<PAGE>
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 June 30, 1996
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.
Title Shares Outstanding as of August 12, 1996
- ----------------------------- ----------------------------------------
Common Stock, $0.10 par value 37,273,400
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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 June 30, 1996 and
September 30, 1995.......................................... 3
Sterling Software, Inc. Consolidated
Statements of Operations for the Three
and Nine
Months Ended June 30, 1996 and 1995......................... 4
Sterling Software, Inc. Consolidated
Statements of Stockholders' Equity for
the Nine
Months Ended June 30, 1996 and 1995......................... 5
Sterling Software, Inc. Consolidated
Statements of Cash Flows for the Nine
Months
Ended June 30, 1996 and 1995................................ 6
Sterling Software, Inc. Notes to
Consolidated Financial Statements........................... 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS................... 14
</TABLE>
PART II - OTHER INFORMATION
<TABLE>
<CAPTION>
<S> <C>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS... 21
ITEM 5 OTHER INFORMATION
Pro Forma Financial Data....................................... 22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K..................... 28
</TABLE>
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STERLING SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
A S S E T S
<TABLE>
<CAPTION>
JUNE 30 SEPTEMBER 30
1996 1995
----------- -------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents................. $ 573,946 $ 179,305
Marketable securities..................... 172,851 61,341
Accounts and notes receivables, net....... 170,740 183,734
Deferred income taxes..................... 1,890
Prepaid expenses and
other current assets.................... 20,860 17,784
---------- ---------
Total current assets................. 938,397 444,054
Property and equipment, net of accumulated
depreciation of $68,306 at June 30, 1996
and $59,716 at September 30, 1995........ 75,204 68,412
Computer software, net of accumulated
amortization of $121,655 at June 30, 1996
and $104,813 at September 30, 1995....... 89,952 80,966
Excess cost over net assets acquired,
net of accumulated amortization of
$28,007 at June 30, 1996 and $23,362
at September 30, 1995.................... 80,971 85,903
Noncurrent deferred income taxes............ 17,960
Other assets................................ 13,700 16,885
--------- --------
$1,198,224 $714,180
========== ========
L I A B I L I T I E S A N D S T O C K H O L D E R S ' E Q U I T Y
Current liabilities:
Current portion of long term debt......... $ 1,519 $ 5,871
Income taxes payable...................... 32,000 4,679
Accounts payable and accrued
liabilities............................ 93,637 114,391
Deferred revenue.......................... 104,630 96,708
---------- --------
Total current liabilities.......... 231,786 221,649
Long-term debt.............................. 1,093 116,668
Deferred income taxes....................... 7,880
Other noncurrent liabilities................ 32,308 27,525
Commitments and contingencies (Note 5)......
Minority interest........................... 21,300
Stockholders' equity:
Preferred stock, $.10 par value;
10,000,000 shares authorized...........
Common stock, $.10 par value; 75,000,000
shares authorized; 38,346,000 and
26,529,000 shares issued at
June 30, 1996 and September 30, 1995,
respectively........................... 3,835 2,653
Additional paid-in capital................ 748,491 336,752
Retained earnings......................... 211,019 9,515
Less treasury stock; at cost; 1,381,000
and 56,000 shares at June 30, 1996 and
September 30, 1995, respectively....... (59,488) (582)
---------- --------
Total stockholders' equity......... 903,857 348,338
---------- --------
$1,198,224 $714,180
========== ========
</TABLE>
See accompanying notes.
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<PAGE>
STERLING SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED JUNE 30 ENDED JUNE 30
------------------ -----------------
1996 1995 1996 1995
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenue:
Products.............................. $ 72,322 $ 60,990 $191,137 $160,957
Product support....................... 44,490 41,571 134,066 115,550
Services.............................. 57,506 48,387 161,756 139,066
-------- -------- -------- --------
174,318 150,948 486,959 415,573
Costs and expenses:
Cost of sales:
Products and product support.......... 19,207 16,733 59,315 48,696
Services.............................. 33,467 32,191 96,256 86,547
-------- -------- -------- --------
52,674 48,924 155,571 135,243
Product development and enhancement... 8,805 11,661 27,139 32,463
Selling, general and administrative... 72,799 56,452 197,241 157,383
Restructuring charge.................. 19,512
Purchased research and development.... 62,000
-------- -------- -------- --------
134,278 117,037 379,951 406,601
-------- -------- -------- --------
Income before other income (expense),
gain on subsidiary public offering,
minority interest and income taxes.... 40,040 33,911 107,008 8,972
Other income (expense):
Interest expense..................... (239) (2,189) (3,036) (6,389)
Investment income.................... 9,350 2,592 16,815 5,719
Other................................ 19 512 471 776
------- ------- -------- -------
9,130 915 14,250 106
------- ------- -------- -------
Income before gain on subsidiary public
offering, minority interest and income
taxes.................................. 49,170 34,826 121,258 9,078
Gain on subsidiary public offering..... 239,936
Minority interest...................... (2,714) (3,871)
-------- ------- -------- -------
Income before income taxes.............. 46,456 34,826 357,323 9,078
Provision for income taxes.............. 17,062 12,537 154,604 28,284
-------- ------- -------- --------
Net income (loss)....................... 29,394 22,289 202,719 (19,206)
Preferred stock dividends............... 49 147
-------- ------- -------- --------
Income (loss) applicable to common
stockholders........................... $ 29,394 $ 22,240 $202,719 $(19,353)
======== ======== ======== ========
Income (loss) per common share:
Net income (loss):
Primary............................... $.80 $.79 $6.24 $(.84)
======== ======= ======== ========
Fully diluted......................... $.80 $.73 $5.80 $(.84)
======== ======= ======== ========
Average common shares outstanding....... 35,758 24,118 30,598 23,036
======== ======= ======== ========
</TABLE>
See accompanying notes.
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<PAGE>
STERLING SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED JUNE 30, 1996 AND 1995
(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................ (19,206) (19,206)
Preferred stock dividends. (147) (147)
Issuance of common stock
and treasury stock for
acquisition............. 720 72 56,260 (1,701) 18,111 74,443
Common stock issuance
costs................... (730) (730)
Issuance of common stock
pursuant to stock
options and warrants.... 1,730 173 30,535 30,708
Issuance of common stock
to retirement plan....... 378 (18) 196 574
Tax benefit from exercise
of stock options......... 12,651 12,651
Issuance of warrants upon
conversion of preferred
stock.................... (200) (20) 20
Other..................... 41 (362) (8) 93 (228)
----- ---- ------ ------ -------- -------- ------ -------- ---------
Balance at June 30, 1995... 24,828 $2,483 $291,219 $(19,143) 66 $ (690) $ 273,869
===== ==== ====== ====== ======== ======== ===== ======== =========
Balance at September 30, 26,529 $2,653 $336,752 $ 9,515 56 $ (582) $ 348,338
1995......................
