<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, 1999
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)
300 Crescent Court, Suite 1200
Dallas, Texas 75201
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (214) 981-1000
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 July 30, 1999
----------------------------- --------------------------------------
Common Stock, $0.10 par value 84,246,875
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<PAGE>
PART I - FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements.............................................. 3
Sterling Software, Inc. Consolidated Balance Sheets at
June 30, 1999 and September 30, 1998.................................... 3
Sterling Software, Inc. Consolidated Statements of Operations
for the Three and Nine Months Ended June 30, 1999 and 1998.............. 4
Sterling Software, Inc. Consolidated Statement of Stockholders'
Equity for the Nine Months Ended June 30, 1999.......................... 5
Sterling Software, Inc. Consolidated Statements of Cash Flows
for the Nine Months Ended June 30, 1999 and 1998........................ 6
Sterling Software, Inc. Notes to Consolidated Financial Statements......... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................... 17
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K ................................. 27
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<PAGE>
STERLING SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share information)
A S S E T S
<TABLE>
<CAPTION>
June 30 September 30
1999 1998
------------- ------------
(unaudited)
Current assets:
<S> <C> <C>
Cash and cash equivalents................................................... $ 425,895 $ 397,312
Marketable securities....................................................... 221,607 310,537
Accounts and notes receivable, net.......................................... 229,763 200,428
Prepaid expenses and other current assets................................... 31,158 32,253
---------- ----------
Total current assets...................................................... 908,423 940,530
Property and equipment, net of accumulated depreciation of $60,112 at
June 30, 1999 and $49,832 at September 30, 1998............................. 76,929 66,726
Computer software, net of accumulated amortization of $121,274 at
June 30, 1999 and $112,734 at September 30, 1998............................ 124,145 81,606
Excess cost over net assets of businesses acquired, net of accumulated
amortization of $35,079 at June 30, 1999 and $27,316 at September 30, 1998.. 125,580 76.086
Other assets................................................................. 19,887 24,040
---------- ----------
$1,254,964 $1,188,988
========== ==========
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:
Accounts payable and accrued liabilities.................................... $ 166,656 $ 164,349
Deferred revenue............................................................ 92,125 102,880
---------- ----------
Total current liabilities................................................. 258,781 267,229
Noncurrent deferred revenue.................................................. 39,288 27,649
Other noncurrent liabilities................................................. 31,311 32,552
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.10 par value; 10,000,000 shares authorized, no shares
issued or outstanding......................................................
Common stock, $.10 par value; 250,000,000 and 125,000,000 shares
authorized at June 30, 1999 and September 30, 1998, respectively;
86,371,000 and 84,845,000 shares issued at June 30, 1999 and
September 30, 1998, respectively........................................... 8,637 8,485
Additional paid-in capital.................................................. 882,274 858,615
Retained earnings........................................................... 89,078 50,462
Less treasury stock, at cost; 2,525,000 and 2,599,000 shares at
June 30, 1999 and September 30, 1998, respectively......................... (54,405) (56,004)
---------- ----------
Total stockholders' equity................................................ 925,584 861,558
---------- ----------
$1,254,964 $1,188,988
========== ==========
</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
----------------------------- -----------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenue:
Products................................. $ 99,238 $ 71,266 $246,419 $206,167
Product support.......................... 52,163 46,425 154,553 137,991
Services................................. 58,364 63,100 175,638 183,096
--------- --------- --------- ---------
209,765 180,791 576,610 527,254
Costs and expenses:
Cost of sales:
Products and product support............ 21,034 17,007 58,803 52,070
Services................................ 52,565 54,708 156,449 159,329
--------- --------- --------- ---------
73,599 71,715 215,252 211,399
Product development and enhancement...... 9,250 8,090 28,129 28,108
Selling, general and administrative...... 74,618 66,407 204,067 203,404
Reorganization costs..................... 14,098 33,753
Purchased research and development....... 22,468 32,091
--------- --------- --------- ---------
194,033 146,212 513,292 442,911
--------- --------- --------- ---------
Income before other income (expense) and
income taxes............................. 15,732 34,579 63,318 84,343
Other income (expense):
Interest expense......................... (43) (90) (302) (195)
Investment income........................ 7,929 8,652 25,140 25,263
Other.................................... 406 (517) 1,054 (1,082)
--------- --------- --------- ---------
8,292 8,045 25,892 23,986
--------- --------- --------- ---------
Income before income taxes................ 24,024 42,624 89,210 108,329
Provision for income taxes................ 14,713 15,413 40,533 39,880
--------- --------- --------- ---------
Net income................................ $ 9,311 $ 27,211 $ 48,677 $ 68,449
========= ========= ========= =========
Income per common share:
Net income:
Basic................................... $.11 $.34 $.59 $.85
========= ========= ========= =========
Diluted................................. $.11 $.32 $.55 $.81
========= ========= ========= =========
</TABLE>
See accompanying notes.
-4-
<PAGE>
STERLING SOFTWARE, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Nine Months Ended June 30, 1999
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Common Stock Treasury Stock
------------------ -----------------
Number Additional Number Total
of Par Paid-in Retained of Stockholders'
Shares Value Capital Earnings Shares Cost Equity
------- ------ --------- -------- -------- -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1998.. 84,845 $8,485 $858,615 $ 50,462 2,599 $(56,004) $861,558
Net income.................... 48,677 48,677
Issuance of common stock
pursuant to stock options.... 1,228 122 16,849 16,971
Issuance of common stock to
401(k) plan.................. 30 (74) 1,599 1,629
Issuance of common stock
pursuant to employee stock
purchase plan................ 298 30 6,780 6,810
Other......................... (10,061) (10,061)
------- ------ --------- -------- ------- -------- ------------
Balance at June 30, 1999....... 86,371 $8,637 $882,274 $ 89,078 2,525 $(54,405) $925,584
======= ====== ========= ======== ======= ======== ============
</TABLE>
See accompanying notes.
-5-
<PAGE>
STERLING SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine Months
Ended June 30
------------------------------
1999 1998
--------- ---------
<S> <C> <C>
Operating activities:
Net income.................................................................. $ 48,677 $ 68,449
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization............................................. 40,333 33,287
Provision for losses on accounts receivable............................... 2,360 2,810
Provision for deferred income taxes....................................... 11,681 27,762
Reorganization costs...................................................... 16,737
Purchased research and development........................................ 32,091
Changes in operating assets and liabilities, net of effects of business
acquisitions:
Increase in accounts and notes receivable.............................. (17,176) (9,136)
Decrease (increase) in prepaid expenses and other assets............... 4,679 (1,791)
Decrease in accounts payable and accrued liabilities................... (64,999) (41,819)
Decrease in deferred revenue........................................... (18,662) (6,844)
Other.................................................................. 4,979 13,346
--------- ---------
Net cash provided by operating activities............................. 60,700 86,064
Investing activities:
Purchases of property and equipment......................................... (23,127) (22,796)
Purchases and capitalized cost of development of computer software.......... (24,292) (20,268)
Business acquisitions, net of cash acquired................................. (89,992) (3,626)
Purchases of investments.................................................... (287,109) (189,944)
Proceeds from sales of investments.......................................... 375,223 145,720
Other....................................................................... (78) 1,798
--------- ---------
Net cash used in investing activities................................. (49,375) (89,116)
Financing activities:
Proceeds from issuance of common stock pursuant to exercise of stock
options.................................................................... 16,971 15,339
Proceeds from issuance of common stock pursuant to employee stock purchase
plan....................................................................... 6,810
Other....................................................................... (3,278) (3,574)
--------- ---------
Net cash provided by financing activities............................. 20,503 11,765
Effect of foreign currency exchange rate changes on cash..................... (3,245) (2,181)
--------- ---------
Increase in cash and cash equivalents........................................ 28,583 6,532
Cash and cash equivalents at beginning of period............................. 397,312 436,955
--------- ---------
Cash and cash equivalents at end of period................................... $ 425,895 $ 443,487
========= =========
Supplemental cash flow information:
Income taxes paid, net of refunds received.................................. $ 18,528 $ 2,563
========= =========
</TABLE>
See accompanying notes.
