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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 3, 1994
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Sterling Software, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 1-8467 75-1873956
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(State or other jurisdiction (Commission (IRS Employer
of incorporation File Number) Identification No.)
8080 N. Central Expwy., Suite 1100, Dallas, Texas 75206
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (214) 891-8600
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ITEM 5. OTHER EVENTS.
GENERAL
On August 31, 1994, Sterling Software, Inc., a Delaware corporation
("Sterling"), and SSI Corporation, a Georgia corporation and a recently
organized wholly owned subsidiary of Sterling ("Merger Sub"), entered into an
Amended and Restated Agreement and Plan of Merger (as amended, the "Merger
Agreement") with KnowledgeWare, Inc., a Georgia corporation ("KnowledgeWare"),
pursuant to which, among other things, (i) Merger Sub will be merged with and
into KnowledgeWare, which will be the surviving corporation and will become a
wholly owned subsidiary of Sterling (the "Merger") and (ii) 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) will be
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 will be
entitled to receive .1322 of a share of Sterling Common Stock for each share of
KnowledgeWare Common Stock; the remaining 20% of the number of shares of
Sterling Common Stock issuable upon effectiveness of the Merger will be placed
in escrow (the "Escrowed Shares") pursuant to the terms of an escrow agreement
(the "Escrow Agreement") and thereafter 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 ("Action") (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 (as defined below) will be assumed by
Sterling; provided that (a) each such option or Warrant will become 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 will become 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. Consummation of the Merger
is subject to the approval and adoption by the KnowledgeWare stockholders of the
Merger Agreement, as well as certain other conditions set forth in the Merger
Agreement. The Special Meeting of Stockholders of KnowledgeWare is scheduled to
be held on November 30, 1994, at the Hotel Nikko, 3300 Peachtree Road, Atlanta,
Georgia, commencing at 10:00 a.m. local time.
All information contained in this Form 8-K relating to KnowledgeWare has
been supplied to Sterling by KnowledgeWare. This Form 8-K summarizes certain
provisions of the Merger Agreement and the Escrow Agreement, copies of which are
included as exhibits to this Form 8-K. Such summaries are qualified in their
entirety by reference to the full text of such agreements.
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BACKGROUND OF THE MERGER
On July 31, 1994, Sterling, KnowledgeWare and Merger Sub entered into an
Agreement and Plan of Merger (the "Initial Merger Agreement") contemplating,
among other things, an exchange ratio of .2983 of a share of Sterling Common
Stock for each share of KnowledgeWare Common Stock outstanding (the "Original
Exchange Ratio").
Following execution of the Initial Merger Agreement, KnowledgeWare
continued to work on finalizing its fourth quarter and year-end financial
results. During the course of its 1994 fiscal year end audit, KnowledgeWare and
its independent auditors undertook an evaluation of KnowledgeWare's credit
procedures for its third party resellers and its fiscal 1994 collection
experience on reseller accounts receivable. This review led KnowledgeWare, in
consultation with its independent auditors, to reevaluate KnowledgeWare's
accounting policy for revenue recognition on sales to third party resellers and
to discuss the possible modification of its accounting policy on the recognition
of revenue for sales to resellers. KnowledgeWare considered that the effect of
such a modification of accounting policy would be retroactive, resulting in a
restatement of first, second and third quarter revenues for fiscal year 1994 and
a lower level of fourth quarter revenue, and resulting in the existence of a
shortfall in eligible receivables under its Revolving Loan and Security
Agreement (the "Loan Agreement") with IBM Credit Corporation ("IBM Credit"), all
of which could create the possibility that Sterling could terminate the Initial
Merger Agreement. On August 30, 1994, KnowledgeWare announced that it expected
a significant loss for its fiscal year and that it anticipated restating
previously reported financial results for prior quarters in fiscal 1994.
