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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 ACT OF 1934
Date of Report (Date of Earliest Event Reported) DECEMBER 20, 1995
STERLING SOFTWARE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
DELAWARE 1-8465 75-1873956
(STATE OF (COMMISSION (IRS EMPLOYER
INCORPORATION) FILE NUMBER) IDENTIFICATION NO.)
8080 NORTH CENTRAL EXPRESSWAY, SUITE 1100, DALLAS, TEXAS 75206
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (214) 891-8600
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<PAGE>
ITEM 5. OTHER EVENTS
PROPOSED SUBSIDIARY INITIAL PUBLIC OFFERING
On December 20, 1995, Sterling Commerce, Inc. ("SCI"), a wholly owned
subsidiary of Sterling Software, Inc. ("Sterling Software"), filed a
Registration Statement on Form S-1 (the "Registration Statement") with the
Securities and Exchange Commission (the "Commission"), for the purpose of
effecting an initial public offering (the "Offering") of up to 13,800,000
shares (the "Shares") of common stock, par value $.01 per share of SCI ("SCI
Common Stock"). In the Registration Statement, SCI has preliminarily estimated
that the initial public offering price will be between $20.00 and $22.00 per
Share. In the Offering, up to 11,200,000 Shares are to be sold by Sterling
Software and 1,800,000 Shares are to be sold by SCI. Following completion of
the Offering as presently contemplated, Sterling Software would own
approximately 84.0% of the outstanding SCI Common Stock (approximately 81.6% if
the over-allotment options to be granted by Sterling Software to the
underwriters are exercised in full). The Offering is expected to be completed
in the second quarter of fiscal 1996.
FORMATION TRANSACTIONS
Sterling Software incorporated SCI as a Delaware corporation in December
1995. In contemplation of the Offering, among other things, (i) Sterling
Software presently intends to cause to be transferred to SCI (a) all of the
issued and outstanding shares of capital stock of the subsidiaries comprising
Sterling Software's Electronic Commerce Group, (b) certain assets relating to
the electronic commerce business currently conducted by Sterling Software's
International Group and (c) certain assets relating to the electronic commerce
business currently conducted by Sterling Software's Federal Systems Group, and
(ii) Sterling Software and SCI will enter into the contractual arrangements
described below in this report.
PROPOSED DISTRIBUTION
Sterling Software presently intends, following the completion of the
Offering, to distribute pro rata to its stockholders as a dividend the
remaining shares of SCI Common Stock then owned by it by means of a tax-free
distribution (the "Distribution"). The Distribution will be subject to certain
conditions, including (i) approval by Sterling Software's stockholders of both
the Distribution and a new Sterling Software stock option plan under which the
total number of shares of common stock, par value $.10 per share, of Sterling
Software ("Sterling Common Stock") available for issuance will be not less than
20% of the total number of such shares then outstanding and (ii) the
declaration by Sterling Software's Board of Directors of a dividend of the
shares of SCI Common Stock then owned by Sterling Software. Such declaration
will be conditioned upon the receipt of a favorable ruling from the Internal
Revenue Service (the "IRS") as to the tax-free nature of the Distribution and
the absence of any change in market conditions or other circumstances that
would cause the Board of Directors of Sterling Software to conclude that the
Distribution is not in the best interests of the stockholders of Sterling
Software. Sterling Software intends to apply to the IRS for a ruling as to the
tax-free nature of the Distribution. Sterling Software presently anticipates
that the Distribution will occur prior to September 30, 1996.
CONTRACTUAL ARRANGEMENTS WITH STERLING SOFTWARE
In anticipation of the Offering, and in view of Sterling Software's intention
to undertake the Distribution, Sterling Software presently intends to enter
into a number of agreements with SCI for the purpose of defining certain
relationships between them following the Offering. These include (i) a Services
Agreement, pursuant to which (a) Sterling Software will continue on an interim
basis to provide to SCI, upon request by SCI, various services, including
accounting and audit, finance and treasury, strategic planning and budgeting,
cash management, insurance and risk management, tax, legal, human resources and
similar administrative and management services that Sterling Software has
historically provided to its subsidiaries (including SCI) and (b) Sterling
Software will permit employees of SCI and its subsidiaries to continue on an
interim basis to participate in certain benefit plans and programs sponsored by
Sterling Software; (ii) a Space Sharing Agreement pursuant to which SCI and
Sterling Software will share certain office facilities; (iii) a Data Processing
Agreement, pursuant to which SCI will provide certain data processing services
to Sterling Software; (iv) a Tax Allocation Agreement, which will provide for
the allocation of payments of taxes for
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periods during which Sterling Software and SCI are included in the same
consolidated group for federal income tax purposes or the same consolidated,
combined or unitary returns for state tax purposes, the allocation of
responsibility for the filing of tax returns and certain other related matters;
(v) an Indemnification Agreement, pursuant to which (a) each of Sterling
Software and SCI will agree to indemnify the other and its directors, officers,
employees, agents and representatives for certain liabilities relating to (1)
violations of federal or state securities laws in connection with the Offering
or the Distribution and (2) the business operations conducted or formerly
conducted by each company, (b) SCI will agree to indemnify Sterling Software
with respect to certain financial obligations of SCI that, after the Offering,
will continue to be guaranteed or secured by Sterling Software, and (c) SCI
will agree to indemnify Sterling Software and its directors, officers,
employees, agents and representatives for any liabilities resulting from
certain acts, failures to act or the provision of incorrect factual information
by SCI in connection with the IRS ruling request that cause the Distribution to
be taxable to Sterling Software or its stockholders; (vi) an International
Marketing Agreement, pursuant to which Sterling Software's International Group
will act as the exclusive distributor (directly and through subdistributors) of
SCI's interchange and communications software products in markets outside the
United States and Canada and will be responsible for sales, marketing and first
level support of those products in those markets; and (vii) a Stock
Registration and Option Agreement, pursuant to which (a) Sterling Software may
request, subject to certain limitations, that SCI register for sale under the
Securities Act of 1933, as amended, and applicable state securities laws the
SCI Common Stock owned by Sterling Software and (b) Sterling Software will
have, after the completion of the Offering but prior to the completion of the
Distribution, an option to purchase from SCI at then-current market prices such
number of shares of Common Stock as Sterling Software may determine to be
necessary for Sterling Software to continue to include SCI in Sterling
Software's consolidated federal income tax return or to ensure the tax-free
nature of the Distribution.
