Revenues: 1994 1993
---- ----
<S> <C> <C>
Software product license.............................. $ 7,298 $19,147
Service agreement..................................... 9,240 9,472
Consulting and education.............................. 4,883 4,234
Other................................................. 370 371
-------- -------
21,791 33,224
-------- -------
Costs and expenses:
Cost of software product license revenues............. 1,495 1,523
Cost of service agreement revenues.................... 2,774 3,244
Cost of consulting and education revenues............. 4,826 3,683
Selling and marketing................................. 11,663 12,745
General and administrative............................ 6,115 4,154
Research and development.............................. 4,678 6,155
Corporate restructuring charge........................ 6,205 -0-
-------- -------
37,756 31,504
-------- -------
Income (loss) from operations........................ (15,965) 1,720
Foreign currency...................................... 596 -0-
Interest income (expense), net......................... (456) (185)
-------- -------
Income (loss) before income taxes.................... (15,825) 1,535
Provision for income taxes............................. -0- (153)
-------- -------
Net income (loss).................................... $(15,825) $ 1,382
======== =======
Net income (loss) per common share..................... $(1.08) $.10
======== =======
Weighted average number of common and common
equivalent shares
outstanding........................................... 14,713 13,305
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
1
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data) (unaudited)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
ASSETS
September 30, June 30,
Current assets: 1994 1994
---- ----
<S> <C> <C>
Cash and cash equivalents......................... $ 5,846 $ 8,519
Trade accounts receivable:
Receivable from related parties............... 250 250
Other, net.................................... 24,286 37,282
Prepaid expenses and other........................ 3,486 3,577
Prepaid income taxes and income taxes receivable.. 199 199
Deferred income taxes............................. 3,356 3,356
-------- --------
Total current assets.......................... 37,423 53,183
-------- --------
Property and equipment:
Leasehold improvements............................ 5,593 5,567
Furniture and fixtures............................ 17,578 17,539
Computers and related equipment and software...... 30,336 29,802
-------- --------
53,507 52,908
Less: accumulated depreciation and amortization.. (33,088) (31,083)
-------- --------
20,419 21,825
-------- --------
Other assets:
Acquired and developed software, net.............. 28,039 28,382
Goodwill, net..................................... 14,266 14,616
Other long-term assets............................ 1,663 1,638
-------- --------
43,968 44,636
-------- --------
$101,810 $119,644
======== ========
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
<S> <C> <C>
Note payable to Sterling Software, Inc.............. $ 18,266 $ -0-
Note payable to IBM Credit Corporation.............. -0- 15,766
Trade accounts payable.............................. 6,906 7,670
Deferred revenues................................... 18,740 22,734
Accrued expenses and other current liabilities...... 12,106 8,732
Accrued compensation and payroll taxes.............. 4,542 6,407
Current portion of long-term debt................... 845 1,627
-------- --------
Total current liabilities....................... 61,405 62,936
Long-term debt....................................... 854 836
Deferred income taxes................................ 3,521 3,521
Shareholders' equity:
Common Stock, without par value--100,000,000 shares
authorized; 14,571,888 and 14,562,381 shares issued
and outstanding on September 30, 1994 and
June 30, 1994, respectively........................ 72,579 72,548
Retained earnings (deficit)......................... (35,464) (19,639)
Cumulative translation adjustments.................. (1,085) (558)
-------- --------
Total shareholders' equity...................... 36,030 52,351
-------- --------
$101,810 $119,644
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) (unaudited)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Three Months Ended
September 30,
-------------
Operating Activities: 1994 1993
---- ----
<S> <C> <C>
Net income (loss)....................................... $(15,825) $ 1,382
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization......................... 3,924 3,432
Capitalization of software development costs.......... (1,243) (1,985)
Provision for uncollectible accounts receivable....... 300 -0-
Foreign currency gain................................. (596) -0-
Changes in operating assets and liabilities, net of
effect on acquisitions:
Trade accounts receivable........................... 13,507 412
Inventories and escrow, prepaid expenses and other.. (673) (837)
Trade accounts payable, accrued expenses and other
current liabilities and accrued compensation and
payroll taxes...................................... 633 (6,031)
Deferred revenues................................... (4,012) (2,707)
Income taxes........................................ -0- 899
-------- -------
Net cash provided (used in) operating activities.. (3,985) (5,435)
-------- -------
Investing activities:
Purchases of property and equipment..................... (452) (1,713)
Other non-current assets................................ 58 21
-------- -------
Net cash used in investing activities............. ( 394) (1,692)