KnowledgeWare also announced that it was negotiating possible revisions to the
Initial Merger Agreement and that it would require additional waivers of non-
compliance with covenants under the Loan Agreement with IBM Credit and
additional working capital from IBM Credit or Sterling.
Renegotiation of the Initial Merger Agreement by the managements of
KnowledgeWare and Sterling led to the execution of the Merger Agreement, which
contains the revised terms of the Merger. Under the Merger Agreement, the
Original Exchange Ratio was revised so that holders of KnowledgeWare Common
Stock will be entitled to receive up to .1653 of a share of Sterling Common
Stock for each share of KnowledgeWare Common Stock. Promptly after the Merger,
KnowledgeWare common stockholders will be entitled to receive .1322 of a share
of Sterling Common Stock for each share of KnowledgeWare Common Stock; the
remaining 20% of the number of shares of Sterling Common Stock issuable upon
effectiveness of the Merger will be placed in escrow pursuant to the terms of
the Escrow Agreement and thereafter 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
Action (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.
Sterling is entitled to indemnification concerning certain Actions pending
as of the date of the Merger Agreement or thereafter arising, including Actions
arising out of violations or alleged violations of securities laws, but
excluding any Actions arising out of ordinary course of business transactions,
Actions brought by current or former employees with respect to their employment
or termination thereof and certain other Actions. As discussed in detail below,
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since August 30, 1994, a number of Actions have been filed against KnowledgeWare
and certain of its officers alleging violations of securities laws. If these
Actions result in losses, claims, liabilities, judgments, costs or expenses
(including amounts paid in settlement) to KnowledgeWare, Merger Sub 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, Merger Sub
or Sterling, no Escrowed Shares will be distributed to the KnowledgeWare common
stockholders. 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 these Actions. Neither KnowledgeWare nor Sterling is able
to quantify the amount of losses, claims, liabilities, judgments, costs or
expenses likely to be paid from the Escrowed Shares in connection with such
Actions because such Actions have only recently been filed, discovery has not
commenced and KnowledgeWare and its advisors cannot estimate the loss, if any,
that will result from the ultimate resolutions of such Actions. There can be no
assurance that additional Actions will not arise in the future that will result
in a claim for indemnification to be satisfied from the Escrowed Shares. In
addition, there can be no assurance that the proceeds from any applicable
insurance and the value of the Escrowed Shares will be sufficient to cover all
losses, claims, liabilities, judgments, costs or expenses in connection with
Actions for which Sterling is entitled to be indemnified.
FINANCIAL CONDITION OF KNOWLEDGEWARE
In early fiscal 1994, KnowledgeWare initiated a business plan to market its
products through indirect distribution channels, which included third party
resellers in both the commercial and government markets. Based on the
successful receivable collection experience of KnowledgeWare with respect to end
user customers, KnowledgeWare did not anticipate significant collection
difficulties from its newly implemented reseller program and, accordingly, did
not implement specific credit procedures for the program. In the course of the
1994 year-end closing process, KnowledgeWare became aware that certain resellers
asserted that they either could not or were not required to pay KnowledgeWare
until they had consummated sales to end users and received payments for the
products. After careful analysis of these receivables, KnowledgeWare modified
its accounting policy for reseller license revenue recognition to more
accurately reflect its collection experience from the third party reseller
program, retroactive to the beginning of fiscal 1994. In addition, during
fiscal 1994, KnowledgeWare incurred increased selling and marketing costs
relative to KnowledgeWare's newer product lines in expectation of significantly
increased product license revenues which were not realized. KnowledgeWare
incurred a net loss for fiscal 1994 of $19.0 million.
As a result, certain covenants in the Loan Agreement were violated, which
caused all amounts owed thereunder to be immediately due and payable. The loss,
together with the covenant violations, resulted in the inclusion in the
auditors' report on the financial statements of KnowledgeWare of an explanatory
paragraph indicating that, at June 30, 1994, there existed substantial doubt
about KnowledgeWare's ability to continue as a going concern.