REDEMPTION OF 5.75% CONVERTIBLE SUBORDINATED DEBENTURES
On December 20, 1995, Sterling Software gave notice of the redemption of all
of the outstanding principal amount of its 5.75% Convertible Subordinated
Debentures due February 1, 2003 (the "Debentures") issued pursuant to the
Indenture, dated as of February 2, 1993, between Sterling Software and Bank of
America Texas, National Association, as trustee (the "Trustee"). The effective
date of the redemption will be February 12, 1996 (the "Redemption Date").
In accordance with the terms of the Indenture, holders of Debentures on the
Redemption Date will be entitled to receive $1,040.25 per $1,000.00 principal
amount of Debentures, together will accrued and unpaid interest from February
1, 1996 to the Redemption Date of $1.756944, for a total of $1,042.006944 (the
"Redemption Price") for each $1,000.00 principal amount of Debentures. Interest
on the Debentures will cease to accrue on and after the Redemption Date.
The Debentures are presently convertible into shares of Sterling Common
Stock. In accordance with the Indenture, the number of shares of Sterling
Common Stock issuable upon the conversion of Debentures is determined by
dividing the principal amount of the Debentures to be converted by $28.35, the
conversion price. Based on the foregoing formula, each $1,000.00 in principal
amount of Debentures is convertible into approximately 35.27 shares of Sterling
Common Stock. Debentures are convertible in whole or in part in any integral
multiple of $1,000.00. No fractional shares of Sterling Common Stock will be
issued upon conversion. Instead, a cash payment for each fractional share will
be made on the basis of the closing sale price of Sterling Common Stock on the
New York Stock Exchange--Composite Tape on the trading day immediately
preceding the date of conversion. No payment or adjustment in respect of
accrued interest on the Debentures will be made upon conversion of the
Debentures. Pursuant to the Indenture, the Debenture holders' right to convert
the Debentures into shares of Sterling Common Stock expires at the close of
business on February 5, 1996, the fifth business day immediately preceding the
Redemption Date. Accordingly, all Debentures not converted into Sterling Common
Stock prior to the close of business on February 5, 1996 will be redeemed at
the Redemption Price. If all $114,922,000 aggregate principal amount of
outstanding Debentures were converted, an additional 4,053,686 shares of
Sterling Common Stock would be issued and outstanding.
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Record holders of Debentures on January 15, 1996 (the "Record Date") will be
entitled to receive the regular semi-annual interest payment on February 1,
1996 (the "Payment Date") of $28.75 for each $1,000.00 principal amount of
Debentures. Accordingly, holders of Debentures who convert their Debentures
into Sterling Common Stock on or prior to January 15, 1996 will not receive
such interest payment. If any holder surrenders a Debenture for conversion
after the close of business on the Record Date and before the close of business
on the Payment Date, then, notwithstanding such conversion, the interest
payable on such Payment Date will be paid to the holder on the Record Date.
However, in the event that a holder surrenders a Debenture for conversion after
the close of business on the Record Date and before the close of business on
the Payment Date, such Debenture, when surrendered for conversion, must be
accompanied by delivery of a check or draft payable in an amount equal to the
interest payable on such Payment Date ($28.75 for each $1,000 principal amount
of Debentures) on the portion of the Debenture so converted. If such payment
does not accompany such Debenture, the Debenture will not be converted. If
Sterling Software defaults in the payment of interest payable on the Payment
Date, the Trustee will repay such funds to the holder.
PROPOSED ACCELERATION OF EMPLOYEE STOCK OPTIONS
In connection with the proposed Offering, management of Sterling Software
presently intends to recommend that the applicable Board Committees that
administer its existing stock option plans (the "Committees") take action to
approve the acceleration of substantially all outstanding options granted under
such plans, effective as of the completion of the Offering. As of the date of
this report, the Committees have not taken action to approve such acceleration.