-6-
<PAGE>
STERLING SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
(unaudited)
1. Summary of Significant Accounting Policies
The Company
Sterling Software, Inc. ("Sterling Software" or the "Company") was
founded in 1981 and became a publicly owned corporation in 1983. Sterling
Software is a worldwide developer and supplier of application development,
information management and systems management software products and services, as
well as a supplier of specialized information technology ("IT") services for
sectors of the federal government.
Basis of Presentation
The consolidated financial statements include the accounts of Sterling
Software after elimination of all significant intercompany balances and
transactions. 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 and
liabilities, the disclosure of contingencies at June 30, 1999 and September 30,
1998 and the results of operations for the three and nine months ended June 30,
1999 and 1998. While management has based its estimates and assumptions on the
facts and circumstances known to it as of the date of this report, actual
amounts may differ from such estimates and assumptions.
Revenue
Revenue from license fees for software products is recognized when
persuasive evidence of a sale arrangement exists, delivery has occurred, the fee
is fixed or determinable and collectibility is probable. Services revenue and
revenue from products involving installation or other services are recognized as
the services are performed.
If software product sale transactions include multiple elements, each
element of the software sale is separately identified and accounted for based on
the relative fair value of such element. Revenue is not recognized on any
element of the sale arrangement if undelivered elements are essential to the
functionality of the delivered elements.
Product support contracts allow customers to receive updated versions
of Sterling Software's products when and if they become available, as well as
bug fixing, and Internet and telephone access to the Company's technical
personnel. 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.
-7-
<PAGE>
When products, product support and services are billed prior to the
time the related revenue is recognized, deferred revenue is recorded and any
material related costs paid in advance are deferred.
Revenue from specialized IT services provided to the federal
government under multi-year contracts is recognized as the services are
performed. Revenue for services provided under other 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.
Returns and allowances and other similar adjustments to revenue
involving software products historically have not been material to the Company's
results of operations.
Cash and Equivalents
Cash equivalents consist primarily of highly liquid investments in
investment-grade commercial paper of various issuers and repurchase agreements
backed by U.S. Treasury securities, with maturities of three months or less when
purchased. Cash equivalents are recorded at fair value.
Marketable Securities and Other Investments
The Company currently invests excess cash in a diversified portfolio
of marketable securities consisting of a variety of investment-grade securities,
including commercial paper, medium-term notes, U.S. government obligations,
municipal obligations and certificates of deposit. 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. Unrealized holding gains and losses on
securities available-for-sale are recorded as a component of stockholders'
equity, net of any related tax effect. The amortized cost of debt securities in
this category is adjusted for amortization of premiums and accretion of
discounts to maturity. Such amortization is included in investment income.
Realized gains and losses and declines in values judged to be other-than-
temporary, if any, on available-for-sale securities are included in investment
income.
-8-
<PAGE>
Earnings Per Common Share
The following table sets forth the computation of basic and diluted
earnings per share (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30 June 30
--------------------------- --------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Basic:
Net income...................................... $ 9,311 $27,211 $48,677 $68,449
========= ========= ========= =========
Weighted average common shares
outstanding .................................. 83,536 80,650 83,087 80,150
========= ========= ========= =========
Net income per common share..................... $ .11 $ .34 $ .59 $ .85
========= ========= ========= =========
Diluted:
Net income...................................... $ 9,311 $27,211 $48,677 $68,449
========= ========= ========= =========
Weighted average common shares
outstanding .................................. 83,536 80,650 83,087 80,150
Effect of dilutive employee stock options....... 4,200 5,712 4,703 4,695
--------- --------- --------- ---------
Adjusted weighted average common shares......... 87,736 86,362 87,790 84,845
========= ========= ========= =========
Net income per common share..................... $ .11 $ .32 $ .55 $ .81
========= ========= ========= =========
</TABLE>
Recent Developments
Effective October 1, 1998, the Company adopted Statement of Position
97-2, "Software Revenue Recognition," as amended by Statement of Position 98-4,
"Deferral of the Effective Date of Certain Provisions of SOP 97-2" ("SOP 97-2").
SOP 97-2 requires each element of a software sale arrangement to be separately
identified and accounted for based on the relative fair value of such element.
Revenue cannot be recognized on any element of the sale arrangement if
undelivered elements are essential to the functionality of the delivered
elements. Adoption of SOP 97-2 did not significantly affect the Company's
results of operations for the three and nine months ended June 30, 1999, nor is
it expected to have a significant impact on results for the remainder of the
year as the Company's revenue recognition policies have historically been
substantially in compliance with the practices required by SOP 97-2.
On December 15, 1998, the Accounting Standards Executive Committee of
the American Institute of Certified Public Accountants released Statement of
Position 98-9, "Modification of SOP 97-2, 'Software Revenue Recognition,' with
Respect to Certain Transactions" ("SOP 98-9"). SOP 98-9 amends SOP 97-2 to
require that an entity recognize revenue for multiple element software product
sale arrangements by means of the "residual method" when (1) there is vendor-
specific objective evidence ("VSOE") of the fair values of all of the
undelivered elements that are not accounted for by means of long-term contract
accounting, (2) VSOE of fair value does not exist for one or more of the
delivered elements, and (3) all revenue recognition criteria of SOP 97-2 (other
than the requirement for VSOE of the fair value of each delivered element) are
satisfied.
-9-
<PAGE>
The provisions of SOP 98-9 that extend the deferral of certain
passages of SOP 97-2 became effective December 15, 1998. All other provisions
of SOP 98-9 will be effective for the Company's fiscal year beginning October 1,
1999. Retroactive application is prohibited. The adoption of SOP 98-9 is not
expected to have a material impact on the financial position or results of
operations of the Company.
Effective October 1, 1998, the Company adopted Statement of Financial
Accounting Standards 130, "Reporting Comprehensive Income" ("FAS 130"). FAS 130
requires the presentation of comprehensive income and its components in a full
set of general-purpose financial statements. Comprehensive income is defined as
the change in equity of a business enterprise during a period from transactions
and other events and circumstances from non-owner sources. It includes all
changes in equity during a period except those resulting from investments by
owners and distributions to owners. The Company's comprehensive income consists
of net income, foreign currency translation adjustments and unrealized gains and
losses on available-for-sale securities; however, the adoption of FAS 130 had no
impact on the Company's net income for the three and nine months ended June 30,
1999 and 1998. Information concerning the Company's comprehensive income for
the three and nine months ended June 30, 1999 and 1998, respectively, is set
forth below (in thousands):
<TABLE>
<CAPTION>
Three Months Nine Months
Ended June 30 Ended June 30
--------------------------- ----------------------------
1999 1998 1999 1998
-------- --------- --------- --------
<S> <C> <C> <C> <C>
Net income................................. $ 9,311 $27,211 $48,677 $68,449
Foreign currency translation adjustments... (5,373) 31 (9,473) (7,493)
Unrealized gains (losses) on
available-for-sale securities, net of
taxes..................................... 257 (23) (588) 36
-------- -------- -------- --------
Comprehensive income....................... $ 4,195 $27,219 $38,616 $60,992
======== ======== ======== ========
</TABLE>
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 and are necessary for a fair presentation of the
financial position and results of operations for the periods presented. Certain
amounts for periods ended prior to June 30, 1999 have been reclassified to
conform to the current period presentation. Results of operations for the
periods presented herein are not necessarily indicative of results of operations
for the entire fiscal year. The information included in this report should be
read in conjunction with the information presented under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the fiscal year ended September 30,
1998.