Net income................ 202,719 202,719
Acquisition of common
stock for treasury....... 1,336 (59,372) (59,372)
Issuance of common stock
pursuant to stock options
and warrants, including a
tax benefit of $45,284.... 7,761 776 267,049 267,825
Issuance of common stock
pursuant to conversion of
5.75% Debentures.......... 4,056 406 111,970 112,376
Proceeds from subsidiary
initial public offering,
net of minority interest
of $7,382................. 32,736 32,736
Issuance of common stock
to retirement plan....... (55) (11) 466 411
Other..................... 39 (1,215) (1,176)
------ ------ -------- -------- ----- ------- -------
Balance at June 30, 1996... 38,346 $3,835 $748,491 $211,019 1,381 $(59,488) $903,857
====== ====== ======== ======== ===== ======== ========
</TABLE>
See accompanying notes.
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STERLING SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED JUNE 30
--------------------
1996 1995
-------- --------
<S> <C> <C>
Operating activities:
Net income (loss)...................... $ 202,719 $(19,206)
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Gain on subsidiary public offering... (239,936)
Minority interest.................... 3,871
Depreciation and amortization........ 39,797 33,938
Provision for losses on accounts
receivable.......................... 3,118 2,643
Provision for deferred income taxes.. 31,229 14,762
Purchased research and development... 62,000
Write-down of property and equipment
and other assets.................... 2,462
Write-down of purchased and
capitalized computer software costs. 6,215
Changes in operating assets and
liabilities, net of effects of
business acquisitions:
Increase in accounts and notes
receivable....................... (18,493) (24,604)
Increase in prepaids and other
assets........................... (3,055) (3,109)
Increase (decrease) in accounts
payable, accrued liabilities and
income taxes payable............. 43,787 (10,407)
Increase in deferred revenue...... 7,799 12,348
Other............................. (1,076) (1,168)
--------- --------
Net cash provided by operating
activities...................... 69,760 75,874
Investing activities:
Purchases of property and equipment.... (24,518) (31,601)
Purchases and capitalized cost of
development of computer software...... (20,444) (16,016)
Business acquisitions, net of cash
acquired.............................. (7,186) (17,489)
Purchases of investments............... (401,266) (81,808)
Proceeds from sales of investments..... 289,822 51,415
Other................................ 774 316
--------- --------
Net cash used in investing
activities...................... (162,818) (95,183)
Financing activities:
Purchases of treasury stock............ (59,372)
Retirement and redemption of debt and
capital lease obligations............. (12,057) (15,264)
Proceeds from issuance of debt......... 4,049 22,661
Proceeds from sales of installment and
lease contracts receivable............ 23,904 9,685
Preacquisition advances to business
acquired.............................. (4,435)
Net proceeds from subsidiary public
offering.............................. 307,576
Proceeds from issuance of common stock
pursuant to stock options and warrants 222,541 30,708
Other.................................. 1,432 (601)
--------- --------
Net cash provided by financing
activities...................... 488,073 42,754
Effect of foreign currency exchange
rate changes on cash................... (374) 286
--------- --------
Increase in cash and cash equivalents... 394,641 23,731
Cash and cash equivalents at beginning
of period.............................. 179,305 101,893
Cash and cash equivalents at end of
period................................. $ 573,946 $125,624
========= ========
Supplemental cash flow information:
Interest paid.......................... $ 4,515 $ 4,667
========= ========
Income taxes paid...................... $ 48,244 $ 8,665
========= ========
Income tax refunds..................... $ 476 $ 1,184
========= ========
</TABLE>
See accompanying notes.
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STERLING SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1996
(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, including but not limited to
Sterling Commerce, Inc., (collectively, "Sterling Software", "Sterling" or the
"Company") after elimination of all significant intercompany balances and
transactions. Certain amounts for periods ended prior to June 30, 1996 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 June 30, 1996 and September 30, 1995 and the results of
operations for the three and nine months ended June 30, 1996 and 1995,
respectively. While management has based its assumptions and estimates on the
facts and circumstances known at June 30, 1996, 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 long-term contracts are recognized
when the current estimate of total contract costs indicates a loss on a contract
is probable.
-7-
<PAGE>
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. SUBSIDIARY INITIAL PUBLIC OFFERING AND PROPOSED DISTRIBUTION
Sterling Commerce, Inc. ("Commerce"), previously a wholly owned subsidiary
of Sterling Software, completed its initial public offering (the "Offering") of
13,800,000 shares of common stock, par value $.01 per share ("Commerce Stock"),
on March 13, 1996. Pursuant to the Offering, Sterling Software sold to the
public 12,000,000 of the 73,200,000 shares of Commerce Stock then owned by it
and Commerce sold 1,800,000 previously unissued shares of Commerce Stock.
Sterling Software currently owns 61,200,000 shares of Commerce Stock,
constituting 81.6% of the total number of outstanding shares of Commerce Stock.
The Offering price was $24 per share of Commerce Stock resulting in net proceeds
to Sterling Software of approximately $267,458,000 after deducting underwriting
discounts and commissions and Sterling Software's pro rata share of Offering
expenses. The Offering resulted in net proceeds to Commerce of approximately
$40,118,000 after deducting underwriting discounts and commissions and
Commerce's pro rata share of Offering expenses. Sterling Software recorded a
gain of approximately $127,164,000, net of tax, from the sale of Commerce Stock
in the Offering.
Sterling Software incorporated Commerce as a wholly owned subsidiary in
December 1995. In contemplation of the Offering, among other things, (i)
Sterling Software caused to be transferred to or merged into Commerce all of the
subsidiaries previously comprising Sterling Software's Electronic Commerce
Group, (ii) Sterling Software caused to be transferred to Commerce certain
assets relating to the electronic commerce
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<PAGE>
business previously conducted by Sterling Software's international operations
and certain assets relating to the electronic commerce business conducted by
Sterling Software's Federal Systems business segment, and (iii) Sterling
Software entered into contractual arrangements with Commerce related to, among
other things, space sharing, tax allocations, international marketing and
certain services.
In connection with the Offering, Sterling Software accelerated the vesting
of substantially all outstanding options granted under Sterling Software's
existing stock option plans. Sterling Software received proceeds of
approximately $202,543,000 from the exercise of approximately 6,880,000 warrants
and employee stock options for the period from January 1, 1996 to June 30, 1996.
Proceeds of approximately $15,852,000 were received from the exercise of
approximately 389,000 warrants and employee stock options for the period from
July 1, 1996 to August 9, 1996. If all remaining outstanding options and
warrants to purchase Sterling Software common stock, par value $.10 per share
("Software Stock"), at August 9, 1996 were exercised, approximately 1,176,000
additional shares of Software Stock would be issued and outstanding, resulting
in additional proceeds to Sterling Software of approximately $42,519,000. There
can be no assurance, however, as to whether or when any of such options or
warrants will be exercised. Under the terms of Sterling Software's stock option
plans, any outstanding options that are not exercised prior to the effective
date of the anticipated Distribution (as defined and discussed more fully below)
of Sterling Software's remaining shares of Commerce Stock, will be adjusted to
preserve the economic value of such options. Although this adjustment will
require approval of the applicable stock option committee, it is anticipated
that the adjustment will be made pursuant to a formula that will both increase
the number of shares subject to options and decrease the exercise price thereof.