To help alleviate KnowledgeWare's anticipated cash flow problems, Sterling
acquired by assignment all of the interest and right of IBM Credit in the Loan
Agreement by paying to IBM
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Credit approximately $15.1 million, which was equal to all amounts owed
thereunder by KnowledgeWare. Concurrently, Sterling and KnowledgeWare modified
the Loan Agreement (as amended, the "Amended Loan Agreement"), among other
things, to (i) increase the term loan portion of the facility from $2.7 million
to $6 million and fix the revolving portion of the facility at $16 million, (ii)
reformulate the borrowing base computation to increase the borrowing capacity
based on KnowledgeWare's eligible accounts receivable and (iii) modify certain
covenants. In addition, in October 1994, Sterling and KnowledgeWare amended the
Amended Loan Agreement to increase the revolving portion of the facility to $22
million and agreed to waive the borrowing base requirements with respect to
borrowings of up to $16 million under the revolving portion of the facility.
Sterling expects that it likely will grant additional waivers with respect to
the borrowing base requirements if KnowledgeWare needs additional cash to fund
operations prior to the consummation of the Merger.
KnowledgeWare anticipates that it will incur a substantial operating loss
in the first quarter of fiscal 1995. In addition, KnowledgeWare expects to
report a charge to earnings in the first quarter of fiscal 1995 of approximately
$6 million attributable to its previously announced plan of restructuring.
KnowledgeWare may also report a charge to earnings in the first quarter of
fiscal 1995 with respect to the 1991 Class Action, the 1994 Class Action Suits
and the Ecta Suit (defined below); however, the amount of such charge, if any,
could not be estimated as of October 28, 1994. KnowledgeWare anticipates filing
its Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 on or
before November 14, 1994 and publicly announcing such results on or before such
date.
CERTAIN LEGAL PROCEEDINGS REGARDING KNOWLEDGEWARE
On December 18, 1991, a complaint (the "1991 Class Action") 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 was a class
action lawsuit alleging violations of Sections 20 and 10(b) of the Securities
Exchange Act of 1934, as amended (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 compliant
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 of the 1991 Class
Action (the "Settlement Agreement"). By entering into the settlement,
KnowledgeWare did not admit the allegations in the suit and, to the contrary,
denied any wrongdoing. The Settlement Agreement, 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 (the "Warrants") to purchase an aggregate of 500,000 shares of
KnowledgeWare 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 to Enforce Stipulation of Settlement for Temporary Injunction of Merger
and for Damages Resulting from Fraud" (the "Motion"). In the Motion, the
plaintiffs allege that the proposed business combination between KnowledgeWare
and Sterling and an announcement by KnowledgeWare that it modified its
accounting policy for revenue recognition and restated
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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 Settlement Agreement. Accordingly, the plaintiffs moved the District Court
for a decree of specific performance of the terms of the Settlement Agreement
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 Settlement Agreement. Alternatively, the
plaintiffs moved for a declaration that the Warrant Agreement set forth in the
Settlement Agreement was the product of fraud and for an award to the plaintiffs
of the appropriate measure of damages.
On August 30 and 31, 1994, and September 12, 22 and 23, 1994, eight
lawsuits were filed against KnowledgeWare 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 KnowledgeWare stockholders 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 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 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 of 1933, as amended,
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 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.
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
initial public announcement of the proposed Merger on August 1, 1994, and as to
the circumstances with respect to the restatement by KnowledgeWare of financial
results for the first three quarters of 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
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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 aggregate purchase price the Investors paid for their KnowledgeWare
Common Stock and the aggregate price for which they sold those shares.