-10-
<PAGE>
3. Business Acquisitions and Reorganizations
Acquisition of Spectra Logic's Alexandria Business and Interlink Computer
Sciences, Inc.
On April 15, 1999, Sterling Software acquired the distributed systems
storage software business (the "Alexandria Business") of Spectra Logic
Corporation in a cash asset acquisition transaction valued at approximately
$33,000,000. On April 30, 1999, Sterling Software acquired Interlink Computer
Sciences, Inc. ("Interlink"), a global supplier of high-performance solutions
for enterprise systems networking, in a two-step cash tender offer/merger
transaction valued at approximately $63,907,000, net of proceeds from
outstanding Interlink stock options and warrants. The total cost of both
acquisitions was approximately $115,128,000, including costs directly related to
the acquisitions of approximately $18,221,000, consisting of employee
termination costs, transaction costs, costs associated with the elimination of
duplicate facilities and other direct costs. At June 30, 1999, of the
$18,221,000 of direct costs, the remaining balance to be paid was $10,128,000.
Both acquisitions were accounted for in accordance with the purchase method
of accounting and, accordingly, the results of operations of the Alexandria
Business and Interlink were included in the Company's results of operations from
the respective dates of the acquisitions as part of the Company's systems
management business segment. Results of operations for the third quarter of
1999 and the first nine months of 1999 include $22,468,000 of purchased research
and development costs, which is the portion of the purchase price from both
acquisitions attributed to in-process research and development, and which was
charged to expense in accordance with the purchase method of accounting.
The components of the aggregate cost of the Alexandria and Interlink
acquisitions were as follows (in thousands):
Cash transaction consideration................................ $ 96,907
Interlink and Alexandria employee severance and benefits...... 11,364
Elimination of duplicate facilities and leases................ 2,725
Transaction costs............................................. 3,445
Other costs................................................... 687
--------
$115,128
========
The aggregate cost of the Alexandria and Interlink acquisitions was
allocated to the respective assets and liabilities acquired and to purchased
research and development, with the remainder recorded as excess cost over net
assets acquired, based on estimates of fair values (in thousands):
Working capital............................................... $ 15,266
Property and equipment........................................ 1,037
Developed software and core technology........................ 37,244
Purchased research and development costs charged to expense... 22,468
Other assets and liabilities (net)............................ 735
Excess cost over net assets acquired.......................... 38,378
--------
$115,128
========
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<PAGE>
The estimates of fair value were determined by the Company's management
based on information furnished by management of Spectra Logic Corporation and
Interlink and a preliminary independent valuation of developed software, core
technology and purchased research and development. Amounts allocated to
purchased research and development were expensed at the time of the acquisitions
as the Company determined that the purchased research and development had not
reached technological feasibility based on the status of design and development
activities that required further refinement and testing.
The Company is using the purchased research and development to create new
products that are expected to become part of the products offered by the systems
management business segment. The Company expects that products developed from
the purchased research and development will generally be released during the
remainder of 1999 and 2000. The development activities required to complete the
purchased research and development technologies include additional coding,
cross-platform porting and validation, quality assurance procedures and beta
testing. The Company's management expects that the purchased research and
development will be successfully developed; however, there can be no assurance
that commercial viability or timely release of these products will be achieved.
Acquisition of Cayenne Software, Inc.
On October 26, 1998, Sterling Software acquired Cayenne Software, Inc.
("Cayenne"), a global supplier of analysis and design solutions for application
and database development, in an $11,400,000 cash-for-stock merger transaction
(the "Cayenne Acquisition"). The total cost of the Cayenne Acquisition was
approximately $33,184,000, including costs directly related to the acquisition
of approximately $21,784,000, consisting of employee termination costs,
transaction costs, costs associated with the elimination of duplicate facilities
and other direct costs. At June 30, 1999, of the $21,784,000 of direct costs,
the remaining balance to be paid was $8,533,000.
The Cayenne Acquisition was accounted for in accordance with the purchase
method of accounting and, accordingly, the results of operations of Cayenne were
included in the Company's results of operations from the date of the acquisition
as part of the Company's application management business segment. Results of
operations for the first nine months of 1999 include $9,623,000 of purchased
research and development costs, which is the portion of the purchase price
attributed to in-process research and development, and which was charged to
expense in accordance with the purchase method of accounting.
The components of the aggregate cost of the Cayenne Acquisition were as
follows (in thousands):
Cash merger consideration..................................... $11,400
Cayenne employee severance and benefits....................... 11,912
Elimination of duplicate facilities and leases................ 5,510
Transaction costs............................................. 2,773
Other costs................................................... 1,589
-------
$33,184
=======
-12-
<PAGE>
The aggregate cost of the Cayenne Acquisition was allocated to the assets
and liabilities acquired and to purchased research and development, with the
remainder recorded as excess cost over net assets acquired, based on estimates
of fair values (in thousands):
Working capital (deficit)...................................... $(3,921)
Property and equipment......................................... 383
Developed software and core technology......................... 11,434
Purchased research and development costs charged to expense.... 9,623
Other assets and liabilities (net)............................. (89)
Excess cost over net assets acquired........................... 15,754
-------
$33,184
=======
The estimates of fair value were determined by the Company's management
based on information furnished by management of Cayenne and an independent
valuation of developed software, core technology and purchased research and
development. Amounts allocated to purchased research and development were
expensed at the time of the Cayenne Acquisition as the Company determined that
the purchased research and development had not reached technological feasibility
based on the status of design and development activities that required further
refinement and testing.
The Company is using the purchased research and development to create new
products that are expected to become part of the products offered by the
application management business segment. Products developed from the purchased
research and development are generally being released during calendar 1999. The
Company's management expects that the purchased research and development will be
successfully developed; however, there can be no assurance that commercial
viability or timely release of these products will be achieved.
Methodology for Valuing Purchased Research and Development
The value of the purchased research and development attributable to each
acquisition was determined by discounting the estimated projected net cash flows
related to the applicable products, including costs to complete the development
of the technology and the future revenues to be earned upon release of the
products. The projected net cash flows from such products were based on
estimates of revenues and operating profits related to such products.
Acquisition of Synon Corporation
On July 31, 1998, Sterling Software acquired Synon Corporation ("Synon"), a
provider of application development software and services, in a stock-for-stock
merger transaction (the "Synon Merger") accounted for as a pooling of interests,
valued at approximately $79,000,000. As a result of the transaction, Sterling
Software issued approximately 2,603,000 shares of the Company's common stock,
par value $.10 per share ("Common Stock"), in exchange for the previously
outstanding shares of Synon capital stock and reserved approximately 375,000
shares of Common Stock for issuance upon exercise of assumed Synon stock
options. The Company's financial statements for periods prior to the Synon
Merger, including the results of the application management business segment,
have been restated to represent the combined financial statements of the
previously separate entities.
