<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended December 31, 1995
or
( ) Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from __________ to __________
Commission File No. 1-8465
STERLING SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 75-1873956
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
8080 North Central Expressway, Suite 1100
Dallas, Texas 75206
(Address of principal executive offices)
(Zip Code)
(214) 891-8600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
<TABLE>
<CAPTION>
Title Shares Outstanding as of February 9, 1996
- ------------------------------ -----------------------------------------
<S> <C>
Common Stock, $0.10 par value 30,413,099
</TABLE>
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Index to Financial Statements
<TABLE>
<CAPTION>
Page
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<S> <C>
Sterling Software, Inc. Consolidated Balance Sheets at December 31, 1995 and
September 30, 1995................................................................... 3
Sterling Software, Inc. Consolidated Statements of Operations for the Three
Months Ended December 31, 1995 and 1994.............................................. 4
Sterling Software, Inc. Consolidated Statements of Stockholders' Equity for the Three
Months Ended December 31, 1995 and 1994.............................................. 5
Sterling Software, Inc. Consolidated Statements of Cash Flows for the Three Months
Ended December 31, 1995 and 1994..................................................... 6
Sterling Software, Inc. Notes to Consolidated Financial Statements..................... 7
<CAPTION>
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Item 5. Other Information
Page
----
<S> <C>
Pro Forma Financial Data............................................................... 23
Item 6. Exhibits and Reports on Form 8-K.............................................. 29
</TABLE>
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STERLING SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share information)
<TABLE>
<CAPTION>
ASSETS
December 31 September 30
1995 1995
------------- --------------
(Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents.................................................. $ 93,977 $179,305
Marketable securities...................................................... 142,562 61,341
Accounts and notes receivable, net......................................... 176,266 183,734
Deferred income taxes...................................................... 1,890 1,890
Prepaid expenses and other current assets.................................. 19,416 17,784
-------- --------
Total current assets..................................................... 434,111 444,054
Property and equipment, net of accumulated depreciation of $62,945 at
December 31, 1995 and $59,716 at September 30, 1995........................ 70,418 68,412
Computer software, net of accumulated amortization of $110,319 at
December 31, 1995 and $104,813 at September 30, 1995....................... 88,602 80,966
Excess cost over net assets acquired, net of accumulated amortization of
$24,946 at December 31, 1995 and $23,362 at September 30, 1995............. 84,337 85,903
Noncurrent deferred income taxes............................................. 6,582 17,960
Other assets................................................................. 18,447 16,885
-------- --------
$702,497 $714,180
======== ========
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Current liabilities:
Current portion of long-term debt.......................................... $ 5,700 $ 5,871
Income taxes payable....................................................... 2,500 4,679
Accounts payable and accrued liabilities................................... 99,631 114,391
Deferred revenue........................................................... 93,188 96,708
-------- --------
Total current liabilities................................................ 201,019 221,649
Long-term debt............................................................... 116,647 116,668
Other noncurrent liabilities................................................. 25,708 27,525
Commitments and contingencies (Note 5).......................................
Stockholders' equity:
Preferred stock, $.10 par value; 10,000,000 shares authorized
Common stock, $.10 par value; 75,000,000 shares authorized; 27,413,000
and 26,529,000 shares issued at December 31, 1995
and September 30, 1995, respectively..................................... 2,741 2,653
Additional paid-in capital................................................. 356,747 336,752
Retained earnings.......................................................... 30,822 9,515
Less treasury stock, at cost: 748,000 and 56,000 shares at
December 31, 1995 and September 30, 1995, respectively................... (31,187) (582)
-------- --------
Total stockholders' equity............................................. 359,123 348,338
-------- --------
$702,497 $714,180
======== ========
</TABLE>
See accompanying notes.
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STERLING SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share information)
(Unaudited)
<TABLE>
<CAPTION>
Three Months
Ended December 31
---------------------
1995 1994
-------- --------
<S> <C> <C>
Revenue:
Products...................................................... $ 52,375 $ 49,551
Product support............................................... 44,671 34,671
Services...................................................... 51,606 42,196
-------- --------
148,652 126,418
Costs and expenses:
Cost of sales:
Products and product support................................ 18,892 16,011
Services.................................................... 30,771 26,499
-------- --------
49,663 42,510
Product development and enhancement........................... 9,360 9,446
Selling, general and administrative........................... 58,932 49,015
Restructuring charge.......................................... 19,512
Purchased research and development............................ 62,000
-------- --------
117,955 182,483
-------- --------
Income (loss) before other income (expense) and income taxes.... 30,697 (56,065)
Other income (expense):
Interest expense.............................................. (1,851) (1,990)
Investment income............................................. 3,121 888
Other......................................................... 317 (136)
-------- --------
1,587 (1,238)
-------- --------
Income (loss) before income taxes............................... 32,284 (57,303)
Provision for income taxes...................................... 10,977 4,352
-------- --------
Net income (loss)............................................... 21,307 (61,655)
Preferred stock dividends....................................... 49
-------- --------
Income (loss) applicable to common stockholders................. $ 21,307 $(61,704)
======== ========
Income (loss) per common share:
Net income (loss):
Primary..................................................... $.72 $(2.87)
======== ========
Fully diluted............................................... $.66 $(2.87)
======== ========
Average common shares outstanding............................... 26,630 21,476
======== ========
</TABLE>
See accompanying notes.
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STERLING SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Three Months Ended December 31, 1995 and 1994
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Preferred Stock Common Stock Treasury Stock
--------------- --------------- -----------------
Number Number Additional Retained Number Total
of Par of Par Paid-in Earnings of Stockholders'
Shares Value Shares Value Capital (Deficit) Shares Cost Equity
------ ----- ------ ------ ---------- --------- ------ --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1994....... 200 $20 22,378 $2,238 $192,064 $ 572 1,793 $(19,090) $175,804
Net loss......................... (61,655) (61,655)
Preferred stock dividends........ (49) (49)
Issuance of common stock
and treasury stock for
acquisition (Note 3)......... 720 72 56,260 (1,701) 18,111 74,443
Common stock issuance
costs........................ (689) (689)
Issuance of common stock
pursuant to stock options
and warrants................. 179 18 2,821 2,839
Issuance of common stock
to retirement plan........... 55 (4) 39 94
Other............................ 326 326
--- --- ------ ------ -------- -------- ------ -------- --------
Balance at December 31, 1994........ 200 $20 23,277 $2,328 $250,511 $(60,806) 88 $ (940) $191,113
=== === ====== ====== ======== ======== ====== ======== ========
Balance at September 30, 1995....... 26,529 $2,653 $336,752 $ 9,515 56 $ (582) $348,338
Net income....................... 21,307 21,307
Purchase of common stock
for treasury................. 700 (30,931) (30,931)
Issuance of common stock
pursuant to stock options
and warrants................. 880 88 19,933 20,021
Issuance of common stock
pursuant to conversion of
5.75% Debentures............. 4 105 105
Issuance of common stock
to retirement plan........... (40) (8) 326 286
Other............................ (3) (3)
------ ------ -------- -------- ------ -------- --------
Balance at December 31, 1995........ 27,413 $2,741 $356,747 $ 30,822 748 $(31,187) $359,123
====== ====== ======== ======== ====== ======== ========
</TABLE>
See accompanying notes.