The magnitude of the adjustment (i.e., the increase in the number of shares
subject to options and the decrease in the exercise price) is not presently
determinable because it is expected to be determined based on the market price
of the Software Stock prior to and following the Distribution. Further, the
Company cannot predict what number of options may remain unexercised at the
effective date of the Distribution.
Sterling Software presently intends to distribute pro rata to its
stockholders as a dividend all of its remaining shares of Commerce Stock by
means of a tax-free distribution (the "Distribution"). Sterling Software's
Board of Directors has conditioned the Distribution upon, among other things,
(i) the approval of both the Distribution and the Company's 1996 Stock Option
Plan by Sterling Software's stockholders, and (ii) the declaration by Sterling
Software's Board of Directors of a dividend of the shares of Commerce Stock then
owned by Sterling Software. At its Annual Meeting of Stockholders held on May
29, 1996, Sterling Software's stockholders approved the Distribution and the
Company's 1996 Stock Option Plan. The declaration of the dividend by the
Sterling Software Board to effect the Distribution is also conditioned upon the
receipt of a favorable ruling from the Internal Revenue Service ("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. Sterling
Software and its advisors believe the ruling request is fully supported by
relevant provisions of federal tax law and are not aware of any impediments to
the receipt of a favorable ruling. While Sterling Software does not control the
IRS ruling process and cannot assure the timing of the ruling, management
continues to believe that the Company will receive a favorable ruling in time to
complete the Distribution by September 30, 1996. Sterling Software has not
determined what action, if any, it would take if it
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were not to receive the favorable tax ruling. No assurance can be given that the
favorable tax ruling will be obtained or that, in any event, the Distribution
will occur, or that, if it does not receive the favorable tax ruling, Sterling
Software will not sell its shares of Commerce Stock to reduce its investment in
Commerce.
In connection with the Distribution, the actual number of shares of
Commerce Stock to be distributed with respect to each outstanding share of
Software Stock will depend upon the number of shares of Software Stock
outstanding on the record date established by the Sterling Software Board (the
"Distribution Record Date") and the number of shares of Commerce Stock owned by
Sterling Software on such date.
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 Software
Stock valued at approximately $74,443,000 and reserved approximately 340,000
shares of Software 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, and KnowledgeWare.
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.
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6. BUSINESS 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. The Electronic Commerce business segment 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
business segment provides enterprise-wide systems management software for large
computing environments. The Federal Systems business segment 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 business segment focuses exclusively on
the applications management market. This business segment provides products for
developing new applications and revitalizing existing applications and
consulting services to ensure that customers are successful using the
applications management products. The Company's international operations are
responsible for sales and first level support of substantially all of the
Company's products outside the United States and Canada. International
operating results are included, as applicable, in the Company's Electronic
Commerce, Systems Management and Applications Management business segments in
the tables contained herein. International revenue of $42,742,000 and
$38,581,000 and international operating profit, exclusive of intercompany
royalties, of $19,797,000 and $18,320,000 for the three months ended June 30,
1996 and 1995, respectively, have been allocated to the appropriate business
segments. International revenue of $122,718,000 and $105,990,000 and
international operating profit, exclusive of intercompany royalties, of
$55,664,000 and $52,002,000 for the nine months ended June 30, 1996 and 1995,
respectively, have been allocated to these business segments.
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Financial information concerning the Company's operations, by business
segment, for the three and nine months ended June 30, 1996 and 1995, restated to
conform to the current year presentation, is summarized as follows (in
thousands):
<TABLE>
<CAPTION>
Three Months Nine Months
Ended June 30 Ended June 30
----------------- ------------------
1996 1995 1996 1995
------- -------- -------- -------
<S> <C> <C> <C> <C>
Revenue:
Electronic Commerce.................... $ 74,745 $ 55,836 $201,574 $152,551
Systems Management..................... 42,558 37,821 118,737 108,482
Federal Systems........................ 27,553 25,372 80,630 73,627
Applications Management................ 28,244 29,548 82,931 74,905
Corporate and other.................... 1,218 2,371 3,087 6,008
-------- -------- -------- --------
Consolidated totals.................... $174,318 $150,948 $486,959 $415,573
======== ======== ======== ========
Operating Profit (Loss):
Electronic Commerce.................... $ 22,998 $ 18,548 $ 65,022 $ 47,752
Systems Management..................... 16,389 14,154 43,549 38,750
Federal Systems........................ 2,038 1,953 6,154 5,346
Applications Management................ 6,155 5,284 14,644 14,900
Restructuring charge................... (19,512)
Purchased research and development ` (62,000)
Corporate and other.................... (7,540) (6,028) (22,361) (16,264)
-------- -------- -------- -------
Consolidated totals................... $ 40,040 $ 33,911 $107,008 $ 8,972
======== ======== ======== =======
</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.
The Electronic Commerce business segment financial information
presented above is not presented on the same basis as the financial information
presented in the Commerce Quarterly Report on Form 10-Q for the quarter ended
June 30, 1996 primarily due to the allocations to the Electronic Commerce
business segment of the results of operations of Sterling Software's
international business segment and corporate expense.
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 Software 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. Approximately 4,056,000
shares of Software Stock were 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 $5.80 for the nine
months ended June 30, 1996.
-12-
<PAGE>
8. SHARE REPURCHASE PROGRAM
On October 2, 1995, the Company renewed a share repurchase program
pursuant to which it may repurchase shares of Software Stock from time to time
through open market transactions. Through March 31, 1996, approximately
1,336,000 shares of Software Stock were repurchased at an aggregate amount of
approximately $59,372,000. No shares were repurchased during the third quarter
of 1996. Any further purchases of Software Stock pursuant to this program will
be made solely at the Company's discretion and may be discontinued at any time
without prior notice.
-13-
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SUBSIDIARY INITIAL PUBLIC OFFERING AND PROPOSED DISTRIBUTION
Commerce, previously a wholly owned subsidiary of Sterling Software,
completed the Offering of 13,800,000 shares of Commerce Stock on March 13, 1996.
Pursuant to the Offering, Sterling Software sold to the public 12,000,000 of the
73,200,000 shares of Commerce Stock then owned by it and Commerce sold 1,800,000
previously unissued shares of Commerce Stock. Sterling Software currently owns
61,200,000 shares of Commerce Stock, constituting 81.6% of the total number of
outstanding shares of Commerce Stock. The Offering price was $24 per share of
Commerce Stock resulting in net proceeds to Sterling Software of approximately
$267,458,000 after deducting underwriting discounts and commissions and Sterling
Software's pro rata share of Offering expenses. The Offering resulted in net
proceeds to Commerce of approximately $40,118,000 after deducting underwriting
discounts and commissions and Commerce's pro rata share of Offering expenses.
Sterling Software recorded a gain of approximately $127,164,000, net of tax,
from the sale of Commerce Stock in the Offering.