-13-
<PAGE>
Reorganization Costs
The Company's results of operations for the third quarter of 1999 and the
first nine months of 1999 include reorganization costs of $14,098,000 related to
the reorganization of the Company's operations in connection with the Alexandria
and Interlink acquisitions. Of the total reorganization costs, approximately
$8,730,000 consisted of non-cash costs and the remaining $5,368,000 required
cash outlays. At June 30, 1999, the remaining balance to be paid was $4,818.000.
The Company does not expect to incur costs related to this reorganization in
excess of the amounts charged to operations in the third quarter of 1999.
The components of the reorganization costs associated with the Alexandria
and Interlink acquisitions were as follows (in thousands):
Employee termination costs..........................................$ 1,760
Write-down of software products that will not be actively marketed.. 8,488
Elimination of duplicate facilities, equipment and other assets..... 885
Out of pocket costs related to the reorganization................... 2,965
-------
$14,098
=======
The Company's results of operations for the first nine months of 1999 also
include reorganization costs of $19,655,000 related to the reorganization of the
Company's operations in connection with the Cayenne Acquisition. Of the total
reorganization costs, approximately $8,007,000 consisted of non-cash costs and
the remaining $11,648,000 required cash outlays. At June 30, 1999, the
remaining balance to be paid was $3,379,000, which consisted primarily of
commitments under lease arrangements for office space and equipment. The
Company does not expect to incur costs related to this reorganization in excess
of the amounts charged to operations in the first quarter of 1999.
The Company's results of operations for the year ended September 30, 1998
include reorganization costs of $45,162,000 primarily related to the
reorganization of the Company's operations in the fourth quarter of 1998 in
connection with the Synon Merger. Of the total reorganization costs,
approximately $9,552,000 consisted of non-cash costs and the remaining
$35,610,000 required cash outlays. At June 30, 1999, the remaining balance to
be paid was $6,754,000, which consisted primarily of commitments under lease
arrangements for office space and equipment. The Company does not expect to
incur costs related to this reorganization in excess of the amounts charged to
operations in the fourth quarter of 1998.
4. Legal Proceedings and Claims
The Company is subject to various legal proceedings and claims that arise
in the normal course of its business. While many of these matters involve
inherent uncertainty, the Company's management believes that the amount of the
liability, if any, ultimately incurred by Sterling Software with respect to any
such existing proceedings and claims, net of applicable reserves and available
insurance, will not materially affect the business, financial condition or
results of operations of the Company.
-14-
<PAGE>
5. Segment Information
Sterling Software is a worldwide developer and supplier of application
development, information management and systems management software products and
services, as well as a supplier of specialized IT services for sectors of the
federal government. The Company addresses these major markets through three
business segments. The application management business segment provides
solutions for both enterprise-scale application development and information
management. Application development solutions include products and services for
business modeling through code generation. Information management solutions
include products and services that enable customers to facilitate enterprise
information access and to extend the life and usefulness of legacy applications.
The systems management business segment provides solutions that enable customers
to simplify the use of multiple computing environments and to increase the
productivity of information systems, ultimately ensuring that the systems meet
the business needs of the organization. The federal systems business segment
provides specialized IT services for sectors of the federal government, as well
as state and local governments.
Financial information concerning the Company's operations, by business
segment, for the three and nine months ended June 30, 1999 and 1998, is
summarized as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Nine Months
Ended June 30 Ended June 30
---------------------------------------------------------------------
1999 1998 1999 1998
--------- --------- --------- ----------
<S> <C> <C> <C> <C>
Revenue:
Application Management.................... $ 93,106 $ 93,649 $273,821 $277,539
Systems Management........................ 76,120 49,983 184,640 142,358
Federal Systems........................... 40,539 37,159 118,149 106,729
Corporate and other....................... 628
--------- --------- --------- ---------
Consolidated totals..................... $209,765 $180,791 $576,610 $527,254
========= ========= ========= =========
Operating Profit (Loss):
Application Management.................... $ 27,514 $ 20,418 $ 75,842 $ 48,818
Systems Management........................ 29,479 19,524 68,288 52,042
Federal Systems........................... 3,136 2,412 9,044 7,119
Reorganization costs...................... (14,098) (33,753)
Purchased research and development........ (22,468) (32,091)
Corporate and other....................... (7,831) (7,775) (24,012) (23,636)
--------- --------- --------- ---------
Consolidated totals...................... $ 15,732 $ 34,579 $ 63,318 $ 84,343
========= ========= ========= =========
</TABLE>
6. Subsequent Events
On July 15, 1999, Sterling Software entered into a definitive merger
agreement to acquire Information Advantage, Inc. ("Information Advantage"), a
provider of web-based and enterprise business intelligence software, in a two-
step cash tender offer/merger transaction. The transaction is valued at
approximately $165,000,000 and is expected to close during the second half of
August 1999.
On July 26, 1999, Sterling Software acquired CoreData, Inc., ("CoreData"),
a developer and supplier of backup software for remote and mobile PCs in a cash
merger transaction valued at approximately $14,000,000.
-15-
<PAGE>
Both acquisitions will be accounted for in accordance with the purchase
method of accounting and, accordingly, the results of operations of CoreData and
Information Advantage will be included in the Company's results of operations
from the respective dates of the acquisitions.
-16-
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Business Combinations and Reorganizations
Acquisition of Spectra Logic's Alexandria Business and Interlink Computer
Sciences, Inc.
On April 15, 1999, Sterling Software acquired the distributed systems
storage software business (the "Alexandria Business") of Spectra Logic
Corporation in a cash asset acquisition transaction valued at approximately
$33,000,000. On April 30, 1999, Sterling Software acquired Interlink Computer
Sciences, Inc. ("Interlink"), a global supplier of high-performance solutions
for enterprise systems networking, in a two-step cash tender offer/merger
transaction valued at approximately $63,907,000, net of proceeds from
outstanding Interlink stock options and warrants. The total cost of both
acquisitions was approximately $115,128,000, including costs directly related to
the acquisitions of approximately $18,221,000, consisting of employee
termination costs, transaction costs, costs associated with the elimination of
duplicate facilities and other direct costs. At June 30, 1999, of the
$18,221,000 of direct costs, the remaining balance to be paid was $10,128,000.
Both acquisitions were accounted for in accordance with the purchase method
of accounting and, accordingly, the results of operations of the Alexandria
Business and Interlink were included in the Company's results of operations from
the respective dates of the acquisitions as part of the Company's systems
management business segment. Results of operations for the third quarter of
1999 and the first nine months of 1999 include $22,468,000 of purchased research
and development costs, which is the portion of the purchase price from both
acquisitions attributed to in-process research and development, and which was
charged to expense in accordance with the purchase method of accounting.
Acquisition of Cayenne Software, Inc.
On October 26, 1998, Sterling Software acquired Cayenne Software, Inc.
("Cayenne"), a global supplier of analysis and design solutions for application
and database development, in an $11,400,000 cash-for-stock merger transaction
(the "Cayenne Acquisition"). The total cost of the Cayenne Acquisition was
approximately $33,184,000, including costs directly related to the acquisition
of approximately $21,784,000, consisting of employee termination costs,
transaction costs, costs associated with the elimination of duplicate facilities
and other direct costs. At June 30, 1999, of the $21,784,000 of direct costs,
the remaining balance to be paid was $8,533,000.