If all options to purchase Sterling Common Stock outstanding at November 30,
1995 were exercised, an additional 8,715,145 shares of Sterling Common Stock
would be issued and outstanding.
OTHER
As of the date hereof, no assurance can be given that (i) the Offering will
be completed or, if completed, will be completed on the terms, including the
assumed public offering price of the SCI Common Stock, described in this report
or (ii) each of the conditions to the Distribution will be satisfied, including
(i) approval by Sterling Software's stockholders of both the Distribution and a
new Sterling Software stock option plan under which the total number of shares
of Sterling Common Stock available for issuance will be not less than 20% of
the total number of such shares then outstanding and (ii) the declaration by
Sterling Software's Board of Directors of a dividend of the shares of SCI
Common Stock then owned by Sterling Software. As described above, such
declaration will be conditioned upon the receipt of a favorable ruling from the
Internal Revenue Service (the "IRS") as to the tax-free nature of the
Distribution and the absence of any change in market conditions or other
circumstances that would cause the Board of Directors of Sterling Software to
conclude that the Distribution is not in the best interests of the stockholders
of Sterling Software.
PRO FORMA FINANCIAL DATA
The selected historical and pro forma financial data set forth below should
be read in conjunction with Sterling Software's consolidated financial
statements and the notes thereto, included in Sterling Software's Annual Report
on Form 10-K for the fiscal year ended September 30, 1995.
The pro forma financial data for Sterling Software include balance sheet
information at September 30, 1995 and the results of operations for the years
ended September 30, 1995 and 1994. This two-year presentation has been included
to illustrate the effects of unusual events included in Sterling Software's
results of operations, including restructuring charges and the write-off of
purchased research and development resulting from acquisitions.
The selected pro forma unaudited consolidated financial data for SCI include
balance sheet information at September 30, 1995 and 1994 and the results of
operations for the years ended September 30, 1995 and 1994.
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STERLING SOFTWARE, INC.
PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
HISTORICAL ADJUSTMENTS PRO FORMA ADJUSTMENTS STERLING
STERLING FOR THE ADJUSTMENTS FOR FOR THE SOFTWARE AS
SOFTWARE DEBENTURE ISSUANCE OF SCI DISTRIBUTION ADJUSTED
AT 9-30-95 CONVERSION(1) COMMON STOCK(2) OF SCI(3) AT 9-30-95
---------- ------------- --------------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash
equivalents.......... $179,305 $ $200,640 $ (395) $379,550
Marketable securities. 61,341 61,341
Accounts and notes
receivable, net...... 183,734 (49,155) 134,579
Other current assets.. 19,674 (4,931) 14,743
-------- --------- -------- --------- --------
Total current
assets............. 444,054 200,640 (54,481) 590,213
Property and
equipment, net....... 68,412 (25,838) 42,574
Computer software,
net.................. 80,966 (32,263) 48,703
Excess cost over net
assets acquired...... 85,903 (10,259) 75,644
Other noncurrent
assets............... 34,845 (6,137) 28,708
-------- --------- -------- --------- --------
Total assets........ $714,180 $ $200,640 $(128,978) $785,842
======== ========= ======== ========= ========
Current liabilities..... $221,649 $101,744 $ (52,362) $271,031
Long-term debt.......... 116,668 (114,987) (320) 1,361
Other noncurrent
liabilities............ 27,525 (21,415) 6,110
Minority interest....... 8,781 (8,781)
Stockholders' equity:(4)
Common stock.......... 2,653 406 3,059
Additional paid in
capital.............. 336,752 114,581 451,333
Retained earnings..... 9,515 90,115 (46,100) 53,530
Less: treasury stock.. (582) (582)
-------- --------- -------- --------- --------
Total stockholders'
equity............. 348,338 114,987 90,115 (46,100) 507,340
-------- --------- -------- --------- --------
Total liabilities
and stockholders'
equity............. $714,180 $ $200,640 $(128,978) $785,842
======== ========= ======== ========= ========
</TABLE>
5
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NOTES TO PRO FORMA CONSOLIDATED BALANCE SHEET
(1) Adjusted to give effect to the assumed conversion of the outstanding
Debentures which are convertible into Sterling Common Stock at a conversion
price of $28.35.
(2) Adjusted to reflect the assumed issuance of 10,200,000 shares of SCI Common
Stock by Sterling Software for $21 per share (the midpoint of the
preliminarily estimated initial public offering price as stated in the
Registration Statement), net of underwriters' discount and expenses of
$13,560,000 associated with the Offering. Additionally, the gain reflected
herein related to the sale by Sterling Software of shares of SCI Common
Stock in the Offering is net of related tax expense and other charges
aggregating to $101,744,000. The 10,200,000 shares of SCI Common Stock
excludes 1,800,000 shares related to the underwriters' overallotment
options.
(3) Adjusted to give effect to the assumed Distribution to Sterling Software's
shareholders.