In connection with the Offering, Sterling Software accelerated the vesting
of substantially all outstanding options granted under Sterling Software's
existing stock option plans. Sterling Software received proceeds of
approximately $202,543,000 from the exercise of approximately 6,880,000 warrants
and employee stock options for the period from January 1, 1996 to June 30, 1996.
Proceeds of approximately $15,852,000 were received from the exercise of
approximately 389,000 warrants and employee stock options for the period from
July 1, 1996 to August 9, 1996. If all remaining outstanding options and
warrants to purchase Software Stock at August 9, 1996 were exercised,
approximately 1,176,000 additional shares of Software Stock would be issued and
outstanding, resulting in additional proceeds to Sterling Software of
approximately $42,519,000. There can be no assurance, however, as to whether or
when any of such options or warrants will be exercised. Under the terms of
Sterling Software's stock option plans, any outstanding options that are not
exercised prior to the effective date of the Distribution of Sterling Software's
remaining shares of Commerce Stock will be adjusted to preserve the economic
value of such options. Although this adjustment will require approval of the
applicable stock option committee, it is anticipated that the adjustment will be
made pursuant to a formula that will both increase the number of shares subject
to options and decrease the exercise price thereof. The magnitude of the
adjustment (i.e., the increase in the number of shares subject to options and
the decrease in the exercise price) is not presently determinable because it is
expected to be determined based on the market price of the Software Stock prior
to and following the Distribution. Further, the Company cannot predict what
number of options may remain unexercised at the effective date of the
Distribution.
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 Debentures.
-14-
<PAGE>
THREE MONTHS ENDED JUNE 30, 1996 AND 1995
Total revenue increased $23,370,000, or 15%, in the third quarter of
1996 over the same period of 1995. The Electronic Commerce business segment
("EC") revenue increased $18,909,000, or 34%, on the strength of a 40% increase
in product revenue, a 19% increase in product support revenue and a 33% increase
in network services revenue. The increase in EC products revenue is the result
of increased revenue in the communications and interchange software product
lines. EC product support revenue increased primarily as a result of an
increase in the installed customer base across all three product lines. The
increased network services revenue was primarily due to an increase in the
network services customer base, primarily in the grocery, telecommunications and
retail vertical markets, and increases in the network processing volume for
existing customers. The Systems Management business segment ("SM") revenue
increased $4,737,000, or 13%. Products revenue increased across all three
product lines primarily due to several significant sales in the third quarter of
1996, higher volume and products acquired in the first quarter of 1996. The
Applications Management business segment ("AM") revenue decreased $1,304,000, or
4%. The decrease is primarily attributable to revenue declines related to
products no longer actively marketed and product marketing rights no longer
owned. The Federal Systems business segment ("FS") revenue increased $2,181,000,
or 9%, due to higher contract billings in the Information Technology Division
offset in part by lower contract billings in the Scientific Systems Division due
to the completion of certain contracts at NASA. Revenue from outside the United
States and Canada represented approximately 25% of the Company's revenue in the
third quarter of 1996 compared to 26% in the third quarter of 1995.
Approximately 41% of the Company's total software revenue was derived from
platforms other than stand-alone mainframes. This compares to 37% for the same
period of 1995.
Total costs and expenses increased $17,241,000, or 15%, in the third
quarter of 1996 over the same period of 1995. Total cost of sales increased
$3,750,000, or 8%, on a 15% increase in revenue, in part due to an increase of
$985,000, or 11%, in depreciation and amortization resulting from a
corresponding increase in property and equipment purchases and new products and
enhancements released from development. In addition, cost of sales, products
and product support, increased commensurate with higher levels of products and
product support revenue. Cost of sales, services, increased 4% on a 19%
increase in services revenue due primarily to the restructuring of the AM
business segment in the first quarter of 1996 and to the reduction of the cost
of sales, services, in Sterling Software's international operations. Product
development and enhancement expense for the third quarter of 1996 was
$8,805,000, net of $7,205,000 of capitalized software costs as compared to third
quarter of 1995 product development and enhancement expense of $11,661,000, net
of $6,323,000 of capitalized software costs. The decrease in gross product
development and enhancement expense is primarily due to a reduction of costs in
the AM business segment due to the restructuring of that segment in the first
quarter of 1996. Development costs capitalized during the third quarter of 1996
and 1995 represented 45% and 35%, respectively, of the gross product development
and enhancement expense of the same respective quarters. The higher capitalized
rate is due to a greater number of development projects having reached
technological feasibility in the third quarter of 1996 compared to the third
quarter of 1995. Product development and enhancement expense and the
capitalization rate may fluctuate from period to period depending in part upon
the number and status of software development projects in process. Software
amortization expense was $5,915,000 and $5,477,000 for the third quarter of 1996
and 1995, respectively. Selling, general and administrative expense
-15-
<PAGE>
increased $16,347,000, or 29%, primarily due to an increase in sales, marketing
and customer support activities supporting the revenue growth in EC.
Income before other income (expense), gain on the Offering, minority
interest and income taxes was $40,040,000 in the third quarter of 1996 as
compared to income before other income (expense), gain on the Offering, minority
interest and income taxes of $33,911,000 in the third quarter of 1995. Interest
expense in the third quarter of 1996 decreased $1,950,000 from the third quarter
of 1995 primarily due to the redemption and conversion of the Debentures.
Investment income increased $6,758,000 as a result of higher average balances of
investments in cash equivalents and marketable securities resulting from the net
proceeds from the Offering of approximately $307,576,000 and the proceeds from
the exercise of stock options of approximately $93,363,000 during the third
quarter of 1996. Income before gain on the Offering, minority interest and
income taxes increased $14,344,000, or 41%, primarily due to higher operating
profits in EC, up 24%, and SM, up 16%, lower interest expense due to the
redemption and conversion of the Debentures, down 89%, and higher investment
income, up 261%, on higher average investment balances of cash equivalents and
marketable securities.
-16-
<PAGE>
NINE MONTHS ENDED JUNE 30, 1996 AND 1995
Total revenue increased $71,386,000, or 17%, in the first nine months
of 1996 over the same period of 1995. Total EC revenue increased $49,023,000,
or 32%, in the first nine months of 1996 over the first nine months of 1995. EC
products revenue increased $24,690,000, or 42%, related to revenue growth in the
communications and interchange software product lines. EC product support
revenue increased primarily as a result of an increase in the installed customer
base across all three product lines. Network services revenue increased
$16,801,000 on the growth in existing customer volume and the addition of new
customers to the network primarily in the grocery, telecommunications and retail
vertical markets. SM revenue increased $10,255,000, or 9%, primarily due to
products and product support revenue increases across the operations management
and storage management product lines. This increase was partially offset by a
product support revenue decline in the VM product line due to the continuing
trend of consolidation and downsizing by customers using the VM operating
system. AM revenue grew $8,026,000, or 11%. AM products and product support
revenue in the first nine months of 1996 increased $8,478,000, or 13%, over the
first nine months of 1995. The increase was partially offset by revenue
declines related to products no longer actively marketed and product marketing
rights no longer owned. FS revenue increased $7,003,000, or 10%, in the first
nine months of 1996 primarily due to higher contract billings in the Information
Technology Division offset in part by lower contract billings in the Scientific
Systems Division due to the completion of certain contracts at NASA. Revenue in
the first nine months of 1996 from outside the United States and Canada grew
$16,728,000, or 16%, over the first nine months of 1995. This revenue
represented 25% of the Company's total revenue in the first nine months of 1996
as compared to 26% for the same period of 1995. For the nine months ended June
30, 1996, approximately 41% of the Company's total software revenue was derived
from platforms other than stand-alone mainframes. This compares to 37% for the
same period in 1995.