The Cayenne Acquisition was accounted for in accordance with the purchase
method of accounting and, accordingly, the results of operations of Cayenne were
included in the Company's results of operations from the date of the acquisition
as part of the Company's application management business segment. Results of
operations for the first nine months of 1999 include $9,623,000 of purchased
research and development costs, which is the portion of the purchase price
attributed to in-process research and development, and which was charged to
expense in accordance with the purchase method of accounting.
-17-
<PAGE>
Acquisition of Synon Corporation
On July 31, 1998, Sterling Software acquired Synon Corporation ("Synon"), a
provider of application development software and services, in a stock-for-stock
merger transaction (the "Synon Merger") accounted for as a pooling of interests,
valued at approximately $79,000,000. As a result of the transaction, Sterling
Software issued approximately 2,603,000 shares of the Company's common stock,
par value $.10 per share ("Common Stock"), in exchange for the previously
outstanding shares of Synon capital stock and reserved approximately 375,000
shares of Common Stock for issuance upon exercise of assumed Synon stock
options. The Company's financial statements for periods prior to the Synon
Merger, including the results of the application management business segment,
have been restated to represent the combined financial statements of the
previously separate entities.
Reorganization Costs
The Company's results of operations for the third quarter of 1999 and the
first nine months of 1999 include reorganization costs of $14,098,000 related to
the reorganization of the Company's operations in connection with the Alexandria
and Interlink acquisitions. Of the total reorganization costs, approximately
$8,730,000 consisted of non-cash costs and the remaining $5,368,000 required
cash outlays. At June 30, 1999, the remaining balance to be paid was $4,818,000.
The Company does not expect to incur costs related to this reorganization in
excess of the amounts charged to operations in the third quarter of 1999.
The Company's results of operations for the first nine months of 1999 also
include reorganization costs of $19,655,000 related to the reorganization of the
Company's operations in connection with the Cayenne Acquisition. Of the total
reorganization costs, approximately $8,007,000 consisted of non-cash costs and
the remaining $11,648,000 required cash outlays. At June 30, 1999, the
remaining balance was $3,379,000, which consisted primarily of commitments under
lease arrangements for office space and equipment. The Company does not expect
to incur costs related to this reorganization in excess of the amounts charged
to operations in the first quarter of 1999.
The Company's results of operations for the year ended September 30, 1998
include reorganization costs of $45,162,000 primarily related to the
reorganization of the Company's operations in the fourth quarter of 1998 in
connection with the Synon Merger. Of the total reorganization costs,
approximately $9,552,000 consisted of non-cash costs and the remaining
$35,610,000 required cash outlays. At June 30, 1999, the remaining balance to
be paid was $6,754,000, which consisted primarily of commitments under lease
arrangements for office space and equipment. The Company does not expect to
incur costs related to this reorganization in excess of the amounts charged to
operations in the fourth quarter of 1998.
-18-
<PAGE>
Results of Operations
Three Months Ended June 30, 1999 and 1998
Total revenue increased $28,974,000, or 16%, in the third quarter of 1999
over the same period of 1998 due to revenue increases in the Company's systems
management and federal systems business segments. Revenue from the systems
management and federal systems business segments increased by 52% and 9%,
respectively, in the third quarter of 1999 over the same period in 1998.
Revenue increases in the systems management and federal systems business
segments were partially offset by a 1% decline in total revenue from the
application management business segment for the same period. Without the effect
of the Synon restatement, total application management revenue would have
increased 25% and total revenue would have increased 30% in the third quarter of
1999 over the same period of 1998.
Revenue generated from the Company's international operations was
$79,972,000 and $70,125,000 in the third quarter of 1999 and 1998, respectively,
representing an increase of $9,847,000, or 14%. This was due to a 53% quarter
over quarter increase in international revenue generated by the systems
management business segment, partially offset by a 6% quarter over quarter
decline in international revenue generated by the application management
business segment. Revenue from the Company's international operations
represented 38% and 39% of total revenue in the third quarter of 1999 and 1998,
respectively. Without the effect of the Synon restatement, revenue from the
Company's international operations would have increased 32% in the third quarter
of 1999 over the same period of 1998.
The Company's recurring revenue includes revenue from product support
agreements generally having terms ranging from one to three years and federal
contracts generally having terms ranging from one to five years. Like most
federal contracts, Sterling Software's federal contracts permit termination by
the government for convenience or for failure to obtain funding. Recurring
revenue decreased to 44% of total revenue in the third quarter of 1999 compared
to 45% in the same period of 1998.
Revenue from the application management business segment decreased $543,000
in the third quarter of 1999 compared to the same period of 1998 due to a 35%
decline in services revenue, partially offset by a 16% increase in products
revenue and an 8% increase in product support revenue. Without the effect of
the Synon restatement, total application management revenue would have increased
25% in the third quarter of 1999 over the same period of 1998 with 30%, 33% and
3% increases in products, product support and services revenue, respectively.
The reported decline in services revenue is due primarily to the Company's
execution of its strategy of transitioning application development consulting
services opportunities to partners and third-party consulting firms in order to
focus the Company's efforts primarily on software product sales. Additionally,
the Company believes that the execution of this strategy has enabled it to
enhance its relationships with third party service providers, namely systems
integrators and independent software vendors, who are also buyers of its
application development tools. Approximately 47% of the application management
business segment's total revenue in the third
-19-
<PAGE>
quarter of 1999 was derived from the Company's international operations,
compared to 49% in the same period of 1998.
Revenue from the systems management business segment increased $26,137,000,
or 52%, in the third quarter of 1999 over the same period of 1998 primarily due
to a 67% increase in products revenue and a 20% increase in product support
revenue. The increase in products revenue was mainly attributable to strong
product sales in the storage management and network management product lines,
including revenue added as a result of the Company's acquisitions of the
Alexandria Business and Interlink. Approximately 48% of the systems management
business segment's total revenue was derived from the Company's international
operations in both the third quarters of 1999 and 1998.
Revenue from the federal systems business segment increased $3,380,000, or
9%, in the third quarter of 1999 over the same period of 1998 primarily due to
higher contract billings in the segment's defense business as well as revenue
added as a result of the Company's acquisition of Mystech Associates, Inc. in
the fourth quarter of 1998 (the "Mystech Merger").
Total costs and expenses increased $47,821,000, or 33%, in the third
quarter of 1999 over the same period of 1998. However, excluding the
Alexandria- and Interlink-related reorganization costs of $14,098,000 and the
write-off of Alexandria- and Interlink-related purchased research and
development costs of $22,468,000 in the third quarter of 1999, total costs and
expenses increased $11,255,000, or 8%. A 10% decrease in total costs in the
application management business segment was offset by increases in total costs
in the systems management and federal systems business segments of 53% and 8%,
respectively. The decrease in total costs in the application management
business segment is primarily a result of the Company's lower cost structure in
that business segment, compared to the cost structure of the former Synon
operation. The increase in total costs in the systems management and federal
systems business segments is consistent with the revenue growth generated in
these segments.
Total cost of sales increased $1,884,000, or 3%, in the third quarter of
1999 compared to the same period of 1998, and represented 35% and 40% of total
revenue in the third quarter of 1999 and 1998, respectively. Cost of sales for
products and product support represented 14% of products and product support
revenue in both the third quarters of 1999 and 1998. Cost of sales for services
represented 90% of services revenue in the third quarter of 1999 compared to 87%
for the same period in 1998.