INTERESTS OF CERTAIN PERSONS IN THE MERGER
Sterling has agreed in the Merger Agreement to assume all outstanding
options granted under KnowledgeWare's Incentive Stock Option Plan of 1984,
Second Incentive Stock Option Plan of 1984, 1988 Stock Incentive Plan, 1989 Non-
Employee Directors Stock Option Plan, 1989 Employee Stock Purchase Plan and 1993
Non-Employee Directors Stock Option Plan (collectively, the "KnowledgeWare Stock
Option Plans"). As of October 6, 1994 there were options outstanding to
purchase an aggregate of 1,545,202 shares of KnowledgeWare Common Stock at a
weighted average exercise price of $9.64 per share. Following the Merger, no
new options will be granted under the KnowledgeWare Stock Option Plans.
Sterling has agreed that all rights to indemnification and advancement of
expenses existing in favor of the current and former directors and officers of
KnowledgeWare, to the extent provided under KnowledgeWare's Articles of
Incorporation, Bylaws and indemnification agreements as of the date of the
Merger Agreement, shall survive for at least six years following the Merger, and
Sterling has agreed to indemnify and advance expenses to such persons to the
full extent as would be required of or permitted by KnowledgeWare. In addition,
to the extent available, Sterling has agreed to cause KnowledgeWare to maintain,
for three years following the Merger, KnowledgeWare's current directors' and
officers' liability insurance, or comparable insurance, with respect to matters
occurring prior to the Merger; provided that in no event will Sterling or
KnowledgeWare be required to expend more than $500,000 in the aggregate to
procure or maintain such insurance, and Sterling and KnowledgeWare will only be
required to obtain as much comparable insurance as is available for an aggregate
expenditure of $500,000. KnowledgeWare has received a binder for a one year
directors' and officers' liability insurance policy with an aggregate limit
comparable to that under KnowledgeWare's prior policy. If KnowledgeWare is
acquired by Sterling during the policy term, the policy converts into a three
year "run-off" policy. The premium for this policy is $600,000. Sterling and
KnowledgeWare have agreed that the payment of such premium by KnowledgeWare
shall satisfy Sterling's obligation to maintain or procure such liability
insurance.
Following the effective time of the Merger, Sterling will enter into a
three year Consultation Agreement with Francis A. Tarkenton, the Chairman of the
Board and Chief Executive Officer of KnowledgeWare, pursuant to which he will be
compensated by Sterling at the rate of $300,000 per year plus the reimbursement
of certain expenses. In addition, following the effective time of the Merger,
Mr. Tarkenton will be added to the Sterling Board of Directors. As a member of
the Sterling board, Mr. Tarkenton will be entitled to Sterling's
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customary outside directors' fees, currently $22,500 per annum and $2,500 for
each meeting attended.
Sterling has acquired by assignment all of the interest and right of IBM
Credit under the Loan Agreement with KnowledgeWare by paying to IBM Credit
approximately $15.1 million, which was equal to all amounts owed thereunder by
KnowledgeWare. Concurrently, Sterling and KnowledgeWare modified the terms of
the Loan Agreement, among other things, to (i) increase the term loan portion of
the facility from $2.7 million to $6 million and fix the revolving portion of
the facility at $16 million, (ii) reformulate the borrowing base computation to
increase the borrowing base capacity based on KnowledgeWare's eligible accounts
receivable and (iii) modify certain covenants. As an inducement to Sterling's
entry into the Amended Loan Agreement, KnowledgeWare agreed to issue to Sterling
warrants to purchase 70,250 shares of KnowledgeWare Common Stock for each
$1,000,000 currently outstanding or subsequently advanced under the loan. The
warrants will be immediately exercisable, expire five years from their date of
issuance and the exercise price will be equal to the market price of
KnowledgeWare Common Stock as of the business day preceding the date of the
advance giving rise to the warrants' issuance. As of October 25, 1994,
KnowledgeWare had issued to Sterling warrants to purchase 1,405,000 shares of
KnowledgeWare Common Stock at a weighted average exercise price of $4.43 per
share. As of October 25, 1994, approximately $4.9 million in additional funds
had been advanced by Sterling to KnowledgeWare since Sterling acquired IBM
Credit's interest in the Loan Agreement. Sterling's entry into the Amended Loan
Agreement was not a condition to the parties' entering into the Merger
Agreement. On October 25, 1994, Sterling and KnowledgeWare amended the Amended
Loan Agreement to increase the revolving portion of the facility to $22 million
and agreed to waive the borrowing base requirements with respect to borrowings
of up to $16 million under the revolving portion of the facility. Sterling