Total costs and expenses decreased $26,650,000 in the first nine
months of 1996 compared to the same period of 1995, due in part 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 $20,328,000, or 15%, in part due to
an increase of $3,381,000, or 13%, in depreciation and amortization resulting
from a corresponding increase in property and equipment purchases and new
products and enhancements released from development. In addition, cost of sales
increased commensurate with higher levels of products, product support and
services revenue. Product development and enhancement expense for the first
nine months of 1996 of $27,139,000 is net of $20,118,000 of capitalized software
development costs. This compares to product development and enhancement expense
of $32,463,000 for the first nine months of 1995, which is net of $15,795,000 of
capitalized costs for the same period. The decrease in gross product
development and enhancement expense is primarily due to a reduction of costs in
the AM business segment due to the restructuring of that segment in the first
quarter of 1996. Development costs capitalized during the first nine months of
1996 and 1995 represented 43% and 33%, respectively, of the gross product
development expense incurred in the same respective periods. The higher
capitalized rate is due to a greater number of development projects having
reached technological feasibility. Software amortization expense was
$17,692,000 and $16,973,000 in the first nine months of 1996 and 1995,
-17-
<PAGE>
respectively. Selling, general and administrative expense increased
$39,858,000, or 25%, primarily due to an increase in sales, marketing and
customer support activities supporting the revenue growth in EC and the
international operations.
Income before other income (expense), gain on the Offering, minority
interest and income taxes was $107,008,000 in the first nine months of 1996 as
compared to income before other income (expense), gain on the Offering, minority
interest and incomes taxes of $8,972,000 in the first nine months of 1995.
Interest expense in the first nine months of 1996 decreased $3,353,000 from the
first nine months of 1995 primarily due to the redemption and conversion of the
Debentures. Investment income in the first nine months of 1996 increased
$11,096,000 over the first nine months of 1995 as a result of higher average
balances of cash equivalents and marketable securities resulting from the net
proceeds from the Offering of approximately $307,576,000 and the proceeds from
the exercise of stock options of approximately $222,541,000. Excluding the
$62,000,000 non-recurring charge for purchased research and development and the
$19,512,000 non-recurring charge for restructuring in the first nine months of
1995, income before gain on the Offering, minority interest and income taxes
increased $30,668,000, or 34%, in part due to higher operating profits in EC, up
36%, and SM, up 12%. In addition, interest expense declined and investment
income increased for the reasons noted above.
LIQUIDITY AND CAPITAL RESOURCES
The Company maintained a strong liquidity and financial position with
$706,611,000 of working capital at June 30, 1996, which includes $573,946,000 of
cash and cash equivalents and $172,851,000 of marketable securities. Net cash
flows from operations was $69,760,000 in the first nine months of 1996 as
compared to $75,874,000 in the first nine months of 1995. Days sales
outstanding at June 30, 1996 measured on a quarterly basis was 89 versus 93 at
March 31, 1996, 107 at December 31, 1995 and 96 at September 30, 1995. Cash
flows from operations, proceeds from the Offering and the exercise of stock
options, and available cash balances were used to fund operations, purchases of
cash equivalents and marketable securities and capital expenditures, including
software additions.
Sterling Software received net proceeds from the Offering of approximately
$267,458,000 after deducting underwriting discounts and commissions and Sterling
Software's pro rata share of offering expenses. The Offering resulted in net
proceeds to Commerce of approximately $40,118,000 after deducting underwriting
discounts and commissions and Commerce's pro rata share of offering expenses. In
connection with the Offering, Sterling Software accelerated the vesting of
substantially all outstanding options granted under Sterling Software's existing
stock option plans. Sterling Software received proceeds of approximately
$222,541,000 from the exercise of approximately 7,761,000 warrants and employee
stock options for the period from October 1, 1995 to June 30, 1996. Proceeds of
approximately $15,852,000 were received from the exercise of approximately
389,000 warrants and employee stock options for the period from July 1, 1996 to
August 9, 1996. At August 9, 1996, approximately 1,176,000 additional shares of
Software Stock would be issued and outstanding if all remaining outstanding
options and warrants were exercised and would
-18-
<PAGE>
result in additional proceeds of approximately $42,519,000. At September 30,
1996, the combined total of cash, cash equivalents and marketable securities is
estimated to be approximately $700,000,000 plus the proceeds, if any, from the
exercise of the warrants and employee stock options that remain unexercised as
of August 9, 1996. This estimate is based on management's assessment of certain
future events and circumstances and constitutes a forward-looking statement. As
such, this estimate is subject to inherent uncertainties and there can be no
assurance that actual results will be consistent with this estimate. See
"Forward-Looking Information" below.
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 Software 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. Approximately 4,056,000
shares of Software Stock were issued upon conversion of the Debentures.
Approximately $10,000 principal amount of Debentures was redeemed for cash on
February 12, 1996. The conversion and redemption of the Debentures will reduce
the Company's interest charges by approximately $1,700,000 per quarter.
At June 30, 1996, after the utilization of $1,146,000 for standby letters
of credit, $33,854,000 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 Sterling Software. At June 30, 1996, $1,350,000 was outstanding
pursuant to foreign lines of credit and $21,350,000 was available for borrowing
thereunder.
On October 2, 1995, the Company renewed a share repurchase program pursuant
to which it may repurchase shares of Software Stock from time to time through
open market transactions. Through March 31, 1996, approximately 1,336,000
shares of Software Stock were repurchased at an aggregate amount of
approximately $59,372,000. No shares were repurchased during the third quarter
of 1996.
At June 30, 1996, 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 existing cash balances
and internally generated funds. No significant commitments exist for future
capital expenditures. The Company believes available balances of cash, cash
equivalents and investments in marketable securities 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.
OTHER MATTERS
Demand for many of the Company's products tends to increase with increases
in the rate of inflation as customers strive to improve 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 prices for products and services.
-19-
<PAGE>
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 enter into hedge transactions in an effort to reduce its
exposure to currency exchange risks.
The Company maintains a strategy of acquiring businesses and products that
fill strategic market niches. 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.