-------- -------
Financing activities:
Proceeds from note payable to Sterling Software, Inc.... 2,500 -0-
Proceeds from note payable to IBM Credit Corporation.... -0- 2,000
Payments on debt........................................ (598) (1,911)
Proceeds from sale of Common Stock and exercise of
stock options.......................................... 31 29
-------- -------
Net cash provided by financing activities......... 1,933 118
-------- -------
Effect of exchange rate changes on cash and cash
equivalents............................................. (227) (441)
-------- -------
Decrease in cash and cash equivalents.................... (2,673) (7,450)
Cash and cash equivalents at beginning of year........... 8,519 16,816
-------- -------
Cash and cash equivalents at end of year.......... $ 5,846 $ 9,366
======== =======
Supplemental disclosures of cash flow information:
Cash paid for:
Interest.............................................. $ 466 $ 335
======== =======
Income taxes.......................................... $ -0- $ -0-
======== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared by [KnowledgeWare] pursuant to the rules and regulations of the
Securities and Exchange Commission regarding interim financial reporting.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements
and should be read in conjunction with the most recent annual audited financial
statements of [KnowledgeWare]. In the opinion of [KnowledgeWare's] management,
the unaudited condensed consolidated financial statements include all
adjustments necessary for a fair presentation. Operating results for the three
months ended September 30, 1994 are not necessarily indicative of the results
expected for the fiscal year ending June 30, 1995.
2. Net Income (Loss) Per Common Share
Net income (loss) per common share is based on [KnowledgeWare's] Common Stock
and is computed using the weighted average number of common and dilutive common
equivalent shares outstanding during the period. Dilutive common equivalent
shares consist of stock options and are calculated based on the treasury stock
method.
3. Income Taxes
[KnowledgeWare] provides for income taxes at the end of each interim period
based on the estimated effective tax rate for the full fiscal year. Cumulative
adjustments to the tax provision are recorded in the interim period in which a
change in the estimated annual effective rate is determined. KnowledgeWare's
net income tax for the first quarter of fiscal 1995 is zero as a result of
significant operating losses. No benefit has been recorded due to limitations
based on a valuation allowance.
4. Inventory
The components of inventory consist of the following (in thousands):
<TABLE>
<CAPTION>
September 30, June 30,
1994 1994
---- ----
<S> <C> <C>
Assembled product kits.......................... $184 $296
Product media, documentation and packaging...... 108 112
---- ----
$292 $408
==== ====
</TABLE>
5. Legal Proceedings
On December 18, 1991, a complaint was filed in the United States District
Court for the Northern District of Georgia, Atlanta Division which consolidated
and amended several class action lawsuits previously filed against KnowledgeWare
in October 1991 (the "1991 Class Action"). The 1991 Class Action was a class
action lawsuit alleging violations of Sections 20 and 10(b) of the Exchange Act
and Rule 10b-5 under the Exchange Act. In summary, the complaint alleged
KnowledgeWare misrepresented or failed to disclose material facts which would
have a material adverse impact on KnowledgeWare or approved such
misrepresentations and omissions. The complaint sought compensatory damages and
reimbursements for the plaintiffs' fees and expenses. On January 26, 1994,
KnowledgeWare entered into and the District Court preliminarily approved a
stipulation of settlement in this lawsuit. By entering into the settlement,
KnowledgeWare did not admit the allegations in the suit and, to the
4
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
5. Legal Proceedings, continued
contrary, denied any wrongdoing. The settlement, which received final court
approval in April 1994, required a cash payment of $1,750,000, all of which was
paid by KnowledgeWare's insurance carrier, and the issuance by KnowledgeWare of
warrants, which allow the holders to acquire an aggregate of 500,000 shares of
KnowledgeWare's Common Stock at a price of $17.50 per share. The warrants are
exercisable for a period of three years from June 9, 1994 (the date of
issuance). On August 30, 1994, the plaintiffs in the 1991 Class Action filed a
motion (the "Motion") alleging that the proposed business combination between
KnowledgeWare and Sterling and the announcement by KnowledgeWare that it
modified its accounting policy for revenue recognition and restated financial
results for the first three quarters of fiscal year 1994 resulted in a
substantially reduced value of the warrants available to the plaintiffs under
the stipulation of settlement. Accordingly, the plaintiffs moved the District
Court for a decree of specific performance of the terms of the stipulation of
settlement entailing the delivery of new warrants of equivalent value to the
original value of the warrants, and for a preliminary injunction of the
consummation of any business combination between KnowledgeWare and Sterling,
pending compliance by KnowledgeWare with the terms of the stipulation of
settlement. Alternatively, the plaintiffs moved for a declaration that the
warrant agreement set forth in the stipulation of settlement was the product of
fraud and for an award to the plaintiffs of the appropriate measure of damages.