expects that it likely will grant additional waivers with respect to the
borrowing base requirements if KnowledgeWare needs additional cash to fund
operations prior to the consummation of the Merger.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE EFFECTS OF THE PROPOSED MERGER ON
THE FUTURE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF STERLING
The Boards of Sterling and KnowledgeWare believe that the proposed Merger
represents an opportunity to create one of the leading software and services
companies in the world, which will be able to provide its customers with a broad
range of products and excellent customer support and assist their movement
toward enterprise-wide computing. Specifically, the Boards of Sterling and
KnowledgeWare believe that the combined company will have 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 will continue to be a leading provider of electronic
commerce software and services in North America, to provide a broad offering of
enterprise-wide systems management software tools and to have a strong presence
in the complex federal systems market. The combined company is expected to be a
leading vendor of application development tools, and will have a substantial
worldwide customer base, a broader global distribution network, a work force of
approximately 3,500 skilled employees and an expected high level of recurring
revenue, all of which Sterling and KnowledgeWare believe will position the
combined company for significant future growth.
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Substantial costs are expected to 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 writeoff 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 million and are included in the aggregate cost of the Merger.
Such costs related to Sterling are expected to be approximately $12 million and
are expected to be charged to the future results of operations of the combined
company and are excluded from the pro forma combined results of operations. The
pro forma combined results of operations also exclude approximately $46.0
million of purchased research and development costs which will be charged to
expense in the period the Merger is consummated.
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 and KnowledgeWare
currently expect to realize as a result of the consolidation of their
operations. 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.
Included on pages A-1 to A-19 of this Current Report on Form 8-K are the
following audited consolidated financial statements, and the notes thereto, of
KnowledgeWare: (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.
b. Pro Forma Financial Information.
Included on pages B-1 to B-6 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 June 30, 1994; (ii)
the unaudited Pro Forma Combined Condensed Statements of Operations of Sterling
and KnowledgeWare for the nine months ended June 30, 1994; (iii) the unaudited
Pro Forma Combined Condensed Statements of Operations of Sterling and
KnowledgeWare for the year ended September 30, 1993; and (iv) the related notes
thereto. The pro forma combined condensed balance sheet assumes the Merger had
been consummated on June 30, 1994. The pro forma combined condensed statements
of operations assume the Merger had been consummated as of October 1, 1992.
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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
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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)
24 Consent of Coopers & Lybrand L.L.P. (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.
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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
A-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.
A-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.
A-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.
A-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.
A-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
A-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.
A-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>
A-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>
A-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
A-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
A-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
A-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
A-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.
A-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
A-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
A-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
A-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
A-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.
A-19
<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 June
30, 1994. The pro forma combined condensed statements of operations assume the
Merger had been consummated as of October 1, 1992.
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.
B-1
<PAGE>
STERLING SOFTWARE, INC.