FORWARD-LOOKING INFORMATION
This report and other reports and statements filed by the Company from time
to time with the Securities and Exchange Commission (collectively, "SEC
Filings") contain or may contain certain forward-looking statements and
information that are based on information available to the Company's management
and various estimates, assumptions and predictions made by the Company's
management. When used in SEC Filings, the words "anticipate," "contemplate,"
"estimate," "expect," "future," "intend," "plan" and similar expressions are
intended to identify forward-looking statements. Such statements are subject to
inherent uncertainties, including, in addition to any uncertainties specifically
identified in the text surrounding such statements, uncertainties with respect
to changes or developments in social, economic, business, industry, market,
legal and regulatory circumstances and conditions and actions taken or omitted
to be taken by third parties, including the Company's stockholders, customers,
suppliers, business partners and competitors, and legislative, regulatory,
judicial and other governmental authorities and officials. Consequently, actual
events, circumstances, consequences, effects and results may vary significantly
from those described in or contemplated by such forward-looking statements or
information.
-20-
<PAGE>
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual Meeting of Stockholders (the "Meeting") on May
29, 1996, at which the stockholders of the Company voted on and approved the
following proposals:
1. A special dividend, if declared by the Board of Directors, consisting of
the distribution to the holders of Sterling Software's then outstanding shares
of common stock, par value $0.10 per share, on a pro rata basis, of shares of
common stock, par value $0.01 per share, of Sterling Software's subsidiary,
Sterling Commerce, Inc., and ratification of certain Intercompany Agreements
described in the Company's Proxy Statement for the Meeting.
2. Adoption of the Sterling Software, Inc. 1996 Stock Option Plan.
3. The election of three Class C directors of the Company for terms
expiring in 1995.
The proposals were approved by the following votes:
<TABLE>
<CAPTION>
1. Special Dividend
----------------
<S> <C> <C> <C>
FOR AGAINST ABSTENTIONS BROKER NON-VOTES
--- ------- ----------- ----------------
25,438,331 389,365 167,507 4,319,285
2. Adoption of 1996 Stock Option Plan
----------------------------------
FOR AGAINST ABSTENTIONS BROKER NON-VOTES
--- ------- ----------- ----------------
19,602,950 6,219,944 177,309 4,319,285
3. Election of Directors
----------------------------------
NAME FOR WITHHELD
---- --- --------
Sam Wyly 29,025,893 1,288,595
Sterling L. Williams 29,276,998 1,037,490
Donald R. Miller, Jr. 29,026,900 1,287,588
</TABLE>
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<PAGE>
ITEM 5. OTHER INFORMATION
PRO FORMA FINANCIAL DATA
The following unaudited financial data illustrate the effects on Sterling
Software of the Distribution and the conversion and redemption of the Debentures
(as such terms are defined in Notes 3 and 7 of the Notes to Consolidated
Financial Statements included in Part I of this report). The pro forma balance
sheet is based on the June 30, 1996 balance sheet of Sterling Software and
assumes the Distribution was consummated on that date. The pro forma statements
of operations data are based on the statements of operations data of Sterling
Software for the nine months ended June 30, 1996 and 1995 and assumes that the
Distribution and the conversion and redemption of the Debentures were
consummated at the beginning of the fiscal periods presented.
The pro forma financial data of Sterling Software do not purport to
represent what the financial position or results of operations of Sterling
Software would have been if the transactions had in fact been consummated on
such date or at the beginning of the periods indicated or to project the
financial position or results of operations for any future date or period. The
pro forma adjustments are estimates based upon currently available information
and upon certain assumptions that Sterling Software's management believes are
reasonable in the circumstances. Actual results may vary from these estimates.
-22-
<PAGE>
STERLING SOFTWARE, INC.
PRO FORMA CONSOLIDATED BALANCE SHEETS
JUNE 30, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
PRO FORMA
HISTORICAL ADJUSTMENTS STERLING
STERLING FOR THE SOFTWARE AS
SOFTWARE AT DISTRIBUTION ADJUSTED AT
JUNE 30, 1996 OF COMMERCE(1) JUNE 30, 1996
------------- -------------- -------------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents.............. $ 573,946 $ (21,706) $552,240
Marketable securities.................. 172,851 (21,428) 151,423
Accounts and notes receivable, net..... 170,740 (57,059) 113,681
Prepaid expenses and other current
assets................................ 20,860 (18,808) 2,052
---------- --------- --------
Total current assets.................. 938,397 (119,001) 819,396
Property and equipment, net............. 75,204 (38,315) 36,889
Computer software, net.................. 89,952 (33,415) 56,537
Excess cost over net assets acquired,
net.................................... 80,971 (9,939) 71,032
Other assets............................ 13,700 (6,868) 6,832
---------- --------- --------
Total assets $1,198,224 $(207,538) $990,686
========== ========= ========
Current liabilities..................... $ 231,786 $ (63,672) $168,114
Long-term debt.......................... 1,093 1,093
Deferred income taxes................... 7,880 (21,191) (13,311)
Other noncurrent liabilities............ 32,308 (6,893) 25,415
Minority interest....................... 21,300 (21,300)
Stockholders' equity:(2)
Common stock........................... 3,835 3,835
Additional paid in capital............. 748,491 (32,736) 715,755
Retained earnings...................... 211,019 (61,746) 149,273
Less: treasury stock.................. (59,488) (59,488)
---------- --------- --------
Total stockholders' equity............ 903,857 (94,482) 809,375
---------- --------- --------
Total liabilities & stockholders'
equity.............................. $1,198,224 $(207,538) $990,686
========== ========= ========
</TABLE>
See accompanying notes.
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<PAGE>
NOTES TO PRO FORMA CONSOLIDATED BALANCE SHEET
(1) Adjusted to give effect to the proposed Distribution.
(2) In connection with the Offering (as defined in Note 3 to Notes to
Consolidated Financial Statements included in Part I of this report),
Sterling Software accelerated the vesting of substantially all outstanding
options granted under Sterling Software's existing stock option plans.
Sterling Software received proceeds of approximately $202,543,000 from the
exercise of 6,880,000 warrants and employee stock options for the period
from January 1, 1996 to June 30, 1996. Proceeds of approximately
$15,852,000 were received from the exercise of approximately 389,000
warrants and employee stock options for the period from July 1, 1996 to
August 9, 1996. If all remaining options and warrants to purchase Software
Stock at August 9, 1996 were exercised, approximately 1,176,000
additional shares of Software Stock would be issued and outstanding,
resulting in additional proceeds to the Company of approximately
$42,519,000. The impact of the potential exercise of Sterling Software's
remaining options and warrants has not been reflected in the accompanying
Pro Forma Consolidated Balance Sheet.
-24-
<PAGE>
STERLING SOFTWARE, INC.