Subsequent to the filing of the Motion, the plaintiffs filed a motion with the
District Court to withdraw the request for a preliminary injunction of the
business combination between KnowledgeWare and Sterling.
On August 30 and 31, 1994, five lawsuits were filed against KnowledgeWare in
the United States District Court for the Northern District of Georgia, Atlanta
Division. The respective cases are styled as follows: (1) Marshall Wolf, on
behalf of himself and all others similarly situated v. KnowledgeWare, Inc.,
Francis A. Tarkenton, Donald P. Addington, and Rick W. Gossett, Civil Action
File No. 1:94-CV-2312-JEC; (2) Ernest Deangelis, on behalf of himself and all
others similarly situated v. KnowledgeWare, Inc., Francis A. Tarkenton, Donald
P. Addington, and Rick W. Gossett, Civil Action No. 1:94-CV-2303-JEC; (3) Steven
Covington, on behalf of himself and all others similarly situated v.
KnowledgeWare, Inc., Francis A. Tarkenton, Donald P. Addington, and Rick W.
Gossett, Civil Action File No. 1:94-CV-2301-JEC; (4) Sam Wietschner v.
KnowledgeWare, Inc., Francis A. Tarkenton, Donald P. Addington, and Rick W.
Gossett, Civil Action File No. 1:94-CV-2320-JEC; and (5) Jack Schecter v.
KnowledgeWare, Inc., Francis A. Tarkenton, Donald P. Addington, and Rick W.
Gossett, Civil Action File No. 1:94-CV-2302-JEC. Three lawsuits were filed
against KnowledgeWare in the United States District Court for the Northern
District of Georgia, Atlanta Division on September 12, 22 and 23, 1994. The
respective cases are styled as follows: (6) Subhash Bhardwaj, on behalf of
himself and all others similarly situated v. KnowledgeWare, Inc., Francis A.
Tarkenton, Donald P. Addington, and Rick W. Gossett, Civil Action File No. 1:94-
CV-2427-JEC; (7) Wayne D. Thornhill, individually, as Attorney in Fact for
Georgette C. Thornhill, and on behalf of himself and all others similarly
situated v. KnowledgeWare, Inc., Francis A. Tarkenton, Donald P. Addington, and
Rick W. Gossett, Civil Action File No. 1:94-CV-2538-JEC; and (8) Paul Cross, on
behalf of himself and all others similarly situated v. KnowledgeWare, Inc.,
Francis A. Tarkenton, Donald P. Addington, and Rick W. Gossett, Civil Action
File No. 1:94-CV-2540-JEC (each of those actions numbered 1-8 may be hereinafter
referred to as the "1994 Class Action Suits"). Each of the 1994 Class Action
Suits is purportedly a class action lawsuit on behalf of [KnowledgeWare's]
shareholders alleging violations of Sections 20 and 10(b) of the Exchange Act,
and Rule 10b-5 under the Exchange Act. The alleged factual basis underlying the
1994 Class Action Suits and the relief sought therein is the plaintiffs'
allegations that [KnowledgeWare] and the individual defendants actively
misrepresented or failed to disclose the actual financial condition of
[KnowledgeWare] throughout fiscal year 1994 and that the value of
[KnowledgeWare's] Common Stock was artificially inflated as a result of such
misrepresentations or failures to disclose. Each of the 1994
5
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
5. Legal Proceedings, continued
Class Action Suits seeks compensatory damages and reimbursement for the
plaintiffs' fees and expenses.