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STERLING SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months
Ended December 31
--------------------
1995 1994
--------- --------
<S> <C> <C>
Operating activities:
Net income (loss).................................................................. $ 21,307 $(61,655)
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation and amortization................................................ 12,592 11,008
Provision for losses on accounts receivable.................................. 1,331 1,500
Provision for deferred income taxes.......................................... 8,477 3,008
Purchased research and development........................................... 62,000
Write-down of property and equipment and other assets........................ 2,242
Write-down of purchased and capitalized computer software costs.............. 6,215
Changes in operating assets and liabilities, net of effects of business
acquisitions:
Decrease (increase) in accounts and notes receivable................. 1,163 (5,020)
Increase in prepaids and other assets................................ (1,912) (2,033)
Decrease in accounts payable, accrued liabilities and income taxes
payable........................................................... (15,152) (1,122)
Increase (decrease) in deferred revenue.............................. (2,590) 4,744
Other................................................................ (2,545) 818
--------- --------
Net cash provided by operating activities........................ 22,671 21,705
Investing activities:
Purchases of property and equipment................................................ (6,725) (14,165)
Purchases and capitalized cost of development of computer software................. (6,251) (4,158)
Business acquisitions, net of cash acquired........................................ (7,186) (7,169)
Purchases of investments........................................................... (124,326) (21,281)
Proceeds from sales of investments................................................. 43,030 8,661
Other.............................................................................. 181 205
--------- --------
Net cash used in investing activities............................ (101,277) (37,907)
Financing activities:
Acquisition of common stock for treasury........................................... (30,931)
Retirement and redemption of debt and capital lease obligations.................... (3,186) (4,596)
Proceeds from issuance of debt..................................................... 2,729 8,960
Proceeds from sales of installment and lease contracts receivable.................. 3,965 4,233
Preacquisition advances to business acquired....................................... (4,435)
Proceeds from issuance of common stock pursuant to stock options and
warrants........................................................................ 20,021 2,839
Other.............................................................................. 798 86
--------- --------
Net cash provided by financing activities........................ (6,604) 7,087
Effect of foreign currency exchange rate changes on cash.............................. (118) 141
--------- --------
Increase (decrease) in cash and cash equivalents...................................... (85,328) (8,974)
Cash and cash equivalents at beginning of period...................................... 179,305 101,893
--------- --------
Cash and cash equivalents at end of period............................................ 93,977 92,919
========= ========
Supplemental cash flow information:
Interest paid...................................................................... $ 370 $ 237
========= ========
Income taxes paid.................................................................. $ 866 $ 1,851
========= ========
Income tax refunds................................................................. $ 387 $ 371
========= ========
</TABLE>
See accompanying notes.
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<PAGE>
STERLING SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1995
(Unaudited)
1. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of Sterling
Software, Inc. and its wholly owned subsidiaries ("Sterling Software",
"Sterling" or the "Company") after elimination of all significant intercompany
balances and transactions. Certain amounts for periods ended prior to
December 31, 1995 have been reclassified to conform to the current year
presentation. The financial statements have been prepared in conformity with
generally accepted accounting principles which require management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities and the disclosure of contingencies at December 31, 1995 and
September 30, 1995 and the results of operations for the three months ended
December 31, 1995 and 1994, respectively. While management has based its
assumptions and estimates on the facts and circumstances known at December 31,
1995, final amounts may differ from such estimates.
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 collection is probable. Service
revenue and revenue from certain 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
ratably over the contract period.
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. Contract accounting is applied for sales of software
products requiring significant modification or customization, such that revenue
is recognized only when the modification or customization is complete.
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.
Revenue from professional services provided to the federal government under
multi-year contracts is recognized as the services are performed. Revenue for
services under long-term contracts is recognized using the percentage-of-
completion method of accounting. Losses on
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long-term contracts are recognized when the current estimate of total contract
costs indicates a loss on a contract is probable.
Cash Equivalents, Marketable Securities and Other Investments
Cash equivalents consist primarily of highly liquid investments in repurchase
agreements backed by U.S. Treasury securities and investment-grade commercial
paper of various issuers, with maturities of three months or less when
purchased. The carrying amount reported in the consolidated balance sheet for
cash and cash equivalents approximates its fair value.
The Company invests excess cash in a diversified portfolio consisting of a
variety of securities including commercial paper, corporate notes and U.S.
government obligations, which may include both investment grade and non-
investment grade securities. The fair values for marketable securities are
based on quoted market prices. All marketable securities and long-term
investments are classified as available-for-sale securities.
2. Unaudited Interim Financial Statements
The interim consolidated financial information contained herein is unaudited
but, in the opinion of management, includes all adjustments, which are of a
normal recurring nature, necessary for a fair presentation of the financial
position and results of operations for the periods presented. Results of
operations for the periods presented herein are not necessarily indicative of
results of operations for the entire year.
3. Proposed Subsidiary Initial Public Offering and Distribution
Sterling Commerce, Inc. ("SCI"), a wholly owned subsidiary of Sterling
Software, has 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 12,000,000 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.
Sterling Software incorporated SCI as a Delaware corporation in December
1995. In contemplation of the Offering, among other things, (i) Sterling
Software will cause to be transferred to SCI all of the issued and outstanding
shares of capital stock of the subsidiaries through which SCI will conduct its
business, which subsidiaries include all of the subsidiaries comprising
Sterling Software's Electronic Commerce Group, (ii) Sterling Software will cause
to be transferred to SCI certain assets relating to the electronic commerce
business
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<PAGE>
conducted by Sterling Software's International Group and certain assets relating
to the electronic commerce business conducted by Sterling Software's Federal
Systems Group, and (iii) SCI will enter into contractual arrangements with
Sterling Software related to space sharing, tax allocations, international
marketing and certain services.
Following the completion of the Offering, Sterling Software intends to
distribute pro rata to its stockholders as a dividend the remaining shares of
SCI Common Stock 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 the
Company's $0.10 par value common stock ("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 has applied to the IRS for a ruling as
to the tax-free nature of the Distribution. It is presently anticipated that the
Distribution will occur prior to September 30, 1996.
In connection with the proposed Offering, Sterling Software has approved the
acceleration of substantially all outstanding options granted under Sterling
Software's existing stock option plans, effective as of the completion of the
Offering. If all options and warrants to purchase Sterling Common Stock
outstanding at January 31, 1996 were exercised, an additional 8,512,000 shares
of Sterling Common Stock would be issued and outstanding, with resulting
proceeds to the Company of approximately $269,710,000. There can be no
assurance, however, as to whether or when any of such options or warrants will
be exercised.
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 described above to the Distribution will be
satisfied.
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The Company has included pro forma financial statements in Part II, Item 5 of
this Form 10-Q to illustrate the effects of the proposed Distribution and the
redemption and conversion of the Company's 5.75% Convertible Subordinated
Debentures. See Note 7.
4. Business Combination
On November 30, 1994, Sterling Software acquired KnowledgeWare, Inc.
("KnowledgeWare"), a Georgia corporation based in Atlanta, Georgia which was a
provider of applications development software and services, for approximately
$106 million, in a stock-for-stock acquisition (the "Merger"). In connection
with the Merger, the Company issued approximately 2,421,000 shares of Sterling
Common Stock valued at approximately $74,443,000 and reserved approximately
340,000 shares of Sterling Common Stock for issuance upon exercise of
KnowledgeWare's options and warrants. In addition, the Company incurred cash
costs directly related to the Merger of approximately $31,672,000. The Merger,
which was accounted for as a purchase, was completed pursuant to the terms of an
Amended and Restated Agreement and Plan of Merger dated as of August 31, 1994,
as amended (the "Merger Agreement"), among the Company, SSI Corporation, a
Georgia corporation and a wholly owned subsidiary of the Company ("Merger Sub"),
and KnowledgeWare. Of the 2,421,000 shares of Sterling Common Stock issued,
approximately 484,800 shares were placed in escrow (the "Escrowed Shares") to
cover certain losses that may result in connection with any pending or
threatened litigation, action, claim, proceeding, dispute or investigation
("Actions") (including amounts paid in settlement) to which the Company is
entitled to indemnification pursuant to the terms of the Merger Agreement. The
Company has entered into settlement agreements for all pending private civil
actions and all of the Escrowed Shares have been distributed pursuant to the
indemnification provisions of the Merger Agreement. See Note 5.