(4) In connection with the Offering, management currently plans to recommend to
the applicable committees of the Board of Directors of Sterling Software
that substantially all outstanding stock options of Sterling Software
become fully vested effective upon completion of the Offering. The impact
of the potential exercise of Sterling Software's options and warrants has
not been reflected in the accompanying Pro Forma Balance Sheet.
6
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STERLING SOFTWARE, INC.
PRO FORMA STATEMENT OF OPERATIONS
YEAR ENDED SEPTEMBER 30, 1995
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
<TABLE>
<CAPTION>
PRO FORMA PROFORMA
ADJUSTMENTS ADJUSTMENTS
HISTORICAL FOR THE FOR STERLING SOFTWARE
STERLING SOFTWARE DEBENTURE DISTRIBUTION AS ADJUSTED
9-30-95 CONVERSION OF SCI(2) 9-30-95
----------------- ----------- ------------ -----------------
<S> <C> <C> <C> <C>
Revenue:
Products.............. $239,903 $ $(71,603) $168,300
Product support....... 159,942 (46,190) 113,752
Services.............. 188,322 (74,063) 114,259
Royalties from
affiliated companies. (11,722)
11,722 (5)
-------- --------- -------- --------
Total revenue....... 588,167 (191,856) 396,311
Cost and expenses:
Cost of sales:
Products and product
support.............. 71,883 (25,879) 57,726
11,722 (5)
Services.............. 118,680 (15,671) 103,009
-------- --------- -------- --------
190,563 (29,828) 160,735
-------- --------- -------- --------
Product research,
development and
enhancement.......... 42,509 (14,807) 27,702
Selling, marketing,
general and
administrative....... 222,745 (75,193) 151,052
3,500 (3)
Restructuring charges. 19,512 19,512
Purchased research and
development.......... 62,000 62,000
-------- --------- -------- --------
Total costs and
expenses........... 537,329 (116,328) 421,001
Income (loss) from
operations........... 50,838 (75,528) (24,690)
Interest expense...... (8,625) 6,612(1) 43 (1,970)
Investment and
interest income...... 9,044 (47) 8,997
Other income.......... 1,637 482 2,119
-------- --------- -------- --------
2,056 6,612 478 9,146
Income (loss) before
income taxes........... 52,894 6,612 (75,050) (15,544)
Provision for income
taxes.................. 43,620 2,645 (30,020) 16,245
-------- --------- -------- --------
Income (loss) from
continuing operations.. $ 9,274 $ 3,967 $(45,030) $(31,789)
======== ========= ======== ========
Income (loss) from
continuing operations
per share.............. $ .39 $ (1.15)
======== ========
</TABLE>
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STERLING SOFTWARE, INC.
PRO FORMA STATEMENT OF OPERATIONS
YEAR ENDED SEPTEMBER 30, 1994
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
<TABLE>
<CAPTION>
PRO FORMA PROFORMA STERLING
HISTORICAL ADJUSTMENTS ADJUSTMENTS SOFTWARE
STERLING FOR THE FOR AS
SOFTWARE DEBENTURE DISTRIBUTION ADJUSTED
9-30-94 CONVERSION OF SCI(2) 9-30-94
---------- ----------- ------------ --------
<S> <C> <C> <C> <C>
Revenue:
Products..................... $178,233 $ $(56,291) $121,942
Product support.............. 133,752 (37,953) 95,799
Services..................... 161,408 (53,246) 108,162
Royalties from affiliated
companies................... (8,426)
8,426 (5)
-------- ------ -------- --------
Total revenue.............. 473,393 (147,490) 325,903
Cost and expenses:
Cost of sales:
Products and product support. 64,123 (24,000) 48,549
8,426 (5)
Services..................... 107,622 (12,282) 95,340
-------- ------ -------- --------
171,745 (27,856) 143,889
-------- ------ -------- --------
Product research, development
and enhancement............. 33,002 (12,497) 20,505
Selling, marketing, general
and administrative.......... 173,112 (60,732) 115,880
3,500 (3)
Restructuring charges........
Purchased research and
development.................
-------- ------ -------- --------
Total costs and expenses... 377,859 (97,585) 280,274
Income (loss) from
operations.................. 95,534 (49,905) 45,629
Interest expense............. (6,658) 6,612 (1) 60 14
Investment and interest
income...................... 1,519 (29) 1,490
Other income................. 2,206 119 2,325
-------- ------ -------- --------
(2,933) 6,612 150 3,829
Income before income taxes..... 92,601 6,612 (49,755) 49,458
Provision for income taxes..... 34,262 2,645 (19,902) 17,005
-------- ------ -------- --------
Income (loss) from continuing
operations..................... $ 58,339 $3,967 $(29,853) $ 32,453
======== ====== ======== ========
</TABLE>
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NOTES TO PRO FORMA STATEMENTS OF OPERATIONS
(1) Adjusted to give effect to the interest savings associated with the
conversion of the outstanding Debentures into Sterling Common Stock.
(2) Adjusted to give effect to the assumed Distribution to Sterling Software's
shareholders.