On September 9, 1994, a lawsuit styled Ecta Corporation and Fairfield
Development, Inc. v. KnowledgeWare, Inc., Donald P. Addington and Francis A.
Tarkenton, Civil Action File No. 4-94-CV-80587, was filed against
[KnowledgeWare] in the Southern District of Iowa, Central Division (the "Ecta
Suit"). The Ecta Suit is a lawsuit alleging violations of Section 10(b) of the
Exchange Act, Rule 10b-5 under the Exchange Act, Section 12(2) of the Securities
Act, violation of the Iowa Blue Sky Laws (Iowa Stat. Ann. (S) 502.502), fraud
and breach of contract. The alleged factual basis underlying the Ecta Suit
arises in connection with the purchase by [KnowledgeWare] of substantially all
of the assets of ClearAccess Corporation (now known as Ecta Corporation) and
Fairfield Software, Inc. (now known as Fairfield Development, Inc.) pursuant to
an Asset Purchase Agreement dated May 26, 1994 (the "Acquisition Agreement").
The plaintiffs allege that [KnowledgeWare] and the individual defendants
misrepresented or failed to disclose the actual financial condition of
[KnowledgeWare], that the value of [KnowledgeWare's] Common Stock was
artificially inflated as a result of such misrepresentations or failures to
disclose and that [KnowledgeWare] has breached certain warranties,
representations and covenants made in the Acquisition Agreement. The Ecta Suit
seeks compensatory damages, rescission of the Acquisition Agreement and/or the
sale of [KnowledgeWare's] securities issued pursuant thereto, punitive damages,
prejudgment interest, and reimbursement of attorneys' fees and costs.
The plaintiffs in the above-described actions seek unspecified compensatory
damages, legal fees and litigation costs. [KnowledgeWare] is unable to predict
the outcome or the potential financial impact of the above-described legal
proceedings either as an amount or range of amounts. [KnowledgeWare] does,
however, believe defense costs related to the proceedings will equal or exceed
the retention amount of $500,000 under the applicable insurance policies.
[KnowledgeWare] has, therefore, accrued a $500,000 loss relative to these
matters in the quarter ended September 30, 1994. For the 12 month period ended
September 30, 1994, KnowledgeWare maintained directors and officers liability
insurance policies with a maximum aggregate loss amount of $4.0 million. Losses,
claims, judgements costs and expenses of Knowledgeware and Sterling resulting
from the above-described actions will also result in claims for indemnification
to be satisfied from the escrowed shares provided for in the Amended Merger
Agreement. As of October 26, 1994, KnowledgeWare estimates that approximately
$55,000 of costs and expenses have been incurred since August 31, 1994 with
respect to the above-described actions.
KnowledgeWare has received informal requests for information from the Staff of
the Securities and Exchange Commission as to which persons and entities had
knowledge of the negotiations between KnowledgeWare and Sterling prior to the
public announcement of the Merger Agreement on August 1, 1994, and as to the
circumstances with respect to KnowledgeWare's restatement of financial results
for the first three quarters of fiscal 1994. Additionally, a request has been
received [by KnowledgeWare] from the National Association of Securities Dealers,
Inc. for information as to persons and entities who may have had information
concerning events preceding the press release of KnowledgeWare made on August
30, 1994 regarding results for fiscal 1994.