PRO FORMA COMBINED CONDENSED BALANCE SHEET
JUNE 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... $106,865 $ 8,519 $(15,766)(d) ++ $ 99,318
(300)(e)++
Marketable securities....... 34,710 -- -- 34,710
Accounts and notes
receivable, net............ 113,616 37,532 -- 151,148
Deferred income tax asset... 10,158 3,356 4,800 (f) 18,314
Prepaid expenses and other
current assets............. 10,676 3,776 -- 14,452
-------- -------- -------- --------
Total current assets...... 276,025 53,183 (11,266) 317,942
Property and equipment, net... 32,752 21,825 (5,000)(c) 49,577
++
Computer software, net........ 60,303 28,382 (3,382)(c) ++ 82,303
(3,000)(f)++
Noncurrent deferred income tax
asset, net................... 3,734 -- -- 3,734
Excess cost over net assets
acquired, net................ 52,398 14,616 7,842 (c) 74,856
Other assets.................. 25,173 1,638 -- 26,811
Investment in and advances to ++
KnowledgeWare................ -- -- 97,811 (a) +
(45,460)(c) ++ --
(52,351)(b)++
-------- -------- -------- --------
Total assets.................. $450,385 $119,644 $(14,806) $555,223
======== ======== ======== ========
Current liabilities:
Notes payable and current
portion of long-term debt.. $ 9,043 $ 17,393 $(15,766)(d) $ 10,670
Accounts payable and accrued ++
liabilities................ 75,461 22,809 25,000 (a) ++ 132,270
9,000 (f)++
Deferred revenue............ 66,582 22,734 -- 89,316
-------- -------- -------- --------
Total current liabilities. 151,086 62,936 18,234 232,256
Long-term debt................ 116,267 836 -- 117,103
Other noncurrent liabilities.. 27,602 3,521 -- 31,123
Stockholders' equity:
Preferred stock............. 20 -- -- 20
Common stock................ 2,202 72,548 241 (a) 2,443
(72,548)(b)
++
Additional paid-in capital.. 191,174 -- 54,532 (a) ++ 245,406
(300)(e)++
++
Accumulated deficit......... (18,748) (20,197) (46,000)(c) +
20,197 (b) ++ (71,948)
(7,200)(f)++
Less: Treasury stock........ (19,218) -- 18,038 (a) (1,180)
-------- -------- -------- --------
Total stockholders'
equity................... 155,430 52,351 (33,040) 174,741
-------- -------- -------- --------
Total liabilities and
stockholders' equity......... $450,385 $119,644 $(14,806) $555,223
======== ======== ======== ========
Shares of common stock
outstanding.................. 20,214 2,407 22,621
======== ======== ========
</TABLE>
See accompanying notes.
B-2
<PAGE>
STERLING SOFTWARE, INC.
PRO FORMA COMBINED CONDENSED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED JUNE 30, 1994
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
KNOWLEDGEWARE
----------------------------------------------
STERLING DEDUCT HISTORICAL PRO FORMA PURCHASE
HISTORICAL HISTORICAL THREE MONTHS NINE MONTHS ACCOUNTING
NINE MONTHS ENDED YEAR ENDED ENDED ENDED ADJUSTMENTS PRO FORMA
JUNE 30, 1994 JUNE 30, 1994 SEPTEMBER 30, 1993 JUNE 30, 1994 (NOTE 3) COMBINED
----------------- ------------- ------------------ ------------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Revenue:
Products............... $122,148 $ 71,294 $19,147 $ 52,147 $174,295
Product support........ 98,065 39,698 9,472 30,226 128,291
Services............... 117,913 21,499 4,605 16,894 134,807
-------- -------- ------- -------- --------
338,126 132,491 33,224 99,267 437,393
Costs and expenses:
Cost of sales:
Products and product ++
support............... 46,886 22,259 4,768 17,491 $ (3) (a) + 64,329
(45) (b) ++
++
Services............... 79,360 18,389 3,682 14,707 (9) (b) 94,058
Selling, general and
administrative........ 123,461 86,743 16,899 69,844 193,305
Product development and
enhancement........... 23,439 24,196 6,155 18,041 41,480
-------- -------- ------- -------- ------ --------
Total costs and
expenses............ 273,146 151,587 31,504 120,083 (57) 393,172
-------- -------- ------- -------- ------ --------
Income (loss) before
other income (expense),
and income taxes....... 64,980 (19,096) 1,720 (20,816) 57 44,221
Other income (expense).. (1,804) 66 (185) 251 386 (c) (1,167)
-------- -------- ------- -------- ------ --------
Income (loss) before
income taxes........... 63,176 (19,030) 1,535 (20,565) 443 43,054
Provision (benefit) for
income taxes........... 23,650 -- 153 (153) 23,497
-------- -------- ------- -------- ------ --------
Net income (loss)....... $ 39,526 $(19,030) $ 1,382 $(20,412) $ 443 $ 19,557
======== ======== ======= ======== ====== ========
Net income (loss) per
common share (Note 4):
Primary................ $ 1.75 $ 0.79
======== ========
Fully diluted.......... $ 1.60 $ 0.79
======== ========
Shares used to compute
per share data (Note
4):
Primary................ 22,568 2,272 24,840
======== ====== ========
Fully diluted.......... 26,624 (1,784) 24,840
======== ====== ========
</TABLE>
See accompanying notes.