(3) Administrative charges incurred by Sterling Software allocated to SCI were
$3,500,000 in 1995 and 1994. This adjustment reflects the addition of those
costs to Sterling Software as if SCI had been historically distributed to
shareholders.
(4) On a pro forma quarterly basis, the revenue and income from continuing
operations of Sterling Software for 1995 and 1994, after giving effect to
the adjustments described above, would be:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------
DECEMBER 31 MARCH 31 JUNE 30 SEPTEMBER 30
----------- -------- -------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Year Ended September 30, 1995:
Revenue........................ $83,596 $94,129 $102,780 $115,806
Income (loss) from continuing
operations.................... (69,914) 11,058 11,810 15,257
Year Ended September 30, 1994:
Revenue........................ $77,316 $80,274 $ 79,704 $ 88,609
Income from continuing
operations.................... 6,518 7,647 8,303 9,985
</TABLE>
Included in the three months ended December 31, 1994 is a restructuring
charge of $19,512,000 and $62,000,000 of purchased research and development
relating to Sterling Software's acquisition of KnowledgeWare, Inc. during
December 1994.
(5) As owner of software products distributed by Sterling Software's
international operations, SCI includes royalties received from Sterling
Software as revenue. Such revenues are eliminated in the pro-forma
adjustment and are an expense to Sterling Software.
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STERLING COMMERCE, INC.
PRO FORMA UNAUDITED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1994 AND 1995
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
<TABLE>
<CAPTION>
1995
1994 1995 (AS ADJUSTED)
-------- -------- -------------
(NOTE 1)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash......................................... $ 379 $ 395 $ 35,395
Accounts and notes receivable, net (Note 6).. 33,642 49,155 49,155
Deferred income taxes benefit (Note 9)....... 3,726 3,463 3,463
Prepaid expenses and other current assets.... 2,412 3,041 3,041
-------- -------- --------
Total current assets....................... 40,159 56,054 91,054
Property and equipment, net (Note 7)........... 17,047 25,838 25,838
Computer software, net of accumulated
amortization of $24,974 in 1994 and $34,112 in
1995 (Note 1)................................. 27,208 32,263 32,263
Excess cost over net assets acquired, net of
accumulated amortization of $2,661 in 1994 and
$3,087 in 1995................................ 10,685 10,259 10,259
Other assets (Note 6).......................... 5,539 4,564 4,564
-------- -------- --------
$100,638 $128,978 $163,978
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities
(Note 8).................................... $ 15,213 $ 21,442 $ 21,442
Deferred revenue............................. 22,748 30,920 30,920
-------- -------- --------
Total current liabilities.................. 37,961 52,362 52,362
Deferred income taxes (Note 9)................. 13,475 17,749 17,749
Other noncurrent liabilities................... 4,208 3,986 3,986
Contingencies and commitments (Notes 10 and 12)
Stockholders' equity:
Preferred stock $.01 par value, 50,000,000
shares authorized...........................
Common stock $.01 par value, 150,000,000
shares authorized; 75,000,000 shares issued
and outstanding............................. 750
Additional paid-in capital................... 89,131
Stockholder's net investment................. 44,994 54,881
--------
Total stockholders' equity................. 89,881
-------- -------- --------
$100,638 $128,978 $163,978
======== ======== ========
</TABLE>
See accompanying notes.
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STERLING COMMERCE, INC.
PRO FORMA UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED SEPTEMBER 30, 1994 AND 1995
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
<TABLE>
<CAPTION>
1994 1995
---------- ----------
<S> <C> <C>
Revenue:
Products............................................... $ 56,291 $ 71,603
Product support........................................ 37,953 46,190
Services............................................... 53,246 74,063
Royalties from affiliated companies.................... 8,426 11,722
---------- ----------
155,916 203,578
Costs and expenses:
Cost of sales:
Products and product support......................... 24,000 25,879
Services............................................. 12,282 15,671
---------- ----------
36,282 41,550
Product development and enhancement.................... 12,497 14,807
Selling, general and administrative.................... 60,732 75,193
Restructuring charges..................................
---------- ----------
109,511 131,550
---------- ----------
Income before other expense and income taxes............. 46,405 72,028
Other expense............................................ 150 478
---------- ----------
Income before income taxes............................... 46,255 71,550
Provision for income taxes (Note 9)...................... 18,502 28,620
---------- ----------
Net income............................................... $ 27,753 $ 42,930
========== ==========
Earnings per common share data:
Earnings per common share.............................. $ 0.38 $ 0.59
========== ==========
Average common shares outstanding...................... 73,200,000 73,200,000
========== ==========
</TABLE>
See accompanying notes.
11
<PAGE>
STERLING COMMERCE, INC.
NOTES TO PRO FORMA UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL INFORMATION
Sterling Software, Inc. ("Sterling Software") organized Sterling Commerce,
Inc. ("SCI") as a wholly owned subsidiary in December 1995. In contemplation of
an initial public offering (the "Offering") by Sterling Software and SCI of
shares of common stock of SCI ("SCI Common Stock"), Sterling Software intends
to transfer to SCI the direct and indirect subsidiaries through which Sterling
Software has historically conducted its electronic commerce business. In
addition, immediately prior to the completion of the Offering, SCI will effect
a 732,000-for-one stock split. Upon the completion of the Offering, Sterling
Software will own approximately 84% of the outstanding shares of SCI Common
Stock (or approximately 81.6% if certain options granted to underwriters in
connection with the Offering are exercised in full).