The operating results of KnowledgeWare are included in the Company's results
of operations from the date of the Merger. In addition, the results of
operations for the first quarter of 1995 include $62,000,000 of purchased
research and development costs, which is the portion of the purchase price
attributed to in-process research and development and which is charged to
expense in accordance with purchase accounting. The $62,000,000 charge has no
related tax benefit. The results of operations also include a charge for
restructure costs of $19,512,000 to integrate KnowledgeWare's business into the
Company's operations.
5. Commitments and Contingencies
The Company is subject to certain legal proceedings and claims that arise in
the ordinary conduct of its business. In the opinion of management, the amount
of ultimate liability with respect to these actions, net of applicable reserves,
will not materially affect the financial condition or results of operations of
the Company.
KnowledgeWare, which was acquired on November 30, 1994, has been subject to
certain legal proceedings and claims in connection with KnowledgeWare's
restatement of its financial results for the first three quarters of its 1994
fiscal year and its financial results for its full 1994 fiscal year involving,
among other claims, allegations of federal and state securities fraud, breach of
contract, breach of fiduciary duty by former officers and directors of
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KnowledgeWare, common law fraud and RICO violations under Federal and State law.
The Company has settled two of those legal proceedings, which were class
actions, for cash paid by KnowledgeWare's insurance carriers and for the
proceeds from the sale of approximately 278,000 of the 484,000 Escrowed Shares
described in Note 4, above. The Company has entered into settlement agreements
with respect to the five remaining proceedings against KnowledgeWare for an
aggregate of approximately $15.6 million, subject to certain possible
adjustments which would reduce that amount. The Company was entitled to
reimbursement from the Escrowed Shares for a major portion of such amounts. In
addition, the Commission has entered an Order Directing Private Investigation
and Directing Officers to take Testimony related to trading in KnowledgeWare
securities from July 1, 1992 through the time of the Merger, KnowledgeWare's
compliance with filing and reporting procedures and/or accuracy of its public
disclosures, and KnowledgeWare's recordkeeping and accounting controls.
Unless appeals are filed in the two class action claims referred to above,
the final settlement of which is a condition of the other described settlements,
all pending private civil actions against KnowledgeWare filed in connection with
KnowledgeWare's restatement of its financial results for the first three
quarters of its 1994 fiscal year and its financial results for its full 1994
fiscal year will have been resolved prior to the end of the Company's second
fiscal quarter. The Commission continues its formal investigation.
The Company's management believes that, in view of its indemnification from
the Escrowed Shares and after giving effect to applicable reserves, the
settlements described above and the ultimate resolution of the Commission's
investigation will not materially affect the financial condition or results of
operations of Sterling Software.
6. Segment Information
The Company acquires, develops, markets and supports a broad range of
computer software products and services in four major markets classified as
Electronic Commerce, Systems Management, Federal Systems and Applications
Management. Each major market is represented by independently operated business
groups. The Electronic Commerce Group provides software and services to
facilitate electronic commerce, defined by the Company as the worldwide
electronic interchange of business information, including electronic data
interchange software and services, data communications software and electronic
payments software for financial institutions. The Systems Management Group
provides enterprise-wide systems management software for large computing
environments. The Federal Systems Group provides highly technical services to
the federal government under several multi-year contracts primarily in support
of National Aeronautics and Space Administration ("NASA") aerospace research
projects and secure communications systems for the Department of Defense. The
Applications Management Group focuses exclusively on the applications management
market. The group provides products for developing new applications and
revitalizing existing applications and consulting services to ensure that
customers are successful using the applications management products. A fifth
business group, the International Group, is responsible for sales and first
level support of the Company's products outside North America. International
Group operating results
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are included, as applicable, in the Company's Electronic Commerce, Systems
Management and Applications Management segments in the business segment tables
contained herein. International Group revenue of $38,190,000 and $32,034,000 and
operating profit of $5,437,000 and $6,339,000 for the three months ended
December 31, 1995 and 1994, respectively, have been allocated to the business
segments.
Financial information concerning the Company's operations, by business
segment, for the three months ended December 31, 1995 and 1994, restated to
conform to the current year presentation, is summarized as follows (in
thousands):
<TABLE>
<CAPTION>
Three Months
Ended December 31
-------------------
1995 1994
-------- --------
<S> <C> <C>
Revenue:
Electronic Commerce............................. $ 59,953 $ 47,905
Systems Management.............................. 35,210 33,374
Federal Systems................................. 26,262 23,665
Applications Management......................... 26,459 20,010
Corporate and other............................. 768 1,464
-------- --------
Consolidated totals............................. $148,652 $126,418
======== ========
Operating Profit (Loss):
Electronic Commerce............................. $ 20,533 $ 12,752
Systems Management.............................. 11,625 11,136
Federal Systems................................. 2,300 1,526
Applications Management......................... 3,859 4,491
Restructuring charge............................ (19,512)
Purchased research and development.............. (62,000)
Corporate and other............................. (7,620) (4,458)
-------- --------
Consolidated totals.......................... $ 30,697 $(56,065)
======== ========
</TABLE>
The amounts presented for "Corporate and other" include corporate expense,
inter-segment eliminations and the results of operations of the Company's retail
software division.
7. Redemption and Conversion of 5.75% Convertible Subordinated Debentures
On December 20, 1995, the Company gave notice of the redemption of all of the
$114,922,000 then outstanding principal amount of its 5.75% Convertible
Subordinated Debentures due February 1, 2003 (the "Debentures"). The effective
date of the redemption was February 12, 1996 (the "Redemption Date"). The
Debentures were convertible into shares of Sterling Common Stock. Approximately
$114,912,000 principal amount
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of the Debentures was presented for conversion. In addition, approximately
$78,000 principal amount of the Debentures had been converted prior to the
announcement of the Redemption. As of February 5, 1996 approximately 4,056,000
shares of Sterling Common Stock had been issued upon conversion of the
Debentures. Approximately $10,000 principal amount of Debentures was redeemed
for cash on February 12, 1996. If the conversion had taken place at October 1,
1995 supplemental primary earnings per share would have been $.68 for the three
months ended December 31, 1995.
8. Share Repurchase Program
On October 2, 1995, the Company renewed a share repurchase program pursuant
to which it may repurchase shares of Sterling Common Stock from time to time
through open market transactions. Through December 31, 1995, 699,500 shares of
Sterling Common Stock were repurchased at an aggregate amount of approximately
$30,931,000. Since December 31, 1995 and through February 9, 1996, approximately
429,400 shares of Sterling Common Stock were repurchased at an aggregate amount
of approximately $22,256,000. Any further purchases of Sterling Common Stock
pursuant to this program will be made solely at the Company's discretion and may
be discontinued at any time without prior notice.
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Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Merger with KnowledgeWare, Inc.
On November 30, 1994, Sterling Software, Inc. ("Sterling Software",
"Sterling" or the "Company") acquired KnowledgeWare, Inc. ("KnowledgeWare"), a
Georgia corporation based in Atlanta, Georgia which was a provider of
applications development software and services, for approximately $106 million,
in a stock-for-stock acquisition (the "Merger"). The operating results of
KnowledgeWare are included in the Company's results of operations from the date
of the Merger. See Note 4 of "Notes to Consolidated Financial Statements" and
the Company's Annual Report on Form 10-K for the fiscal year ended September 30,
1995.