On October 27, 1994, KnowledgeWare received a letter on behalf of certain
persons (the "Investors") who purchased shares of KnowledgeWare Common Stock
pursuant to a stock purchase agreement between the Investors and KnowledgeWare
dated January 26, 1994. The Investors assert that in light of, among other
things, KnowledgeWare's announcement on September 1, 1994 and KnowledgeWare's
other public statements disclosing its restatement of its financial statements
for the first, second and third quarters of fiscal 1994, it is the position of
the Investors that KnowledgeWare is in breach of the representations and
warranties it made to the Investors in the stock purchase agreement and seek to
recover damages in the amount of approximately $9.5 million, representing the
difference between the
6
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
- --------------------------------------------------------------------------------
5. Legal Proceedings, continued
aggregate purchase price the Investors paid for their KnowledgeWare Common Stock
and the aggregate price for which they sold those shares.
6. Reclassifications
Certain changes in the presentation of amounts as of and for the three
months ended September 30, 1993 have been made to conform to the comparable
presentations as of and for the three months ended September 30, 1994.
7. Note Payable
On August 31, 1994 [KnowledgeWare] entered into a revolving and term loan
agreement with Sterling to replace the loan agreement with IBM Credit
Corporation and expand [KnowledgeWare's] borrowing capacity. The agreement
provides for maximum borrowings under the loan arrangement of $22,000,000,
(including a revolving line of credit of $16,000,000 and a term loan of
$6,000,000), the issuance of 70,250 warrants to purchase [KnowledgeWare's]
common stock at its fair market value upon the date of issuance (initially $4.50
per share) for each one million dollars drawn; and interest at 1 1/4% over prime
and a maturity date of August 31, 1995. [KnowledgeWare] has reserved a maximum
of 1,545,500 shares of its Common Stock for issuance under the loan agreement
with Sterling. On October 25, 1994, Sterling and KnowledgeWare amended the
arrangement to increase the revolving portion of the facility to $22,000,000 and
agreed to waive the borrowing base requirements with respect to borrowings of up
to $16,000,000 under the revolving portion of the facility. [KnowledgeWare] has
reserved an additional 421,500 shares of its Common Stock for issuance under the
loan agreement with Sterling.
8. Corporate Restructuring Charge
As a result of a rapidly changing operating environment and disappointing
fiscal 1994 performance, [KnowledgeWare] implemented a plan to restructure its
operations in the first quarter of fiscal 1995. The plan included the
termination of approximately 250 employees, consolidation of corporate real
estate and the closing of certain European subsidiaries. The restructuring
charge of $6,205,000 included approximately $4,000,000 related to the reduction
of personnel, $1,800,000 related to consolidation of corporate real estate and
$400,000 related to the closing of certain European subsidiaries. Accrued
expenses at September 30, 1994 include approximately $3,500,000 relative to this
restructuring charge and approximately $1,100,000 relative to a restructuring
charge in the third quarter of fiscal 1993.
9. Liquidity
[KnowledgeWare] has suffered recurring losses from operations. These losses
have resulted in negative working capital and an accumulated deficit. In
addition, losses in the fourth quarter of fiscal 1994 violated financial
covenants in the line of credit agreement with IBM Credit Corporation for which
[KnowledgeWare] received a waiver until September 30, 1994. The loan was
subsequently acquired and amended by Sterling Software, Inc. Management [of
KnowledgeWare] believes that existing cash balances must be supplemented by
additional cash from outside sources in order to fund currently anticipated cash
and capital requirements.
Understanding its strategic alternatives, including remaining an independent
company and the impact of financial constraints on its ability to invest in and
execute future plans, management [of KnowledgeWare]
7
<PAGE>
KNOWLEDGEWARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
- --------------------------------------------------------------------------------
9. Liquidity, continued
engaged Alex Brown to seek potential candidates for a business combination. On
July 31, 1994 the Board of Directors [of KnowledgeWare] approved [the] plans [of
KnowledgeWare's management] to enter into a merger agreement with Sterling
Software. Management [of KnowledgeWare] announced on August 1, 1994, it had
entered into a Merger Agreement and an Amended and Restated Merger Agreement was
executed as of August 31, 1994.
The financial statements [of KnowledgeWare] do not include any adjustments
that may be necessary as a result of this uncertainty.
8