The pro forma unaudited balance sheet reflects the formation of SCI as
described above, as well as the receipt of approximately $35,000,000 of net
proceeds from SCI's anticipated sale of 1,800,000 shares of SCI Common Stock
pursuant to the Offering. It is anticipated that Sterling Software will
simultaneously sell 10,200,000 shares of SCI Common Stock pursuant to the
Offering, and that Sterling Software will thereafter own 63,000,000 of the
75,000,000 shares of SCI Common Stock outstanding.
Sterling Software has announced that, following the completion of the
Offering, Sterling Software intends to distribute pro rata to its stockholders
as a dividend its remaining shares of SCI Common Stock by means of a tax-free
distribution. The distribution will be subject to certain conditions, including
approval by Sterling Software stockholders of both the distribution and a new
Sterling Software stock option plan and the declaration by Sterling Software's
Board of Directors of a dividend of the shares of Common Stock then owned by
Sterling Software. Such declaration is expected to be conditioned upon the
receipt of a favorable ruling from the IRS as to the tax-free nature of the
distribution and the absence of any change in market conditions or other
circumstances that cause the Board of Directors of Sterling Software to
conclude that the distribution is not in the best interests of the stockholders
of Sterling Software. Sterling Software has advised SCI that it presently
anticipates that the distribution will occur prior to September 30, 1996.
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The Pro Forma Unaudited Consolidated Financial Statements have been prepared
using Sterling Software's historical basis in the assets and liabilities of the
Electronic Commerce Group, including goodwill and other intangible assets
recognized by Sterling Software in the original acquisition of certain
businesses conducted by SCI. All significant intercompany accounts among SCI
and its consolidated subsidiaries have been eliminated.
The Pro Forma Unaudited Consolidated Financial Statements reflect the results
of operations, financial condition and cash flows of SCI as a component of
Sterling Software and may not be indicative of actual results of operations and
financial position of SCI under other ownership. Management believes that the
consolidated income statements include a reasonable allocation of
administrative costs incurred by Sterling Software which benefit SCI. These
allocations of corporate expenses were approximately $3,500,000 in 1994 and
1995.
Sterling Software's international operations will act as a distributor of
SCI's products outside the United States and Canada for the foreseeable future
and will pay a royalty to SCI. Management believes that the royalties as
reflected herein have been determined on an arm's-length basis.
Revenue
Revenue from license fees, including leasing transactions, for standard
software products is recognized when the software is delivered, provided no
significant future vendor obligations exist and
12
<PAGE>
STERLING COMMERCE, INC.
NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
collection is probable. If software product transactions include the right to
receive future products, a portion of the software product revenue is deferred
and recognized as products are delivered. Services revenue and revenue from
products involving installation or other services are recognized as the
services are performed.
Product support contracts entitle the customer to telephone support, bug
fixing and the right to receive software updates as they are released. Revenue
from product support contracts, including product support included in initial
license fees, is recognized ratably over the contract period. All significant
costs and expenses associated with product support contracts are expensed as
incurred, which approximates ratable expenses over the contract period.
When products, product support and services are billed prior to the time the
related revenue is recognized, deferred revenue is recorded and related costs
paid in advance are deferred.
Software Development Costs
SCI capitalizes the costs of developing and testing new or significantly
enhanced software products in accordance with the provisions of Statement of
Financial Accounting Standards No. 86, "Accounting for the Costs of Computer
Software to be Sold, Leased or Otherwise Marketed." Unamortized software
development costs of $24,928,000 and $27,555,000 included in "Computer
software, net" at September 30, 1994 and 1995, respectively.
Depreciation and Amortization
Property and equipment are recorded at cost and depreciated using the
straight-line method over average useful lives of three to fifteen years.
Computer software costs are amortized on a product-by-product basis using the
greater of the amount computed by taking the ratio of current year net revenue
to estimated future net revenue or the amount computed by the straight-line
method over periods ranging from three to five years. Leasehold improvements
are amortized over the term of the lease. Excess costs over the net assets of
businesses acquired are amortized on a straight-line basis over periods of ten
to forty years. Other intangible assets are amortized on a straight-line basis
over periods of three to ten years.
Depreciation and amortization consists of the following for the years ended
September 30, 1994 and 1995 (in thousands):
<TABLE>
<CAPTION>
1994 1995
------- -------
<S> <C> <C>
Property and equipment...................................... $ 4,579 $ 7,084
Purchased computer software................................. 1,385 1,405
Capitalized computer software development costs............. 7,353 7,772
Excess costs over net assets of businesses acquired......... 407 426
Intangible assets........................................... 773 830
------- -------
$14,497 $17,517
======= =======
</TABLE>
Income Taxes
SCI plans to enter into a tax sharing agreement with Sterling Software
covering the period of time SCI will be included in Sterling Software's
consolidated tax returns. SCI's operations have historically been included in
consolidated income tax returns filed by Sterling Software. Income tax expense
in the accompanying financial statements has been computed assuming SCI filed
separate income tax returns. Deferred taxes result primarily from the use of
accelerated depreciation for tax purposes, expensing of development costs and
from the timing of deductions for expenses under certain employee benefit plans
and accrued expenses.