Product development expense for the third quarter of 1999 grew 14% to
$9,250,000, as compared to product development expense in the third quarter of
1998 of $8,090,000. Gross product development expense, before capitalization of
software, was 11% of non-federal revenue in the third quarter of 1999 compared
with 10% for the same period of 1998. In the third quarter of 1999, the Company
capitalized $9,811,000 of development costs, a 51% capitalization rate, and
amortized $7,181,000 of software. This compares to $6,869,000 of capitalized
development costs, or a 46% capitalization rate, and $5,455,000 of software
amortization in the third quarter of 1998. Product development expenses and the
capitalization rate historically have fluctuated, and may in the future continue
to fluctuate, from period to period depending in part upon the number and status
of software development projects that are in process.
-20-
<PAGE>
Selling, general and administrative expenses increased $8,211,000, or 12%,
in the third quarter of 1999 compared to the same period of 1998, primarily due
to an increase in selling, general and administrative expenses in the systems
management business segment, partially offset by a decrease in selling, general
and administrative expenses in the application management business segment. The
decrease in selling, general and administrative expenses in the application
management business segment is primarily a result of the Company's lower cost
structure in that business segment, compared to the cost structure of the former
Synon operation. The increase in selling, general and administrative expenses
in the systems management business segment is consistent with the revenue growth
generated in this segment. Selling, general and administrative expenses
represented 36% and 37% of total revenue in the third quarter of 1999 and 1998,
respectively.
Income before income taxes in the third quarter of 1999 was $24,024,000
compared to $42,624,000 for the same period of 1998. However, excluding the
Alexandria- and Interlink-related reorganization costs of $14,098,000 and the
write-off of Alexandria- and Interlink-related purchased research and
development costs of $22,468,000 in the third quarter of 1999, income before
income taxes was $60,590,000, representing an increase of $17,966,000, or 42%,
primarily due to higher profits in all three of the Company's business segments.
The Company's effective tax rate for the third quarter of 1999 was 61%
compared to 36% for the same period of 1998. The effective tax rate for the
third quarter of 1999 was adversely impacted by the write-off of purchased
research and development costs related to the Interlink acquisition and certain
acquisition and reorganization costs related to the Alexandria and Interlink
acquisitions. Neither of these items will provide a tax benefit to the Company.
Before the net tax benefit related to the Alexandria- and Interlink-related
reorganization costs and the write-off of purchased research and development
costs, the Company's effective tax rate for the third quarter of 1999 was 34%.
The effective tax rate for the third quarter of 1998 was adversely impacted by
unbenefited losses incurred by Synon prior to the Synon Merger.
Nine Months Ended June 30, 1999 and 1998
Total revenue increased $49,356,000, or 9%, in the first nine months of
1999 over the same period of 1998 due to revenue increases in the Company's
systems management and federal systems business segments. Revenue from the
systems management and federal systems business segments increased by 30% and
11%, respectively, in the first nine months of 1999 over the same period in
1998. Revenue increases in the systems management and federal systems business
segments were partially offset by a 1% decline in total revenue from the
application management business segment for the same period. Without the effect
of the Synon restatement, total application management revenue would have
increased 24% and total revenue would have increased 23% in the first nine
months of 1999 over the same period of 1998.
Revenue generated from the Company's international operations was
$223,665,000 and $209,264,000 in the nine months ended June 30, 1999 and 1998,
respectively, representing an increase of $14,401,000, or 7%. This was due to a
28% period over period increase in international revenue generated by the
systems management business segment, partially offset by
-21-
<PAGE>
a 3% period over period decline in international revenue generated by the
application management business segment. Revenue from the Company's
international operations represented 39% and 40% of total revenue in the first
nine months of 1999 and 1998, respectively. Without the effect of the Synon
restatement, revenue from the Company's international operations would have
increased 25% in the first nine months of 1999 over the same period of 1998.
The Company's recurring revenue includes revenue from product support
agreements generally having terms ranging from one to three years and federal
contracts generally having terms ranging from one to five years. Like most
federal contracts, Sterling Software's federal contracts permit termination by
the government for convenience or for failure to obtain funding. Recurring
revenue increased to 47% of total revenue in the first nine months of 1999
compared to 46% in the same period of 1998.
Revenue from the application management business segment declined
$3,718,000, or 1%, in the first nine months of 1999 compared to the same period
of 1998 due to a 27% decline in services revenue, partially offset by a 5%
increase in products revenue and a 13% increase in product support revenue.
Without the effect of the Synon restatement, total application management
revenue would have increased 24% in the nine months ended June 30, 1999 over the
same period of 1998 with 23%, 40% and 7% increases in products, product support
and services revenue, respectively. The reported decline in services revenue is
due primarily to the Company's execution of its strategy of transitioning
application development consulting services opportunities to partners and third-
party consulting firms in order to focus the Company's efforts primarily on
software product sales. Additionally, the Company believes that the execution
of this strategy has enabled it to enhance its relationships with third party
service providers, namely systems integrators and independent software vendors,
who are also buyers of its application development tools. Approximately 50% of
the application management business segment's total revenue in the first nine
months of 1999 was derived from the Company's international operations, compared
to 51% in the same period of 1998.
Revenue from the systems management business segment increased $42,282,000,
or 30%, in the nine months ended June 30, 1999 over the same period of 1998,
primarily due to a 39% increase in products revenue and a 10% increase in
product support revenue. The increase in products revenue was mainly
attributable to higher product sales in the storage management and network
management product lines, including revenue added as a result of the Company's
acquisitions of the Alexandria Business and Interlink. Approximately 47% of the
systems management business segment's total revenue in the first nine months of
1999 was derived from the Company's international operations, compared to 48% in
the same period of 1998.
Revenue from the federal systems business segment increased $11,420,000, or
11%, in the first nine months of 1999 over the same period of 1998 primarily due
to higher contract billings in the segment's defense business as well as revenue
added as a result of the Mystech Merger.
-22-
<PAGE>
Total costs and expenses increased $70,381,000, or 16%, in the first nine
months of 1999 over the same period of 1998. However, excluding the Alexandria-
and Interlink-related reorganization costs of $14,098,000 and the write-off of
Alexandria- and Interlink-related purchased research and development costs of
$22,468,000 in the third quarter of 1999, and the Cayenne-related reorganization
costs of $19,655,000 and the write-off of Cayenne-related purchased research and
development costs of $9,623,000 in the first quarter of 1999, total costs and
expenses increased $4,537,000, or 1%. A 13% decrease in total costs in the
application management business segment was offset by increases in total costs
in the systems management and federal systems business segments of 29% and 10%,
respectively. The decrease in total costs in the application management
business segment is primarily a result of the Company's lower cost structure in
that business segment, compared to the cost structure of the former Synon
operation. The increase in total costs in the systems management and federal
systems business segments is consistent with the revenue growth generated in
these segments.
Total cost of sales increased $3,853,000, or 2%, in the first nine months
of 1999 compared to the same period of 1998, and represented 37% and 40% of
total revenue in the first nine months of 1999 and 1998, respectively. Cost of
sales for products and product support represented 15% of products and product
support revenue in both the first nine months of 1999 and 1998. Cost of sales
for services represented 89% of services revenue in the first nine months of
1999 compared to 87% for the same period in 1998.
Product development expense for the first nine months of 1999 remained
constant at $28,129,000 as compared to product development expense in the first
nine months of 1998 of $28,108,000. Gross product development expense, before
capitalization of software, was 11% of non-federal revenue in both the nine
months ended June 30, 1999 and 1998. In the first nine months of 1999, the
Company capitalized $23,903,000 of development costs, a 46% capitalization rate,
and amortized $18,609,000 of software. This compares to $20,026,000 of
capitalized development costs, or a 42% capitalization rate, and $15,559,000 of
software amortization in the first nine months of 1998. Product development
expenses and the capitalization rate historically have fluctuated, and may in
the future continue to fluctuate, from period to period depending in part upon
the number and status of software development projects that are in process.