The Company's restructuring charge in the first quarter of 1995 related to
the combining of the companies was $19,512,000, consisting of employee
termination costs, write-offs of software products which will not be actively
marketed, elimination of duplicate facilities and equipment, and out-of-pocket
and other costs related to the reorganization.
Of the total restructuring charge of $19,512,000, approximately $8,377,000 is
a non-cash charge and the remaining $11,135,000 requires cash outlays, of which
substantially all have been expended. Future cash expenditures related to the
restructuring are anticipated to be made from cash generated from operations.
The Company does not expect to incur costs related to the restructure in excess
of the amount charged to operations in the first quarter of 1995.
Three Months Ended December 31, 1995 and 1994
Revenue increased $22,234,000, or 18%, in the first quarter of 1996 over the
same period of 1995. The Electronic Commerce Group ("ECG") revenue increased
$12,048,000, or 25%, on the strength of a 31% increase in network services
revenue, an 18% increase in product revenue and a 28% increase in product
support revenue. The increased network services revenue was due to an increase
in the network services customer base, primarily in the grocery, hardlines and
retail vertical markets, and increases in the network processing volume for
existing customers. The increase in ECG product revenue is the result of
increased revenue in the group's communications and interchange software product
lines partially offset by a decline in revenue from the federal government of
$839,000, or 68%, due to the federal government shutdown during the three months
ended December 31, 1995. ECG product support revenue increased primarily as a
result of an increase in the installed customer base across all three product
lines and price increases for some products. The Systems Management Group
("SMG") revenue increased $1,836,000, or 6%. SMG's product and product support
revenue increased across the operations management and storage management
product lines. This increase was partially offset by a revenue decline in the
VM software product line due to the continuing trend of consolidation and
downsizing by customers using the VM operating system. The Applications
Management Group ("AMG") revenue increased $6,449,000, or 32%, due to businesses
acquired in the Merger. AMG's product revenue declined 11% in the first quarter
of 1996 over the first quarter of 1995. In the first quarter of 1995, the
group's operations outside of North America closed several large contracts which
were not repeated in the first quarter of 1996 and subsequent to the Merger
there was a reduced marketing and sales emphasis on certain products which
became non-strategic after the Merger. As a direct result of the acquisition,
product support and consulting services revenue increased 99% and 61%
respectively in the first
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<PAGE>
quarter of 1996 versus the same quarter of 1995. The Federal Systems Group
("FSG") revenue increased $2,597,000, or 11%, due to higher contract billings in
the Information Technology Division offset in part by lower contract billings
due to the completion of certain contracts at NASA. Revenue from outside North
America represented approximately 26% of the Company's revenue in the first
quarter of 1996 compared to 25% in the first quarter of 1995. Approximately 43%
of the Company's total product revenue was generated from non-mainframe
products. This compares with 37% in the first quarter of 1995.
Total costs and expenses decreased $64,528,000, primarily due to a
$62,000,000 charge in the first quarter of 1995 for the portion of the purchase
price of KnowledgeWare attributed to in-process research and development and to
a $19,512,000 charge for restructuring in the first quarter of 1995 resulting
from the Merger. Total cost of sales increased $7,153,000, or 17%, on an 18%
increase in revenue. Product development expense for the first quarter of 1996
was $9,360,000, net of $6,066,000 of capitalized software costs as compared to
first quarter of 1995 product development expense of $9,446,000, net of
$4,146,000 of capitalized software costs. The increase in gross product
development expense is primarily due to more projects in development and higher
costs in the first quarter of 1996 than in the same period of 1995 resulting
from the businesses acquired November 30, 1994. Total capitalized costs
represented 39% and 31% of total development expense in the first quarter of
1996 and 1995 respectively. Product development expense and the capitalization
rate may fluctuate from period to period depending in part upon the number and
status of software development projects which are in process. Selling, general
and administrative expense increased $9,917,000, or 20%, primarily due to
businesses acquired in the Merger and due to increased headcount in ECG and
International Group ("IG") to support the continuing growth of the Company.
Investment income increased $2,233,000 as a result of higher average balances
of investments in marketable securities. The income before income taxes was
$32,284,000 in the first quarter of 1996 as compared to a loss before income
taxes of $57,303,000 in the first quarter of 1995. Excluding the $62,000,000
non-recurring charge for purchased research and development and the $19,512,000
non-recurring charge for restructuring, income before income taxes increased
$8,075,000, or 33%, primarily due to higher operating profits in ECG, up 61%,
FSG, up 51%, and SMG, up 4%, partially offset by a 14% decline in AMG's
operating profit resulting from the inclusion of the full operating costs of the
businesses acquired in the first quarter of 1995.
Liquidity and Capital Resources
The Company maintained a strong liquidity and financial position with
$233,092,000 of working capital at December 31, 1995, which includes $93,977,000
of cash and cash equivalents and $142,562,000 of marketable securities. Net cash
flows from operations was $22,671,000 in the first quarter of 1996 as compared
to $21,705,000 in the first quarter of 1995. Cash generated from higher
operating profits was offset in part by cash paid to settle current
liabilities at the end of 1995 and the repurchase of the Company's $0.10 par
value Common Stock ("Sterling Common Stock"). Days sales outstanding at December
31, 1995 measured on a quarterly basis was 107 versus 96 at September 30, 1995
and 103 at December 31, 1994. The increase in days sales outstanding in the
first quarter is consistent with historical trends. Cash flows from operations
and available cash balances were
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<PAGE>
used to fund operations, marketable securities purchases and capital
expenditures, including software additions.
On December 20, 1995, the Company gave notice of the redemption of all of the
$114,922,000 then outstanding principal amount of its 5.75% Convertible
Subordinated Debentures due February 1, 2003 (the "Debentures"). The effective
date of the redemption was February 12, 1996 (the "Redemption Date"). The
Debentures were convertible into shares of Sterling Common Stock. Approximately
$114,912,000 principal amount of the Debentures was presented for conversion. In
addition, approximately $78,000 principal amount of the Debentures had been
converted prior to the announcement of the Redemption. As of February 5, 1996
approximately 4,056,000 shares of Sterling Common Stock had been issued upon
conversion of the Debentures. Approximately $10,000 principal amount of
Debentures was redeemed for cash on February 12, 1996. The conversion of the
Debentures will reduce the Company's interest charges by approximately
$1,700,000 per quarter.
At December 31, 1995, after the utilization of $1,659,000 for standby letters
of credit, $33,341,000 was available for borrowing on the Company's $35 million
revolving credit and term loan agreement. Certain of the Company's foreign
subsidiaries have separate lines of credit available for foreign exchange
exposure management and working capital requirements. These lines of credit are
guaranteed by the U.S. parent company. At December 31, 1995, $5,633,000 was
outstanding pursuant to foreign lines of credit and $16,615,000 was available
for borrowing thereunder.
On October 2, 1995, the Company renewed a share repurchase program pursuant
to which it may repurchase shares of Sterling Common Stock from time to time
through open market transactions. Through December 31, 1995, 699,500 shares of
Sterling Common Stock were repurchased at an aggregate amount of approximately
$30,931,000. Since December 31, 1995 and through February 9, 1996, approximately
429,400 shares of Sterling Common Stock were repurchased at an aggregate amount
of approximately $22,256,000.
At December 31, 1995, the Company's capital resource commitments consisted of
commitments under lease arrangements for office space and equipment. The Company
intends to meet such obligations primarily from internally generated funds. No
significant commitments exist for future capital expenditures. The Company
believes available balances of cash, cash equivalents and short-term investments
combined with cash flows from operations and amounts available under credit and
term loan agreements are sufficient to meet the Company's cash requirements for
the foreseeable future.