Earnings Per Share
The earnings per share calculation is based on shares outstanding after the
organization of SCI and before the Offering. The shares have been reflected as
outstanding for all years presented.
13
<PAGE>
STERLING COMMERCE, INC.
NOTES TO PRO FORMA UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. TRANSACTIONS WITH AFFILIATED COMPANIES
Amounts payable and receivable from Sterling Software arise as a result of
various transactions between SCI and Sterling Software, including SCI's
participation in Sterling Software's central cash management program,
royalties paid to SCI as a result of Sterling Software acting as an
international distributor, tax expense charged to SCI and other expenses
incurred on behalf of SCI as described below. At the end of each year, net
available cash flow after consideration of the charges as described above, is
distributed to Sterling Software.
Certain costs and expenses (other than the expense allocations discussed in
Note 2) are initially incurred by Sterling Software on behalf of SCI, and
charged to SCI. An analysis of significant items follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30
-----------------------
1994 1995
----------- -----------
<S> <C> <C>
Summary of Expenses:
Legal, accounting and professional fees......... $1,376 $ 600
Payroll related................................. 739 1,403
Occupancy....................................... 694 661
Miscellaneous................................... 349 374
----------- -----------
$ 3,158 $ 3,038
=========== ===========
</TABLE>
The international operations of Sterling Software act as a distributor of
certain of SCI's products.
4. BUSINESS COMBINATIONS
In August 1994, Sterling Software acquired all of the outstanding common
stock of American Business Computer Company ("ABC"), a Michigan corporation
based near Detroit, Michigan, which developed, marketed and supported UNIX-
based electronic data interchange products, including products that provide
sophisticated electronic commerce gateway functionality, in a stock-for-stock
acquisition (the "ABC Merger") accounted for as a pooling of interests. The
business formerly conducted by ABC is included in the results of operations of
SCI. SCI's financial statements for periods prior to the ABC Merger represent
the combined financial statements of the previously separate entities adjusted
to conform ABC's fiscal years and accounting policies to those used by SCI.
In March 1995, Sterling Software acquired for cash all of the outstanding
common stock of MAXXUS, Inc. ("MAXXUS"), a San Francisco-based leading
provider of Financial Electronic Data Interchange software. MAXXUS's business
is included in the results of operations of SCI from the date of acquisition.
5. LEGAL PROCEEDINGS AND CLAIMS
SCI is subject to certain legal proceedings and claims which arise in the
conduct of its business. In the opinion of management, the amount of any
liability with respect to these actions will not have a material affect on the
financial condition or results of operations of SCI.
14
<PAGE>
STERLING COMMERCE, INC.
NOTES TO PRO FORMA UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. ACCOUNTS AND NOTES RECEIVABLE
Accounts and notes receivable consist of the following at September 30 (in
thousands):
<TABLE>
<CAPTION>
1994 1995
------- -------
<S> <C> <C>
Trade..................................................... $26,794 $39,851
Unbilled.................................................. 7,692 9,490
Other..................................................... 1,986 1,814
------- -------
36,472 51,155
Less: Allowance for doubtful accounts..................... 2,830 2,000
------- -------
$33,642 $49,155
======= =======
</TABLE>
At September 30, 1994 and 1995, accounts receivable include $1,154,000 and
$1,290,000, respectively, due under contracts with the federal government and
related agencies. The remainder of SCI's receivables are due principally from
corporations in diverse industries located in the United States and Canada.
7. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at September 30 (in
thousands):
<TABLE>
<CAPTION>
1994 1995
------- -------
<S> <C> <C>
Computer and peripheral equipment......................... $23,700 $36,634
Furniture, fixtures and other equipment................... 3,989 5,016
Building and improvements................................. 2,072 3,131
------- -------
29,761 44,781
Less accumulated depreciation............................. 12,714 18,943
------- -------
$17,047 $25,838
======= =======
</TABLE>
8. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following at
September 30 (in thousands):
<TABLE>
<CAPTION>
1994 1995
------- -------
<S> <C> <C>
Trade accounts payable.................................... $ 5,178 $ 7,204
Accrued compensation...................................... 7,906 11,113
Other accrued liabilities................................. 2,129 3,125
------- -------
$15,213 $21,442
======= =======
</TABLE>
15
<PAGE>
STERLING COMMERCE, INC.