B-3
<PAGE>
STERLING SOFTWARE, INC.
PRO FORMA COMBINED CONDENSED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED SEPTEMBER 30, 1993
(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 30,1993 JUNE 30, 1993 SEPTEMBER 30, 1992 SEPTEMBER 30, 1993 SEPTEMBER 30, 1993 (NOTE 3) COMBINED
----------------- ------------- ------------------ ------------------ ------------------ ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Products.......... $150,473 $ 80,307 $19,950 $19,147 $ 79,504 $229,977
Product support... 121,268 35,256 8,344 9,472 36,384 157,652
Services.......... 140,054 13,198 1,663 4,605 16,140 156,194
-------- -------- ------- ------- -------- --------
411,795 128,761 29,957 33,224 132,028 543,823
Costs and expenses:
Cost of sales:
Products and ++
product support. 65,998 17,051 2,982 4,768 18,837 $ 1,410 (a) + 87,002
757 (b) ++
++
Services......... 105,133 7,487 1,084 3,682 10,085 105 (b) 115,323
Sales, general
and
administrative... 168,174 80,919 17,246 16,899 80,572 248,746
Product
development and
enhancement...... 26,630 28,867 7,642 6,155 27,380 54,010
Restructuring
charges.......... 91,260 21,976 -- -- 21,976 113,236
-------- -------- ------- ------- -------- ------- --------
Total costs and
expenses....... 457,195 156,300 28,954 31,504 158,850 2,272 618,317
-------- -------- ------- ------- -------- ------- --------
Income (loss)
before other
income (expense)
income taxes,
extraordinary item
and cumulative
effect of a change
in accounting
principle......... (45,400) (27,539) 1,003 1,720 (26,822) (2,272) (74,494)
Other income (ex-
pense)............ (2,933) 340 228 (185) (73) 515 (c) (2,491)
-------- -------- ------- ------- -------- ------- -------
Income (loss)
before income
taxes,
extraordinary item
and cumulative
effect of a change
in accounting
principle ........ (48,333) (27,199) 1,231 1,535 (26,895) (1,757) (76,985)
Provision (benefit)
for income taxes.. (14,983) (1,400) 437 153 (1,684) (16,667)
-------- -------- ------- ------- -------- ------- --------
Income (loss)
before
extraordinary item
and cumulative
effect of a change
in accounting
principle......... $(33,350) $(25,799) $ 794 $ 1,382 $(25,211) $(1,757) $(60,318)
======== ======== ======= ======= ======== ======= ========
Income (loss) per
common share
before
extraordinary item
and cumulative
effect of a change
in accounting
principle (Note
4):
Primary........... $ (2.00) $ (3.13)
======== ========
Fully diluted..... $ (2.00) $ (3.13)
======== ========
Shares used to
compute per share
data (Note 4):
Primary........... 17,200 2,407 19,607
======== ======= ========
Fully diluted..... 17,200 2,407 19,607
======== ======= ========
</TABLE>
See accompanying notes.