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<PAGE>
Proposed Subsidiary Initial Public Offering and Distribution
Sterling Commerce, Inc. ("SCI"), a wholly owned subsidiary of Sterling
Software has 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 12,000,000 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. Sterling Software presently intends to use
the proceeds that it would receive upon the completion of the Offering for
working capital and other general corporate purposes, including, but not limited
to, possible acquisitions of software assets and companies.
Sterling Software incorporated SCI as a Delaware corporation in December
1995. In contemplation of the Offering, among other things, (i) Sterling
Software will cause to be transferred to SCI all of the issued and outstanding
shares of capital stock of the subsidiaries through which SCI conducts its
business, which subsidiaries include all of the subsidiaries previously
comprising Sterling Software's Electronic Commerce Group, (ii) Sterling Software
will cause to be transferred to SCI certain assets relating to the electronic
commerce business previously conducted by Sterling Software's International
Group and certain assets relating to the electronic commerce business previously
conducted by Sterling Software's Federal Systems Group, and (iii) SCI will enter
into contractual arrangements with Sterling Software related to space sharing,
tax allocations, international marketing and certain services among others.
Following the completion of the Offering, Sterling Software intends to
distribute pro rata to its stockholders as a dividend the remaining shares of
SCI Common Stock 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 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 has
applied to the IRS for a ruling as to the tax-free nature of the Distribution.
It is presently anticipated that the Distribution will occur prior to
September 30, 1996.
In connection with the proposed Offering, Sterling Software
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has approved the acceleration of substantially all outstanding options granted
under Sterling Software's existing stock option plans, effective as of the
completion of the Offering. If all options and warrants to purchase Sterling
Common Stock outstanding at January 31, 1996 were exercised, an additional
8,512,000 shares of Sterling Common Stock would be issued and outstanding, with
resulting proceeds to the Company of approximately $269,710,000. There can be no
assurance, however, as to whether or when any of such options or warrants will
be exercised.
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.
The Company has included pro forma financial statements in Part II, Item 5 of
this Form 10-Q to illustrate the effects of the proposed Distribution and the
redemption and conversion of the Company's 5.75% Convertible Subordinated
Debentures.
Other Matters
Demand for many of the Company's products tends to improve with increased
inflation as customers strive to increase employee productivity and reduce
costs. However, the effect of inflation on the Company's relatively labor
intensive cost structure could adversely affect its results of operations to the
extent the Company might not be able to recover increased operating costs
through increased product licensing and prices.
The assets and liabilities of non-U.S. operations are translated into U.S.
dollars at exchange rates in effect as of the respective balance sheet dates,
and revenue and expense accounts of these operations are translated at average
exchange rates during the month the transactions occur. Unrealized translation
gains and losses are included as an adjustment to retained earnings. The Company
has mitigated a portion of its currency exposure through decentralized sales,
marketing and support operations and through international development
facilities, in which all costs are local currency based. When necessary, the
Company may also hedge to prevent material exposure.
The Company maintains a strategy of acquiring businesses and products that
fill strategic market niches within the business groups. This acquisition
strategy contributes in part of the Company's growth in revenue and operating
profit before restructuring charges. The impact of future acquisitions on
continued growth in revenue and operating profit cannot presently be determined.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On November 30, 1994, Sterling Software, Inc. ("Sterling", "Sterling
Software" or the "Company") acquired KnowledgeWare, Inc. ("KnowledgeWare"), in a
stock-for-stock acquisition described in more detail in Note 4 under "Notes to
Consolidated Financial Statements" in Part I of this Report. In connection with
that transaction, Sterling Software placed 484,800 shares of its common stock in
escrow (the "Escrowed Shares") to cover certain losses that may result in
connection with any pending or threatened litigation, action, claim, proceeding,
dispute or investigation (including amounts paid in settlement) to which
Sterling Software is entitled to indemnification pursuant to the terms of the
merger agreement providing for the acquisition. A number of lawsuits were filed
against KnowledgeWare and certain of its former officers and directors alleging
violations of securities laws and related laws.
On December 18, 1991, a complaint ("KnowledgeWare I") was filed in the
United States District Court for the Northern District Of Georgia, Atlanta
Division (the "Georgia Court") which consolidated and amended several class
action lawsuits previously filed against KnowledgeWare and certain of its former
officers and directors in October 1991. KnowledgeWare I 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. 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.
In April 1994, the Georgia Court approved a settlement of the 1991 class action.
However, on August 30, 1994, the plaintiffs in KnowledgeWare I filed motions
alleging 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 financial results for the first
three quarters of fiscal year 1994 had substantially reduced the value of
warrants (the "Warrants") available to the plaintiffs under the settlement
agreement.
In August and September, 1994, eight lawsuits were filed against
KnowledgeWare and certain of its former directors and officers in the Georgia
Court. Subsequently, these lawsuits were consolidated ("KnowledgeWare II").
KnowledgeWare II was a class action 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 KnowledgeWare II
was the plaintiffs' allegation 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. The plaintiffs in KnowledgeWare II sought compensatory
damages and reimbursement for the plaintiffs' fees and expenses.
On October 25, 1995, Sterling and the defendants in KnowledgeWare I and
KnowledgeWare II entered into settlement agreements to resolve KnowledgeWare I
and KnowledgeWare II for an aggregate of
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<PAGE>
approximately $3.75 million in cash plus approximately 278,000 of the Escrowed
Shares. The cash portion of the settlement was paid by KnowledgeWare's
insurance carriers. Pursuant to the terms of the settlement agreements, the
plaintiff class members in KnowledgeWare I are receiving $2.0 million of
proceeds from the sale of Escrowed Shares in lieu of the Warrants. The plaintiff
class members in KnowledgeWare II are receiving the remainder of the proceeds
from the sale of Escrowed Shares included in the settlement and $3.75 million in
cash, net of plaintiffs' attorneys fees and certain costs. On January 4, 1996,
the Court granted final approval to the settlement of KnowledgeWare I and II.
Three other lawsuits were filed against KnowledgeWare and certain of its
former officers and directors in the United States District Court, District of
Minnesota, Fourth Division. The first such suit, filed on January 19, 1995, was
brought against KnowledgeWare by seven named plaintiffs, including Irwin L.
Jacobs, who purchased 666,700 shares of KnowledgeWare common stock in a private
placement (the "Jacobs Suit"). The second suit, filed on January 20, 1995, was
brought against KnowledgeWare and its former directors and certain of its former
officers by over twenty named plaintiffs who purchased shares of KnowledgeWare
common stock on the open market on and after November 1993 (the "Second Jacobs
Suit"). The third suit, filed on June 27, 1995, was brought by certain
investment clients of Mitchell Hutchins Asset Management, Inc., who had
purchased 177,000 shares of KnowledgeWare common stock in a private placement in
January of 1994, against KnowledgeWare and certain of its former directors and
officers (the "Compass Investors Suit"). These three suits were consolidated by
court order on September 11, 1995.
In the Jacobs Suit, the plaintiffs alleged that representations and
warranties in the private placement agreement relating to the financial
condition of KnowledgeWare were false and misleading in that they contained
untrue statements or omitted to state material facts necessary to make the
statements not misleading. The claims included breach of contract, violation of
Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, controlling person
liability of the individual defendants under Section 20 of the Exchange Act and
the Georgia and Minnesota Securities Acts, claims for violation of Section 18 of
the Exchange Act, violations of the Minnesota Consumer Fraud Act, breaches of
fiduciary duty by the individual defendants, common law fraud and claims for
treble and punitive damages and attorneys' fees under Federal and Georgia RICO
statutes. Actual damages claimed were in the approximate amount of $8.1 million,
plus interest.