PRO FORMA STATEMENTS OF OPERATIONS
NINE MONTHS ENDED JUNE 30, 1996
(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
JUNE 30, 1996 CONVERSION OF COMMERCE(2) JUNE 30, 1996
------------- --------------- ---------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Revenue:
Products............................... $191,137 $ (60,206) $130,931
Product support........................ 134,066 (41,354) 92,712
Services............................... 161,756 (72,271) 89,485
Royalties from affiliated companies.... (13,620)
13,620 (4)
-------- ------ --------- --------
Total revenue......................... 486,959 (173,831) 313,128
Cost and expenses:
Cost of sales:
Products and product support.......... 59,315 (22,040) 50,895
13,620 (4)
Services.............................. 96,256 (16,907) 79,349
-------- ------ --------- --------
155,571 (25,327) 130,244
Product development and enhancement.... 27,139 (11,252) 15,887
Selling, general and administrative.... 197,241 (70,844) 128,147
1,750 (3)
-------- ------ --------- --------
Total costs and expenses.............. 379,951 (105,673) 274,278
-------- ------ --------- --------
Income from operations................. 107,008 (68,158) 38,850
Interest expense....................... (3,036) 2,581 (1) 110 (345)
Investment income...................... 16,815 (797) 16,018
Other.................................. 471 375 846
-------- ------ --------- --------
14,250 2,581 (312) 16,519
-------- ------ --------- --------
Income before gain on subsidiary public
offering, minority interest and income
taxes.................................. 121,258 2,581 (68,470) 55,369
Gain on subsidiary public offering..... 239,936 (239,936) (5)
Minority interest...................... (3,871) 3,871 (5)
-------- ------ --------- --------
Income before income taxes.............. 357,323 2,581 (304,535) 55,369
Provision for income taxes 154,604 877 (27,047) 15,662
(112,772) (5)
-------- ------ --------- --------
Income from continuing operations....... $202,719 $1,704 $(164,716) $ 39,707
======== ====== ========= ========
Pro forma income from continuing
operations per share................... $ 5.80 $ 1.13
======== ========
</TABLE>
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<PAGE>
STERLING SOFTWARE, INC.
PRO FORMA STATEMENTS OF OPERATIONS
NINE MONTHS ENDED JUNE 30, 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
JUNE 30, 1995 CONVERSION OF COMMERCE(2) JUNE 30, 1995
------------- --------------- ---------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Revenue:
Products............................... $160,957 $ (44,616) $116,341
Product support........................ 115,550 (33,705) 81,845
Services............................... 139,066 (56,747) 82,319
Royalties from affiliated companies.... (7,940)
7,940 (4)
-------- --------- --------
Total revenue......................... 415,573 (135,068) 280,505
Cost and expenses:
Cost of sales:
Products and product support.......... 48,696 (16,548) 40,088
7,940 (4)
Services.............................. 86,547 (12,925) 73,622
-------- ------ --------- --------
135,243 (21,533) 113,710
Product development and enhancement.... 32,463 (11,337) 21,126
Selling, general and administrative.... 157,383 (53,122) 106,886
2,625 (3)
Restructuring charges.................. 19,512 19,512
Purchased research and development..... 62,000 62,000
-------- ------ --------- --------
Total costs and expenses.............. 406,601 (83,367) 323,234
-------- ------ --------- --------
Income (loss) from operations.......... 8,972 (51,701) (42,729)
Interest expense....................... (6,389) 4,959 (1) 38 (1,392)
Investment income...................... 5,719 (16) 5,703
Other income........................... 776 321 1,097
-------- ------ --------- --------
106 4,959 343 5,408
-------- ------ --------- --------
Income (loss) before income taxes....... 9,078 4,959 (51,358) (37,321)
Provision (benefit) for income taxes.... 28,284 1,984 (20,543) 9,725
-------- ------ --------- --------
Income (loss) from continuing operations $(19,206) $2,975 $ (30,815) $(47,046)
======== ====== ========= ========
Pro forma income (loss) from continuing
operations per share................... $ (.84) $ (1.74)
======== ========
</TABLE>
-26-
<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 Software Stock.
(2) Adjusted to give effect to the Distribution.
(3) Administrative charges incurred by Sterling Software allocated to Commerce
were approximately $1,750,000 and $2,625,000 in the nine months ended June
30, 1996 and 1995, respectively. No administrative charges were allocated
to Commerce in the third quarter of 1996 as these costs were incurred by
Commerce during this period. The historical adjustment reflects the
addition of those costs to Sterling Software as if Commerce had been
historically distributed to stockholders.
(4) As owner of software products distributed by Sterling Software's
international operations, Commerce includes royalties received from
Sterling Software as revenue. Such revenues are eliminated in the pro forma
adjustment and are an expense to Sterling Software.
(5) This adjustment is to reflect the reclassification of the gain on the
Offering and minority interest to discontinued operations, which is
expected to occur if the Distribution occurs.
-27-
<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)
10(a) - Form of Amendment to Change in Control Severance Agreement
dated as of June 18, 1996, between the Company and each of its
executive officers (9)
11(a) - Computation of Earnings Per Share, Three Months Ended June 30,
1996 (9)
11(b) - Computation of Earnings Per Share, Three Months Ended June 30,
1995 (9)
11(c) - Computation of Earnings Per Share, Nine Months Ended June 30,
1996 (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.
-28-
<PAGE>
(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.
During the three months ended June 30, 1996, the Company filed a Current
Report on Form 8-K dated May 29, 1996 reporting information under Item 5.
-29-
<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: August 13, 1996 /s/ Sterling L. Williams
-------------------------------
Sterling L. Williams
President, Chief Executive Officer
and Director
(Principal Executive Officer)
Date: August 13, 1996 /s/ Jeannette P. Meier
---------------------------------
Jeannette P. Meier
Executive Vice President, Chief
Financial Officer and General Counsel
(Principal Financial and Accounting Officer)
-30-
<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)
10(a) - Form of Amendment to Change in Control Severance Agreement
dated as of June 18, 1996, between the Company and each of
its executive officers (9)
11(a) - Computation of Earnings Per Share, Three Months Ended
June 30, 1996 (9)
-31-
<PAGE>
11(b) - Computation of Earnings Per Share, Three Months Ended
June 30, 1995 (9)
11(c) - Computation of Earnings Per Share, Nine Months Ended
June 30, 1996 (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.
-32-
<PAGE>
EXHIBIT 10(a)
FORM OF
AMENDMENT TO
CHANGE IN CONTROL SEVERANCE AGREEMENT
THIS AMENDMENT TO CHANGE IN CONTROL SEVERANCE AGREEMENT (this "Amendment"),
dated as of June __, 1996, by and between Sterling Software, Inc., a Delaware
corporation (the "Company"), and ______________________________ (the
"Executive").
WITNESSETH:
WHEREAS, the Company and the Executive are parties to a Change in Control
Severance Agreement, dated as of February 12, 1996 (the "Agreement"); and
WHEREAS, the Company and the Executive desire to amend the Agreement as set
forth in this Amendment;
NOW, THEREFORE, the Company and the Executive agree as follows:
1. Amendment: The last paragraph of Section 1(b) of the Agreement is
---------
hereby amended in its entirety to read as follows:
"Notwithstanding the foregoing provisions of Sections 1(b)(iii) or
1(b)(iv), unless otherwise determined in a specific case by majority vote
of the Board, a "Change in Control" shall not be deemed to have occurred
for purposes of Section 1(b)(iii) or 1(b)(iv) solely because (A) the
Company, (B) an entity in which the Company directly or indirectly
beneficially owns 50% or more of the outstanding Voting Stock (a
"Subsidiary"), or (C) any Company-sponsored employee stock ownership plan
or any other employee benefit plan of the Company or any Subsidiary either
files or becomes obligated to file a report or a proxy statement under or
in response to Schedule 13D, Schedule 14D-1, Form 8-K or Schedule 14A (or
any successor schedule, form or report or item therein) under the Exchange
Act disclosing beneficial ownership by it of shares of Voting Stock of the
Company, whether in excess of 20% or otherwise, or because the Company
reports that a change in control of the Company has occurred or will occur
in the future by reason of such beneficial ownership or any increase or
decrease thereof."