B-4
<PAGE>
STERLING SOFTWARE
NOTES TO PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS
1.GENERAL
The Merger is expected to be accounted for as a purchase. The pro forma
combined condensed financial statements reflect the issuance of 2,407,005
shares of Sterling Common Stock for an aggregate 14,562,381 shares of
KnowledgeWare Common Stock (KnowledgeWare Common Stock outstanding as of
June 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 to be issued will be 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
$97.8 million which represents the estimated value of the Sterling Common
Stock to be issued (based on a price of $30.25 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:
<TABLE>
<S> <C>
Investment advisor, legal, accounting and other professional
fees............................................................ $ 2,800
Out of pocket costs related to due diligence and acquisition
evaluation...................................................... 2,500
KnowledgeWare employee severance and benefits.................... 8,500
Elimination of duplicate facilities and leases of KnowledgeWare.. 7,700
Other merger related liabilities................................. 3,500
-------
$25,000
=======
</TABLE>
Such costs, including the write-off of costs related to certain software
products which will not be actively marketed by the combined company,
related to Sterling's current operations are expected to be approximately
$12 million and will be charged to the results of operations of the
combined company upon consummation of the Merger.
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 not be determined
until after consummation of the Merger and will be based on a complete
evaluation of the assets and liabilities of KnowledgeWare as acquired.
Accordingly, the information presented herein may differ from the actual
purchase price allocation.
2.PRO FORMA COMBINED CONDENSED BALANCE SHEET
The accompanying pro forma combined condensed balance sheet assumes the
Merger was consummated on June 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.
B-5
<PAGE>
(c) To record the aggregate cost of the Merger of $97.8 million as follows:
<TABLE>
<S> <C>
Working capital (deficit). $(9,753)
Property and equipment.... 16,825
Software.................. 25,000
Purchased research and
development costs charged
to expense............... 46,000
Other assets.............. 1,638
Other liabilities......... (4,357)
Excess cost over net
assets acquired.......... 22,458
-------
$97,811
=======
</TABLE>
(d) To record the repayment of all amounts outstanding under
KnowledgeWare's line of credit agreement with IBM Credit.
(e) To record direct costs associated with registering the shares of
Sterling Common Stock.
(f) To record costs associated with Sterling's elimination duplicate
facilities, severance costs relating to termination of certain
employees and the writeoff 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 statements of operations have been prepared
as if the Merger was consummated as of October 1, 1992 and reflects the
following pro forma adjustments:
(a) To record amortization of purchased software computed using the 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
IBM Credit 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 pro forma income (loss) before extraordinary items and
cumulative effect of change in accounting principle, 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. Additionally, income applicable to common stockholders has been
reduced to reflect combined pro forma preferred dividends of $.1 million
and $1.0 million, for the nine months ended June 30, 1994 and the year
ended September 30, 1993, respectively.
The combined pro forma 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") in the 1994
computations, and the conversion of Sterling's 8% Convertible Subordinated
Debentures due 2001 (the "8% Debentures") and the conversion of the 5 3/4%
Debentures in the 1993 computations, if such conversions have a dilutive
effect. Upon assumed conversion of Sterling's convertible debentures,
income applicable to common stockholders is adjusted to reflect the
elimination of after tax interest expense related to such debentures. For
purposes of these computations, 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.
For the year ended September 30, 1993, neither the common share equivalents
nor the assumed conversion of the convertible debentures had a dilutive
effect on the pro forma loss per share calculations. Accordingly, the pro
forma loss per share calculation for such period is based on the weighted
average number of common shares outstanding during the period.
B-6
<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: November 3, 1994
By: George H. Ellis
-------------------------------------
Its: Executive Vice President and
-------------------------------------
Chief Financial Officer
-------------------------------------
<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)
- - - ---------------------------------------
(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 and No. 33-54961), 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 and No.
33-53833), 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.
November 3, 1994