In the Second Jacobs Suit, the plaintiffs alleged they purchased shares of
KnowledgeWare common stock based on defendants' representations which allegedly
contained untrue statements of material fact or omitted to state material facts
necessary to make the statements not misleading. The claims in the Second Jacobs
Suit for violation of law were substantially the same as those in the Jacobs
Suit, except in the Second Jacobs Suit there was no claim for breach of
contract. Plaintiffs sought to rescind the stock purchases, in the case of stock
still held, or to recover rescissory damages in the aggregate amount of $5.8
million, plus interest and other relief.
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<PAGE>
The plaintiffs in the Compass Investors Suit alleged claims substantially
identical to those alleged in the Jacobs Suit, except in the Compass Investors
Suit there was no claim for breach of fiduciary duty. Plaintiffs in the Compass
Investors Suit sought compensatory damages of more than $2.0 million, treble and
punitive damages, interest, attorneys' fees and expenses.
On December 19, 1995, Sterling Software and the defendants entered into
settlement agreements with respect to the Jacobs Suit, the Second Jacobs Suit
and the Compass Investors Suit, pursuant to the terms of which KnowledgeWare
will pay to certain plaintiffs in those actions approximately $12.2 million,
less the amounts that other plaintiffs in those actions receive in the
settlement of KnowledgeWare II. In connection with this settlement, on
January 24, 1996, Sterling Software, acting under its indemnification rights,
received the remaining 206,796 Escrowed Shares to reimburse it for a portion of
the amounts paid in the settlement and for costs and expenses related to these
and other claims, proceedings, disputes and investments for which Sterling
Software is entitled to indemnification. This application of the remaining
Escrowed Shares together with the use of Escrowed Shares to satisfy the
settlements of KnowledgeWare I and KnowledgeWare II, described above, has
utilized all the shares in the escrow.
On September 9, 1994, a lawsuit (the "Ecta Suit") was filed against
KnowledgeWare and certain of its former officers and directors in the Southern
District of Iowa, Central Division (the "Iowa Court"). The Ecta Suit alleged
violations of Section 10 (b) of the Exchange Act and Rule 10b-5 under the
Exchange Act, Section 12 (2) of the Securities Act of 1933, violation of the
Iowa Blue Sky Laws, fraud and breach of contract. The alleged factual basis
underlying the Ecta Suit arose 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 alleged 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 had breached certain warranties, representations
and covenants made in the Acquisition Agreement. The Ecta Suit sought
unspecified 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.
On April 27, 1995, Gerald Caussade, a former employee of KnowledgeWare and
a principal of Ecta Corporation and Fairfield Development, Inc. (plaintiffs in
the Ecta Suit referred to above), filed suit (the "Caussade Suit") in the Iowa
Court against KnowledgeWare, Donald Addington, Francis Tarkenton, Sterling
Software, Inc., Werner Frank and Sterling Williams. The plaintiff claimed (a)
breach of contract as a third party beneficiary under the Acquisition Agreement,
(b) as to the individual defendants, tortious interference with plaintiff's
business relations with KnowledgeWare, (c) fraudulent misrepresentation and
negligent misrepresentation in connection with his accepting employment with
KnowledgeWare, (d) wrongful termination in violation of public policy in
connection with his termination from employment and (e) breach of contract under
his employment contract. Plaintiff sought unspecified compensatory damages,
damages for emotional distress, punitive damages and interest and other costs.
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On December 26, 1995, Sterling Software and the defendants entered into a
settlement agreement with respect to the Ecta Suit and the Caussade Suit.
Pursuant to the terms of the settlement agreement with respect to the Ecta Suit
and the Caussade Suit, KnowledgeWare will settle those actions by the payment of
$3.4 million, less amounts received by plaintiffs in the Ecta Suit in the
settlement of KnowledgeWare II. The settlement of these actions satisfies all
remaining payment obligations with respect to the assets purchased by
KnowledgeWare from the plaintiffs in the Ecta Suit, including product royalty
obligations.
Unless appeals are filed in KnowledgeWare I or KnowledgeWare II, the final
settlement of which is a condition of the other described settlements, all
pending private civil actions against KnowledgeWare filed in connection with
KnowledgeWare's restatement of its financial results for the first three
quarters of its 1994 fiscal year and its financial results for its full 1994
fiscal year will have been resolved prior to the Company's second fiscal
quarter. The Securities and Exchange Commission continues its formal
investigation previously reported in Sterling Software's Annual Report on Form
10-K for the fiscal year ended September 30, 1995. See Note 5.
Sterling Software's management believes that, in view of Sterling
Software's indemnification from the Escrowed Shares and after giving effect to
applicable reserves, the settlements described above and the ultimate resolution
of the Securities and Exchange Commission's investigation will not materially
affect the financial condition or results of operations of Sterling Software.
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Item 5. Other Information
Pro Forma Financial Data
The pro forma financial statements included in this report illustrate the
effects of the proposed Distribution (as such terms are defined in Note 3 to
Notes to Consolidated Financial Statements included in Part I) and the
conversion of the Company's 5.75% Convertible Subordinated Debentures due
February 2, 2003 (the "Debentures"). 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
this report, and 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 includes balance sheet information at December 31, 1995 and statements
of operations for the three months ended December 31, 1995 and 1994.
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<PAGE>
STERLING SOFTWARE, INC.
PRO FORMA CONSOLIDATED BALANCE SHEETS
December 31, 1995
(in thousands)
<TABLE>
<CAPTION>
Pro Forma
Adjustments Pro Forma Sterling
Historical for the Adjustments Software as
Sterling Debenture for the Adjusted at
Software at Redemption and Distribution Dec. 31, 1995
Dec. 31, 1995 Conversion(1) of SCI(2) (4)
------------- -------------- ------------ -------------
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents......................... $ 93,977 $ (10) $ (3,527) $ 90,440
Marketable securities............................. 142,562 142,562
Accounts and notes receivable, net................ 176,266 (48,758) 127,508
Other current assets.............................. 21,306 (6,393) 14,913
-------- --------- --------- --------
Total current assets......................... 434,111 (10) (58,678) 375,423
Property and equipment, net........................... 70,418 (29,941) 40,477
Computer software, net................................ 88,602 (32,890) 55,712
Excess cost over net assets acquired, net............. 84,337 (10,152) 74,185
Other noncurrent assets............................... 25,029 (5,885) 19,144
-------- --------- --------- --------
Total assets................................. $702,497 $ (10) $(137,546) $564,941
======== ========= ========= ========
Current liabilities................................... $201,019 $ (53,096) $147,923
Long-term debt........................................ 116,647 $(114,882) (1,461) 304
Other noncurrent liabilities.......................... 25,708 (23,387) 2,321
Stockholders' equity:(3)
Common stock...................................... 2,741 405 3,146
Additional paid in capital........................ 356,747 114,467 471,214
Retained earnings................................. 30,822 (59,602) (28,780)
Less: treasury stock............................. (31,187) (31,187)
-------- --------- --------- --------
Total stockholders' equity................... 359,123 114,872 (59,602) 414,393
-------- --------- --------- --------
Total liabilities & stockholders' equity..... $702,497 $ (10) $(137,546) $564,941
======== ========= ========= ========
</TABLE>
See accompanying notes.