Selling, general and administrative expenses increased $663,000 in the nine
months ended June 30, 1999 compared to the same period of 1998, primarily due to
an increase in selling, general and administrative expenses in the systems
management business segment offset by decreased selling, general and
administrative expenses in the application management business segment. The
decrease in selling, general and administrative expenses in the application
management business segment is primarily a result of the Company's lower cost
structure in that business segment, compared to the cost structure of the former
Synon operation. The increase in selling, general and administrative expenses
in the systems management business segment is consistent with the revenue growth
generated in this segment. Selling, general and administrative expenses
represented 35% and 39% of total revenue in the first nine months of 1999 and
1998, respectively.
-23-
<PAGE>
Income before income taxes in the first nine months of 1999 was $89,210,000
compared to $108,329,000 for the same period of 1998. However, excluding the
Alexandria- and Interlink-related reorganization costs of $14,098,000 and the
write-off of Alexandria- and Interlink-related purchased research and
development costs of $22,468,000 in the third quarter of 1999, and Cayenne-
related reorganization costs of $19,655,000 and the write-off of Cayenne-related
purchased research and development costs of $9,623,000 in the first quarter of
1999, income before income taxes was $155,054,000, representing an increase of
$46,725,000, or 43%, primarily due to higher profits in all three of the
Company's business segments.
The Company's effective tax rate for the first nine months of 1999 was 45%
compared to 37% for the same period of 1998. The effective tax rate for the
first nine months of 1999 was adversely impacted by the write-off of purchased
research and development costs related to the Cayenne and Interlink acquisitions
and certain acquisition and reorganization costs related to the Cayenne,
Alexandria and Interlink acquisitions. None of these items will provide a tax
benefit to the Company. Before the net tax benefit related to the Cayenne-,
Alexandria- and Interlink-related reorganization costs and the write-off of
purchased research and development costs, the Company's effective tax rate for
the first nine months of 1999 was 34%. The effective tax rate for the first nine
months of 1998 was adversely impacted by unbenefited losses incurred by Synon
prior to the Synon Merger.
Liquidity and Capital Resources
The Company maintained a strong liquidity and financial position with
$649,642,000 of working capital at June 30, 1999, which included $425,895,000 of
cash and cash equivalents and $221,607,000 of marketable securities. Net cash
provided by operating activities was $60,700,000 in the first nine months of
1999 as compared to $86,064,000 in the first nine months of 1998. Net cash
provided by operating activities in the first nine months of 1999 was reduced by
payments made during the period of approximately $52,806,000 related to the
Company's acquisitions and related reorganizations that have occurred in the
preceding twelve months. Net cash provided by operating activities in the first
nine months of 1998 was reduced by payments of approximately $25,227,000 related
to the acquisition of substantially all of the assets of the Software Division
of Texas Instruments Incorporated and the related reorganizations that occurred
in the third quarter of 1997.
Investing activities used $49,375,000 of cash in the first nine months of
1999 as compared to $89,116,000 in the first nine months of 1998. Capital
expenditures in the first nine months of 1999 were $23,127,000 compared to
$22,796,000 in the first nine months of 1998. Purchases and capitalized costs
of computer software were $24,292,000 and $20,268,000 in the first nine months
of 1999 and 1998, respectively. Cash provided by operating activities, together
with other available cash, was used to fund capital expenditures and additions
to computer software, as well as the Cayenne, Alexandria and Interlink
acquisitions.
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<PAGE>
Financing activities provided $20,503,000 of cash in the first nine months
of 1999 compared to $11,765,000 in the first nine months of 1998. The Company
received proceeds of approximately $16,971,000 and $15,339,000 from the exercise
of employee stock options in the first nine months of 1999 and 1998,
respectively. Also, the Company received proceeds of $6,810,000 in the first
nine months of 1999 from the issuance of Common Stock pursuant to the Company's
employee stock purchase plan.
The Company is party to a bank credit agreement (the "Credit Agreement")
which provides for unsecured revolving credit loans of up to $35,000,000.
Borrowings under the Credit Agreement, which expires on June 30, 2000, bear
interest at the lower of the lender's base rate or a Eurodollar lending rate
plus one-half percent. No amounts were borrowed under the Credit Agreement
during the first nine months of 1999 or 1998.
At June 30, 1999, the Company's short- and long-term cash commitments,
including remaining costs related to the Company's acquisitions and related
reorganizations that have occurred in the preceding twelve months, consisted
primarily of commitments under lease arrangements for office space and
equipment. The Company intends to meet such obligations primarily from cash
provided by operating activities.
The Company believes that available cash balances, cash equivalents and
short-term investments combined with cash provided by operating activities and
amounts available under existing credit agreements are sufficient to meet the
Company's cash requirements for the foreseeable future.
Other Matters
Foreign Currency Matters
The assets and liabilities of the Company's non-U.S. operations are
translated into U.S. dollars at exchange rates in effect as of the applicable
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 exposure to
foreign currency exchange rate fluctuations through decentralized sales,
marketing and support operations, and through international development
facilities, in which substantially all costs are local-currency based. The
Company has entered, and may in the future enter, into hedging transactions in
an effort to reduce its exposure to currency exchange risks.
Year 2000 Issues
The following discussion regarding year 2000 matters constitutes a "Year
2000 Readiness Disclosure" within the meaning of the Year 2000 Information and
Readiness Disclosure Act.
-25-
<PAGE>
Like most companies in the IT industry, the Company has been and is
continuing to address the impact of the so-called "year 2000" issue. A more
detailed discussion of certain risks associated with the year 2000 issue and the
Company's actions and plans to address this issue is set forth in the Company's
Annual Report on Form 10-K for the fiscal year ended September 30, 1998.
Among other risks associated with the year 2000 issue, some commentators
have predicted that it may affect historical purchasing patterns and trends in
the software industry. For example, certain industry analysts believe that many
customers and potential customers are heavily engaged in testing and correcting
year 2000 problems in their systems, and therefore, may choose to defer system
investments during calendar 1999, negatively impacting the revenues of
enterprise software vendors like the Company. Other analysts have indicated
that many enterprises that have completed their year 2000 corrective measures
intend to make no changes to their existing computing environments during the
latter part of calendar 1999 and the early part of 2000, also resulting in the
potential deferral of system investments. Because of the unprecedented nature of
the year 2000 issue and the general uncertainty that surrounds it, there can be
no assurance that it will not affect customer purchasing patterns,
lengthen the Company's sales cycles or otherwise negatively affect demand for
the Company's products.
As the turn of the century approaches, the Company is continuing to assess
the need for, implement and refine contingency plans associated with the year
2000 issue. Among other things, the Company's product support and internal MIS
organizations are developing and refining plans to ensure the ready availability
of adequate customer and product support resources, and the Company's critical
business systems, in late December of 1999 and early January of 2000.