NOTES TO PRO FORMA UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. INCOME TAXES
The provision for income taxes is composed of the following (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30
--------------------------
1994 1995
------------ ------------
<S> <C> <C>
Current:
Federal....................................... $ 16,608 $ 21,073
State......................................... 2,372 3,010
Deferred:
Federal....................................... (418) 3,970
State......................................... (60) 567
------------ ------------
$ 18,502 $ 28,620
============ ============
</TABLE>
The effective income tax rate on income before taxes differed from the
federal income tax statutory rate for the following reasons (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30
-------------------------
1994 1995
------------ ------------
<S> <C> <C>
Tax expense at U.S. federal statutory rate...... $ 16,189 $ 25,043
State income taxes, net of federal benefit...... 2,313 3,577
------------ ------------
$ 18,502 $ 28,620
============ ============
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of SCI's net deferred tax asset as of September 30 are as follows (in
thousands):
<TABLE>
<CAPTION>
1994 1995
------- -------
<S> <C> <C>
Deferred income tax assets:
Deferred revenue.......................................... $ 1,254 $ 843
Reserves and restructuring accruals....................... 2,472 2,620
------- -------
Deferred income tax assets.............................. 3,726 3,463
------- -------
Deferred income tax liabilities:
Capitalized software costs................................ 11,240 11,361
Depreciation and amortization............................. 2,235 6,388
------- -------
Deferred income tax liabilities......................... 13,475 17,749
------- -------
Deferred income tax liability net of deferred income tax
assets................................................. $ 9,749 $14,286
======= =======
</TABLE>
16
<PAGE>
STERLING COMMERCE, INC.
NOTES TO PRO FORMA UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. COMMITMENTS
SCI leases certain facilities and equipment under operating leases. Total
rent expense for the years ended September 30, 1994 and 1995 was $6,071,000
and $7,537,000, respectively. At September 30, 1995, minimum future rental
payments due under all operating leases, net of future sublease income, are as
follows (in thousands):
<TABLE>
<S> <C>
1996............................................................ $ 7,562
1997............................................................ 6,820
1998............................................................ 5,990
1999............................................................ 4,857
2000............................................................ 2,289
Thereafter...................................................... 11,333
-------
$38,851
=======
</TABLE>
11. STOCK OPTIONS
SCI expects to adopt a stock option plan for the granting of options to
certain of SCI's officers, directors, employees, advisors, consultants and
non-employee directors. The total number of shares of Common Stock available
for issuance under the option plan initially is expected to be 15,000,000.
12. POSTRETIREMENT BENEFITS
SCI participates in Sterling Software's plan that provides retirement
benefits under the provisions of Section 401(k) of the Internal Revenue Code
for all domestic employees who have completed a specified term of service.
Pursuant to this plan, eligible participants may elect to contribute a
percentage of their annual gross compensation and SCI will contribute
additional amounts, as provided by the plan. Benefits under the plan are
limited to the assets of the plan. SCI contributions charged to expense during
1994 and 1995 were $861,000 and $930,000, respectively. A portion of SCI's
contributions are invested in Sterling Common Stock. During 1994 and 1995,
SCI's contributions included 12,088 and 7,807 shares of Sterling Common Stock,
respectively. Of the 1995 contribution, 2,789 shares of Sterling Common Stock
were transferred to the plan in October 1995.
SCI does not provide other significant postemployment benefits.
17
<PAGE>
STERLING COMMERCE, INC.
NOTES TO PRO FORMA UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
13. QUARTERLY FINANCIAL RESULTS
SCI's consolidated operating results for each quarter of 1994 and 1995 are
summarized as follows (in thousands, except share information):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------------------------------
DECEMBER 31 MARCH 31 JUNE 30 SEPTEMBER 30
----------- ---------- ---------- ------------
<S> <C> <C> <C> <C>
Year ended September 30, 1994:
Revenue..................... $ 34,393 $ 36,778 $ 39,171 $ 45,574
Cost of sales............... 8,704 8,359 8,907 10,312
Product development and en-
hancement.................. 2,470 3,594 3,045 3,388
Selling, general and admin-
istrative.................. 15,218 14,168 15,270 16,076
Income before other expense
and
income taxes............... 8,001 10,657 11,949 15,798
Net income.................. 4,772 6,375 7,139 9,467
Earning per common share.... $ 0.06 $ 0.09 $ 0.10 $ 0.13
Average common shares out-
standing................... 73,200,000 73,200,000 73,200,000 73,200,000
Year ended September 30, 1995:
Revenue..................... $ 45,096 $ 46,275 $ 51,637 $ 60,570
Cost of sales............... 9,592 9,648 10,233 12,077
Product development and en-
hancement.................. 3,599 4,032 3,706 3,470
Selling, general and admin-
istrative.................. 17,303 16,535 19,284 22,071
Income before other expense
and
income taxes............... 14,602 16,060 18,414 22,952
Net income.................. 8,726 9,568 10,946 13,690
Earnings per common share... $ 0.12 $ 0.13 $ 0.15 $ 0.19
Average common shares out-
standing................... 73,200,000 73,200,000 73,200,000 73,200,000
</TABLE>
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned hereunto duly authorized.
STERLING SOFTWARE, INC.
By /s/ Jeannette P. Meier
-----------------------------------
Jeannette P. Meier
Executive Vice President,
Secretary and General Counsel
Date: December 20, 1995
19