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<PAGE>
NOTES TO PRO FORMA CONSOLIDATED BALANCE SHEET
(1) Adjusted to give effect to the conversion and redemption of the outstanding
Debentures. On December 20, 1995, the Company gave notice of the redemption
of all of the $114,922,000 then outstanding principal amount of the
Debentures. The effective date of the redemption was February 12, 1996 (the
"Redemption Date"). The Debentures were convertible into shares of Sterling
Software's $0.10 par value Common Stock ("Sterling Common Stock").
Approximately $114,912,000 principal amount of the Debentures was presented
for conversion. In addition, approximately $78,000 principal amount of the
Debentures had been converted prior to the announcement of the Redemption.
As of February 5, 1996 approximately 4,056,000 shares of Sterling Common
Stock had been issued upon conversion of the Debentures. Approximately
$10,000 principal amount of Debentures was redeemed for cash on February 12,
1996.
(2) Adjusted to give effect to the proposed Distribution.
(3) In connection with the proposed Offering, Sterling Software has approved the
acceleration of substantially all outstanding options granted under Sterling
Software's existing stock option plans, effective as of the 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
Consolidated Balance Sheet. If all options and warrants to purchase Sterling
Common Stock outstanding at January 31, 1996 were exercised, an additional
8,512,000 shares of Sterling Common Stock would be issued and outstanding
with resulting proceeds to the Company of approximately $269,710,000.
(4) The Pro Forma Consolidated Balance Sheet does not reflect the receipt of any
proceeds from the sale of SCI Common Stock (as such terms are defined in
Note 3 to Notes to Consolidated Financial Statements included in Part I) in
the Offering.
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STERLING SOFTWARE, INC.
PRO FORMA STATEMENTS OF OPERATIONS
Three Months Ended December 31, 1995
(in thousands, except per share information)
<TABLE>
<CAPTION>
Pro Forma
Historical Adjustments for Pro Forma Sterling
Sterling the Debenture Adjustments for Software as
Software at Redemption and the Distribution Adjusted at
Dec. 31, 1995 Conversion of SCI(2) Dec. 31, 1995
------------- --------------- ---------------- -------------
<S> <C> <C> <C> <C>
Revenue:
Products................................ $ 52,375 $(17,403) $34,972
Product support......................... 44,671 (13,477) 31,194
Services................................ 51,606 (21,787) 29,819
Royalties from affiliated companies..... (3,483)
3,483 (4)
-------- ------ -------- -------
Total revenue...................... 148,652 (52,667) 95,985
Cost and expenses:
Cost of sales:
Product and product support.............. 18,892 (7,221) 15,154
3,483 (4)
Services................................. 30,771 (4,695) 26,076
-------- ------ -------- -------
49,663 (8,433) 41,230
-------- ------ -------- -------
Product research, development and
enhancement............................ 9,360 (3,288) 6,072
Selling, marketing, general and
administrative......................... 58,932 (20,255) 39,552
875 (3)
-------- ------ -------- -------
Total costs and expenses........... 117,955 (31,101) 86,854
Income from operations................... 30,697 (21,566) 9,131
Interest expense......................... (1,851) 1,745 (1) 12 (94)
Investment & interest income............. 3,121 (16) 3,105
Other income............................. 317 214 531
-------- ------ -------- -------
1,587 1,745 210 3,452
-------- ------ -------- -------
Income before income taxes.................. 32,284 1,745 (21,356) 12,673
Provision for income taxes.................. 10,977 698 (8,542) 3,133
-------- ------ -------- -------
Income from continuing operations........... $ 21,307 $1,047 $(12,814) $ 9,540
======== ====== ======== =======
Pro forma income from
continuing operations per share.......... $ .66 $ .28
======== =======
</TABLE>
-26-
<PAGE>
STERLING SOFTWARE, INC.
PRO FORMA STATEMENTS OF OPERATIONS
Three Months Ended December 31, 1994
(in thousands, except per share information)
<TABLE>
<CAPTION>
Pro Forma
Historical Adjustments for Pro Forma Sterling
Sterling the Debenture Adjustments for Software as
Software at Redemption and the Distribution Adjusted at
Dec. 31, 1994 Conversion of SCI(2) Dec. 31, 1994
------------- --------------- ---------------- -------------
<S> <C> <C> <C> <C>
Revenue:
Products................................ $ 49,551 $(15,319) $ 34,232
Product support......................... 34,671 (10,466) 24,205
Services................................ 42,196 (17,037) 25,159
Royalties from affiliated companies..... (2,274)
2,274 (4)
-------- ------ -------- --------
Total revenue...................... 126,418 (42,822) 83,596
Cost and expenses:
Cost of sales:
Product and product support............. 16,011 (5,855) 12,430
2,274 (4)
Services................................ 26,499 (3,737) 22,762
-------- ------ -------- --------
42,510 (7,318) 35,192
-------- ------ -------- --------
Product research, development and
enhancement.......................... 9,446 (3,599) 5,847
Selling, marketing, general and
administrative....................... 49,015 (17,303) 32,587
875 (3)
Restructuring charges................... 19,512 19,512
Purchased research and development...... 62,000 62,000
-------- ------ -------- --------
Total costs and expenses........... 182,483 (27,345) 155,138
Income (loss) from operations........... (56,065) (15,477) (71,542)
Interest expense........................ (1,990) 1,745 (1) 25 (220)
Investment & interest income............ 888 888
Other income............................ (136) 34 (102)
-------- ------ -------- --------
(1,238) 1,745 59 566
-------- ------ -------- --------
Income (loss) before income taxes........... (57,303) 1,745 (15,418) (70,976)
Provision (benefit) for income taxes........ 4,352 698 (6,167) (1,117)
-------- ------ -------- --------
Income (loss) from continuing operations.... $(61,655) $1,047 $ (9,251) $(69,859)
======== ====== ======== ========
Pro forma income (loss) from continuing
operations per share.................... $ (2.87) $ (2.74)
======== ========
</TABLE>
-27-
<PAGE>
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 proposed Distribution.
(3) Administrative charges incurred by Sterling Software allocated to SCI were
approximately $875,000 in the three months ended December 31, 1995 and 1994,
respectively. This adjustment reflects the addition of those costs to
Sterling Software as if SCI had been historically distributed to
stockholders.
(4) 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.
-28-
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of this Quarterly Report on
Form 10-Q:
2(a) - Amended and Restated Agreement and Plan of Merger dated as of
August 31, 1994, among the Company, KnowledgeWare, Inc. and SSI
Corporation ("KWI Agreement and Plan of Merger") (1)
2(b) - Agreement dated October 11, 1994 among the Company,
KnowledgeWare, Inc. and SSI Corporation (1)
2(c) - First Amendment to KWI Agreement and Plan of Merger (1)
3(a) - Certificate of Incorporation of the Company (2)
3(b) - Certificate of Amendment of Certificate of Incorporation of the
Company (3)
3(c) - Certificate of Amendment of Certificate of Incorporation of the
Company (4)
3(d) - Certificate of Amendment of Certificate of Incorporation of
the Company (5)
3(e) - Restated Bylaws of the Company (6)
4(a) - Indenture dated February 2, 1993 between the Company and Bank
of America Texas, National Association, as Trustee, including
the form of 5.75% Convertible Subordinated Debenture attached
as Exhibit A thereto (7)
4(b) - Warrant Agreement dated June 9, 1994 between KnowledgeWare,
Inc. and Trust Company Bank (8)
4(c) - Supplemental Warrant Agreement dated as of November 30, 1994
between KnowledgeWare, Inc. and Trust Company Bank (8)
11 - Computation of Earnings Per Share, Three Months Ended
December 31, 1995 (9)
27 - Financial Data Schedule (9)
- --------------------
-29-
<PAGE>
(1) Previously filed as an exhibit to the Company's Registration Statement No.