Section 14 of the Agreement is hereby amended in its entirety to read as
follows:
"14. Termination of Prior Agreements. Upon the effectiveness of this
-------------------------------
Agreement pursuant to Section 1(f) of this Agreement, the Employment Agreement
between Executive and Sterling Software, dated _______________, as amended to
the date hereof (the "Employment Agreement") shall terminate automatically and
shall thereafter be of no further force or effect; provided, however, that if
this Agreement is held wholly invalid, unenforceable or otherwise illegal, the
preceding clause shall have no effect and the Employment Agreement shall be
deemed to have continued at all times in force and effect.
<PAGE>
Subject to the foregoing proviso, this Agreement, upon its effectiveness
pursuant to such Section 1(f), supersedes all prior agreements, arrangements and
understandings with respect to the subject matter hereof."
2. Defined Terms: Terms used in this Amendment with initial capital
-------------
letters are used herein as defined in the Agreement.
3. References to and Continuation of Agreement: (a) On and after the
-------------------------------------------
date hereof, each reference in the Agreement to "this Agreement," "hereunder,"
"hereof," "herein" or words of like import referring to the Agreement will be a
reference to the Agreement as amended by this Amendment.
(b) Except as specifically amended by this Amendment, the Agreement
will remain in full force and effect and is hereby ratified and confirmed.
4. Governing Law: The validity, interpretation, construction and
-------------
performance of this Amendment will be governed by and construed in accordance
with the substantive laws of the State of Delaware, without giving effect to the
principles of conflict of laws of such State.
5. Counterparts: This Amendment may be executed in one or more
------------
counterparts, each of which shall be deemed to be an original but all of which
together will constitute one and the same agreement.
IN WITNESS WHEREOF, the parties have caused this Amendment to be duly
executed and delivered as of the date first above written.
STERLING SOFTWARE, INC.
By__________________________
[Name and Title]
__________________________
[Executive]
<PAGE>
EXHIBIT 11(A)
COMPUTATION OF EARNINGS PER SHARE, THREE MONTHS ENDED JUNE 30, 1996
STERLING SOFTWARE, INC. EXHIBIT 11(A)
COMPUTATION OF EARNINGS PER SHARE
THREE MONTHS ENDED JUNE 30, 1996
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
<TABLE>
<CAPTION>
FULLY
PRIMARY DILUTED
------- -------
Earnings:
<S> <C> <C>
Earnings applicable to common
stockholders....................... $29,394 $29,394
======= =======
Shares:
Weighted average of shares outstanding.. 35,758 35,758
Add common shares issued on assumed
exercise of options and warrants...... 2,771 2,775
Less common shares assumed repurchased.. (1,565) (1,560)
------- -------
36,964 36,973
======= =======
Earnings per common share:
Primary................................ $ .80
Fully diluted.......................... ======= $ .80
=======
</TABLE>
<PAGE>
EXHIBIT 11(B)
COMPUTATION OF EARNINGS PER SHARE, THREE MONTHS ENDED JUNE 30, 1995
EXHIBIT 11(B)
STERLING SOFTWARE, INC.
COMPUTATION OF EARNINGS PER SHARE
THREE MONTHS ENDED JUNE 30, 1995
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
<TABLE>
<CAPTION>
FULLY
PRIMARY DILUTED
------- -------
Earnings:
<S> <C> <C>
Earnings applicable to common
stockholders............................. $22,240 $22,240
Add: Interest expense on amounts
outstanding for the 5-3/4%
Convertible Subordinated
Debentures (net of applicable
income taxes).................... 391 1,053
Interest income on investment of
proceeds from assumed conversion
of options and warrants (net of
applicable income taxes)......... 377
------- -------
$22,631 $23,670
======= =======
Shares:
Weighted average of shares outstanding... 24,118 24,118
Add common shares issued on assumed
exercise of options and warrants...... 9,379 9,379
Less common shares assumed repurchased... (4,952) (4,952)
------- -------
28,545 28,545
======= =======
Common shares issued on assumed
conversion of 5-3/4% Convertible
Subordinated Debentures.................. 4,056
-------
32,601
=======
Earnings per common share:
Primary................................ $ .79
Fully diluted.......................... ======= $ .73
=======
</TABLE>
<PAGE>
EXHIBIT 11(C)
COMPUTATION OF EARNINGS PER SHARE, NINE MONTHS ENDED JUNE 30, 1996
STERLING SOFTWARE, INC. EXHIBIT 11(C)
COMPUTATION OF EARNINGS PER SHARE
NINE MONTHS ENDED JUNE 30, 1996
(IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
<TABLE>
<CAPTION>
FULLY
PRIMARY DILUTED
------- -------
Earnings:
<S> <C> <C>
Earnings applicable to common
stockholders.......................... $202,719 $202,719
Add: Interest expense on amounts
outstanding for the 5-3/4%
Convertible Subordinated
Debentures (net of
applicable income taxes)...... 1,685
-------- --------
$202,719 $204,404
======== ========
Shares:
Weighted average of shares outstanding. 30,598 30,598
Add common shares issued on assumed
exercise of options and warrants.... 6,191 6,222
Less common shares assumed repurchased. (4,308) (3,565)
-------- --------
32,481
========
Common shares issued on assumed
conversion of 5-3/4% Convertible
Subordinated Debentures.............. 1,998
--------
35,253
========
Earnings per common share:
Primary................................ $ 6.24
Fully diluted.......................... ======== $ 5.80
========
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1996
<PERIOD-START> OCT-01-1995
<PERIOD-END> JUN-30-1996
<CASH> 573,946
<SECURITIES> 172,851
<RECEIVABLES> 170,740
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 938,397
<PP&E> 143,510
<DEPRECIATION> 68,306
<TOTAL-ASSETS> 1,198,224
<CURRENT-LIABILITIES> 231,786
<BONDS> 0
0
0
<COMMON> 3,835
<OTHER-SE> 900,022
<TOTAL-LIABILITY-AND-EQUITY> 1,198,224
<SALES> 486,959
<TOTAL-REVENUES> 486,959
<CGS> 155,571
<TOTAL-COSTS> 379,951
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,036
<INCOME-PRETAX> 357,323
<INCOME-TAX> 154,604
<INCOME-CONTINUING> 202,719
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 202,719
<EPS-PRIMARY> 6.24
<EPS-DILUTED> 5.80
</TABLE>