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. Such
statements are based upon the beliefs and assumptions of, and on information
available to, the Company's management. The following statements are or may
constitute forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995: (i) statements preceded by, followed
by or that include the words "may", "will", "could", "should", "believe",
"expect", "future", "potential", "anticipate", "intend", "plan", "estimate" or
"continue" or the negative or other variations thereof and (ii) other statements
regarding matters that are not historical facts. Such forward-looking
statements are subject to various risks and uncertainties, including (i) risks
and uncertainties relating to the possible invalidity of the underlying beliefs
and assumptions, (ii) possible changes or developments in social, economic,
business, industry, market, legal and regulatory circumstances and conditions,
and (iii) actions taken or omitted to be taken by third parties, including
customers, suppliers, business partners, competitors and legislative,
regulatory, judicial and other governmental authorities and officials. In
addition to any risks and uncertainties specifically identified in the text
surrounding such forward-looking statements, the statements in the immediately
preceding sentence and the statements under captions such as "Risk Factors",
"Certain Considerations Relative to the Company" and "Special Considerations" in
the SEC Filings constitute cautionary statements identifying important factors
that could cause actual amounts, results, events and circumstances to differ
materially from those reflected in such forward-looking statements.
-26-
<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:
2.1 Agreement and Plan of Merger, dated as of June 20, 1998, among the
Company, Sterling Software (Southern), Inc. and Synon Corporation
(1), (2)
2.2 Agreement and Plan of Merger, dated as of August 27, 1998, among the
Company, Sterling Software (Southern), Inc. and Cayenne Software,
Inc. (2), (3)
2.3 Asset Purchase Agreement, dated as of March 6, 1999, between the
Company, Spectra Logic Corporation, Sterling Software (U.S.A.), Inc.,
Nathan C. Thompson and Michael J. Sausa (2), (4)
2.4 Agreement and Plan of Merger, dated as of March 23, 1999, among the
Company, Sterling Software (Southwest), Inc. and Interlink Computer
Sciences, Inc. (2), (5)
2.5 Agreement and Plan of Merger, dated as of July 15, 1999, among the
Company, Sterling Software Acquisition Corp. and Information
Advantage, Inc. (2), (6)
3.1 Certificate of Incorporation, as amended, of the Company (4)
3.2 Bylaws, as amended, of the Company (7)
27 Financial Data Schedule (8)
_____________
(1) Previously filed as an exhibit to the Company's Current Report on Form 8-K
dated June 21, 1998 and incorporated herein by reference (SEC File No.
98652676).
(2) In accordance with Item 601 of Regulation S-K, the schedules and exhibits
relating to the agreement have been omitted. The Company will furnish
supplementally to the Securities and Exchange Commission such schedules or
exhibits upon request.
(3) Previously filed as an exhibit to the Current Report on Form 8-K dated
August 27, 1998 filed by Cayenne Software, Inc. and incorporated herein by
reference (File ID #000-19682, SEC File No. 98700698).
(4) Previously filed as an exhibit to the Company's Quarterly Report on Form 10-
Q for the quarter ended March 31, 1999 and incorporated herein by reference
(SEC File No. 99617213).
(5) Previously filed as an exhibit to the Company's Tender Offer Statement on
Schedule 14D-1 dated March 30, 1999 and incorporated herein by reference
(SEC File No. 99579124).
(6) Previously filed as an exhibit to the Company's Tender Offer Statement on
Schedule 14D-1 dated July 21, 1999 and incorporated herein by reference (SEC
File No. 99667898).
(7) Previously filed as an exhibit to the Company's Registration Statement on
Form 8-A/A filed on May 27, 1998 and incorporated herein by reference (SEC
File No. 98632257).
(8) Filed herewith.
-27-
<PAGE>
(b) Reports on Form 8-K.
The Company did not file any Current Reports on Form 8-K during the three
month period ended June 30, 1999.
-28-
<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 4, 1999 By: /s/ Sterling L. Williams
------------------------------------
Sterling L. Williams
President, Chief Executive Officer
and Director
(Principal Executive Officer)
Date: August 4, 1999 /s/ R. Logan Wray
------------------------------------
R. Logan Wray
Senior Vice President
and Chief Financial Officer
(Principal Financial and Accounting
Officer)
-29-
<PAGE>
EXHIBIT INDEX
-------------
Exhibit
No. Description
- ------- -----------
2.1 Agreement and Plan of Merger, dated as of June 20, 1998, among the
Company, Sterling Software (Southern), Inc. and Synon Corporation
(1), (2)
2.2 Agreement and Plan of Merger, dated as of August 27, 1998, among the
Company, Sterling Software (Southern), Inc. and Cayenne Software,
Inc. (2), (3)
2.3 Asset Purchase Agreement, dated as of March 6, 1999, between the
Company, Spectra Logic Corporation, Sterling Software (U.S.A.), Inc.,
Nathan C. Thompson and Michael J. Sausa (2), (4)
2.4 Agreement and Plan of Merger, dated as of March 23, 1999, among the
Company, Sterling Software (Southwest), Inc. and Interlink Computer
Sciences, Inc. (2), (5)
2.5 Agreement and Plan of Merger, dated as of July 15, 1999, among the
Company, Sterling Software Acquisition Corp. and Information
Advantage, Inc. (2), (6)
3.1 Certificate of Incorporation, as amended, of the Company (4)
3.2 Bylaws, as amended, of the Company (7)
27 Financial Data Schedule (8)
_____________
(1) Previously filed as an exhibit to the Company's Current Report on Form 8-K
dated June 21, 1998 and incorporated herein by reference (SEC File No.
98652676).
(2) In accordance with Item 601 of Regulation S-K, the schedules and exhibits
relating to the agreement have been omitted. The Company will furnish
supplementally to the Securities and Exchange Commission such schedules or
exhibits upon request.
(3) Previously filed as an exhibit to the Current Report on Form 8-K dated
August 27, 1998 filed by Cayenne Software, Inc. and incorporated herein by
reference (File ID #000-19682, SEC File No. 98700698).
(4) Previously filed as an exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1999 and incorporated herein by
reference (SEC File No. 99617213).
(5) Previously filed as an exhibit to the Company's Tender Offer Statement on
Schedule 14D-1 dated March 30, 1999 and incorporated herein by reference
(SEC File No. 99579124).
(6) Previously filed as an exhibit to the Company's Tender Offer Statement on
Schedule 14D-1 dated July 21, 1999 and incorporated herein by reference
(SEC File No. 99667898).
(7) Previously filed as an exhibit to the Company's Registration Statement on
Form 8-A/A filed on May 27, 1998 and incorporated herein by reference (SEC
File No. 98632257).
(8) Filed herewith.
-30-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS INCLUDED IN THE STERLING SOFTWARE, INC.
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER AND NINE MONTHS ENDED JUNE 30,
1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> SEP-30-1999 SEP-30-1999
<PERIOD-START> APR-01-1999 OCT-01-1998
<PERIOD-END> JUN-30-1999 JUN-30-1999
<CASH> 425,895 425,895
<SECURITIES> 221,607 221,607
<RECEIVABLES> 229,763 229,763
<ALLOWANCES> 0 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 908,423 908,423
<PP&E> 76,929 76,929
<DEPRECIATION> 60,112 60,112
<TOTAL-ASSETS> 1,254,964 1,254,964
<CURRENT-LIABILITIES> 258,781 258,781
<BONDS> 0 0
0 0
0 0
<COMMON> 8,637 8,637
<OTHER-SE> 916,947 916,947
<TOTAL-LIABILITY-AND-EQUITY> 1,254,964 1,254,964
<SALES> 209,765 576,610
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<CGS> 73,599 215,252
<TOTAL-COSTS> 157,467 447,448
<OTHER-EXPENSES> 36,566 65,844
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 43 302
<INCOME-PRETAX> 24,024 89,210
<INCOME-TAX> 14,713 40,533
<INCOME-CONTINUING> 9,311 48,677
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