33-56185 on Form S-4 and incorporated herein by reference.
(2) Previously filed as an exhibit to the Company's Registration Statement No.
2-82506 on Form S-1 and incorporated herein by reference.
(3) Previously filed as an exhibit to the Company'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 Company's Registration Statement No.
33-69926 on Form S-8 and incorporated herein by reference.
(5) Previously filed as an exhibit to the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1995 and incorporated herein by
reference.
(6) Previously filed as an exhibit to the Company's Registration Statement No.
33-47131 on Form S-8 and incorporated herein by reference.
(7) Previously filed as an exhibit to the Company's Annual Report on Form 10-K
for the fiscal year ended September 30, 1995 and incorporated herein by
reference.
(8) Previously filed as an exhibit to the Company's Registration Statement No.
33-56679 on Form S-3 and incorporated herein by reference.
(9) Filed herewith.
(b) Reports on Form 8-K.
On October 31, 1995, the Company filed a Current Report on Form 8-K, dated
October 25, 1995, in which the Company reported under Item 5 entering into the
settlement agreements with respect to two class action suits described under
"Item 1. Legal Proceedings" in Part II of this Report on Form 10-Q.
On December 20, 1995, the Company filed a Current Report on Form 8-K, dated
December 20, 1995, in which the Company reported under Item 5 information
related to a proposed initial public offering (the "IPO") of common stock of
Sterling Commerce, Inc., a wholly-owned subsidiary of the Company ("SCI"), a
proposed dividend of the Company's remaining ownership of SCI following the IPO
(the "Spin-off"), and the announcement of the Company's planned redemption of
its 5.75% Convertible Subordinated Debentures due February 1, 2003 (the
"Debentures"). The Company included in such report the following financial
statements:
1. Sterling Software, Inc.
(i) Pro Forma Consolidated Balance Sheet as of September 30, 1995,
showing adjustments for (a) the assumed conversion prior to
redemption, of the Debentures, (b) the IPO and (c) the Spin-off;
(ii) Pro Forma Statement of Operations for the Years Ended September
30, 1995 and 1994, showing adjustments for (a) the assumed conversion
of the Debentures and (b) the Spin-off; and
(iii) the related notes thereto.
-30-
<PAGE>
2. Sterling Commerce, Inc.
(i) Pro Forma Unaudited Consolidated Balance Sheets (a) as of
September 30, 1994 and 1995 and (b) as of September 30, 1995 (as
adjusted for SCI's receipt of proceeds from its issuance and sale of
common stock in the IPO);
(ii) Pro Forma Unaudited Consolidated Statements of Operations for the
Years Ended September 30, 1994 and 1995; and
(iii) the related notes thereto.
-31-
<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 thereunto duly authorized.
STERLING SOFTWARE, INC.
Date: February 12, 1996 /s/ Sterling L. Williams
----------------------------------------------
Sterling L. Williams
President, Chief Executive Officer
and Director
(Principal Executive Officer)
Date: February 12, 1996 /s/ George H. Ellis
----------------------------------------------
George H. Ellis
Executive Vice President
and Chief Financial Officer
(Principal Financial and Accounting Officer)
-32-
<PAGE>
EXHIBIT INDEX
-----------------
Exhibit
No. Description
- ------- ---------------------------------------------------------------
2(a) - Amended and Restated Agreement and Plan of Merger dated as
of August 31, 1994, among the Company, KnowledgeWare, Inc. and
SSI Corporation ("KWI Agreement and Plan of Merger") (1)
2(b) - Agreement dated October 11, 1994 among the Company,
KnowledgeWare, Inc. and SSI Corporation (1)
2(c) - First Amendment to KWI Agreement and Plan of Merger (1)
3(a) - Certificate of Incorporation of the Company (2)
3(b) - Certificate of Amendment of Certificate of Incorporation of
the Company (3)
3(c) - Certificate of Amendment of Certificate of Incorporation of
the Company (4)
3(d) - Certificate of Amendment of Certificate of Incorporation of
the Company (5)
3(e) - Restated Bylaws of the Company (6)
4(a) - Indenture dated February 2, 1993 between the Company and Bank
of America Texas, National Association, as Trustee, including
the form of 5.75% Convertible Subordinated Debenture attached
as Exhibit A thereto (7)
4(b) - Warrant Agreement dated June 9, 1994 between KnowledgeWare,
Inc. and Trust Company Bank (8)
4(c) - Supplemental Warrant Agreement dated as of November 30, 1994
between KnowledgeWare, Inc. and Trust Company Bank (8)
<PAGE>
11 - Computation of Earnings Per Share, Three Months Ended
December 31, 1995 (9)
27 - Financial Data Schedule (9)
- --------------------
(1) Previously filed as an exhibit to the Company's Registration Statement
No. 33-56185 on Form S-4 and incorporated herein by reference.
(2) Previously filed as an exhibit to the Company's Registration Statement
No. 2-82506 on Form S-1 and incorporated herein by reference.
(3) Previously filed as an exhibit to the Company'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 Company's Registration Statement
No. 33-69926 on Form S-8 and incorporated herein by reference.
(5) Previously filed as an exhibit to the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1995 and incorporated herein by
reference.
(6) Previously filed as an exhibit to the Company's Registration Statement
No. 33-47131 on Form S-8 and incorporated herein by reference.
(7) Previously filed as an exhibit to the Company's Annual Report on Form 10-K
for the fiscal year ended September 30, 1995 and incorporated herein by
reference.
(8) Previously filed as an exhibit to the Company's Registration Statement
No. 33-56679 on Form S-3 and incorporated herein by reference.
(9) Filed herewith.
<PAGE>
STERLING SOFTWARE, INC. EXHIBIT 11
COMPUTATION OF EARNINGS PER SHARE
THREE MONTHS ENDED DECEMBER 31, 1995
(in thousands, except per share information)
<TABLE>
<CAPTION>
Fully
Primary Diluted
------- -------
<S> <C> <C>
Earnings:
Earnings applicable to common stockholders................................... $21,307 $21,307
Add: Interest expense on amounts outstanding for the 5 3/4% Convertible
Subordinated Debentures (net of applicable income taxes)............ 218 1,160
------- -------
$21,525 $22,467
======= =======
Shares:
Weighted average of shares outstanding....................................... 26,630 26,630
Add common shares issued on assumed exercise of options and warrants......... 8,616 8,616
Less common shares assumed repurchased....................................... (5,333) (5,074)
------- -------
29,913 30,172
=======
Common shares issued on assumed conversion of 5 3/4% Convertible
Subordinated Debentures...................................................... 4,052
-------
34,224
=======
Earnings per common share:
Primary...................................................................... $ .72
=======
Fully diluted................................................................ $.66
=======
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Form 10Q and
is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-1996
<PERIOD-END> DEC-31-1995
<CASH> 93,977
<SECURITIES> 142,562
<RECEIVABLES> 176,266
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 434,111
<PP&E> 133,363
<DEPRECIATION> 62,945
<TOTAL-ASSETS> 702,497
<CURRENT-LIABILITIES> 201,019
<BONDS> 116,647
0
0
<COMMON> 2,741
<OTHER-SE> 356,382
<TOTAL-LIABILITY-AND-EQUITY> 702,497
<SALES> 148,652
<TOTAL-REVENUES> 148,652
<CGS> 49,663
<TOTAL-COSTS> 117,955
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,851
<INCOME-PRETAX> 32,284
<INCOME-TAX> 10,977
<INCOME-CONTINUING> 21,307
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 21,307
<EPS-PRIMARY> 0.72
<EPS-DILUTED> 0.66
</TABLE>
