<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 1997
OR
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to ______________.
Commission file number 0-15322
SYSTEM SOFTWARE ASSOCIATES, INC.
--------------------------------
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
Delaware 36-3144515
- --------------------------------------------- ------------------------------------
<S> <C>
(State or other jurisdiction of incorporation (IRS Employer Identification Number)
or organization)
500 W. Madison, 32nd Floor
Chicago, Illinois 60661
- --------------------------------------------- ------------------------------------
(Address of principal executive offices) (Zip Code)
(Registrant's telephone number, including area code) (312) 258-6000
------------------------------------
</TABLE>
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 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 .
--------------- -----------
At September 5, 1997, there were 42,731,937 and zero shares outstanding of
the Company's Common ($.0033 par value) and Preferred ($.01 par value) Stock,
respectively.
TOTAL OF SEQUENTIALLY
NUMBERED PAGES: 19
--
<PAGE>
SYSTEM SOFTWARE ASSOCIATES, INC.
INDEX
<TABLE>
<CAPTION>
Page
No.
<S> <C> <C>
Part I Financial information
Consolidated Balance Sheets-- 3-4
July 31, 1997 and October 31, 1996
Consolidated Statements of Operations-- 5
three and nine months ended July 31, 1997 and 1996
Consolidated Statements of Cash Flows-- 6
nine months ended July 31, 1997 and 1996
Notes to Consolidated Financial Statements 7-11
Management's Discussion and Analysis of Financial Condition and 12-16
Results of Operations
Part II Other information 16-18
Signature Page 19
</TABLE>
2
<PAGE>
Part I - Financial Information
Item I - Financial Statements
SYSTEM SOFTWARE ASSOCIATES, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
(in millions)
<TABLE>
<CAPTION>
July 31, October 31,
1997 1996
----------- ----------
(unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and equivalents $ 32.1 $ 38.1
Accounts receivable, less allowance for doubtful
accounts of $16.5 and $16.5 169.9 163.6
Income taxes receivable 3.8 4.4
Deferred income taxes 11.0 10.1
Prepaid expenses and other current assets 29.3 25.5
------ ------
Total current assets 246.1 241.7
------ ------
PROPERTY and EQUIPMENT:
Data processing equipment 39.7 37.3
Furniture and office equipment 17.0 18.7
Leasehold improvements 9.8 9.0
Transportation equipment 1.5 2.3
------ ------
68.0 67.3
Less - Accumulated depreciation and amortization 43.5 39.5
------ ------
Total property and equipment 24.5 27.8
------ ------
OTHER ASSETS:
Software costs, less accumulated amortization
of $81.6 and $61.1 95.9 82.8
Cost in excess of net assets of acquired businesses,
less accumulated amortization of $11.0 and $8.7 20.6 22.8
Deferred income taxes 1.5 1.2
Investments in associated companies 1.5 2.2
Miscellaneous 4.9 5.9
------ ------
Total other assets 124.4 114.9
------ ------
TOTAL ASSETS $395.0 $384.4
====== ======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
<PAGE>
SYSTEM SOFTWARE ASSOCIATES, INC.
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
(in millions, except share data)
<TABLE>
<CAPTION>
July 31, October 31,
1997 1996
----------- -----------
(unaudited)
<S> <C> <C>
CURRENT LIABILITIES:
Short-term borrowings and current maturities
of senior notes payable $ 71.8 $ --
Accrued commissions and royalties 24.1 26.3
Accounts payable and other accrued liabilities 63.0 62.5
Accrued compensation and related benefits 20.6 23.8
Deferred revenue 55.8 58.8
------ ------
Total current liabilities 235.3 171.4
------ ------
LONG-TERM OBLIGATIONS 13.5 75.1
------ ------
DEFERRED REVENUE 30.4 27.7
------ ------
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 100,000 shares
authorized, none issued or outstanding -- --
Common stock, $.0033 par value, 250,000,000 and
60,000,000 shares authorized, 42,652,000 and
42,577,000 shares issued 0.1 0.1
Capital in excess of par value 42.8 32.8
Retained earnings 76.9 78.5
Cumulative translation adjustment (4.0) (1.2)
------ ------
Total stockholders' equity 115.8 110.2
------ ------
TOTAL LIABILITIES and STOCKHOLDERS' EQUITY $395.0 $384.4
====== ======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
<PAGE>
SYSTEM SOFTWARE ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
July 31, July 31,
------------------ -----------------
1997 1996 1997 1996
------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenues:
License fees $ 83.2 $ 45.2 $213.4 $145.2
Client services and other 31.5 27.1 91.6 86.2
------ ------ ------ ------
Total revenues 114.7 72.3 305.0 231.4
------ ------ ------ ------
Costs and Expenses:
Cost of license fees 19.4 17.9 52.4 43.4
Cost of client services and other 24.7 23.4 71.8 64.9
Sales and marketing 22.3 26.2 66.2 71.3
Research and development 12.1 14.9 39.0 38.3
General and administrative 24.7 24.0 64.8 57.6
Special charge 1.7 -- 1.7 --
------ ------ ------ ------
Total costs and expenses 104.9 106.4 295.9 275.5
------ ------ ------ ------
Operating income (loss) 9.8 (34.1) 9.1 (44.1)
Gain on sale of available-for-sale securities -- 3.6 -- 3.6
Non-operating income (expense), net (4.6) (1.2) (11.6) (2.0)
------ ------ ------ ------
Income (loss) before income taxes 5.2 (31.7) (2.5) (42.5)
Provision (benefit) for income taxes 1.9 (11.4) (0.9) (15.4)
------ ------ ------ ------
Net income (loss) $ 3.3 $(20.3) $ (1.6) $(27.1)
====== ====== ====== ======
Earnings (loss) per share $ 0.08 $(0.47) $(0.04) $(0.63)
====== ====== ====== ======
Dividends per share $ -- $ -- $ -- $ 0.10
====== ====== ====== ======
Weighted average common and equivalent
shares outstanding 43.6 43.0 43.7 43.1
====== ====== ====== ======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
5
<PAGE>
<TABLE>
<CAPTION>
SYSTEM SOFTWARE ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions, unaudited)
Nine Months Ended
July 31,
-----------------
1997 1996
------- -------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income (loss) $ (1.6) $(27.1)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization of property and equipment 6.8 6.5
Amortization of other assets 26.0 16.8
Provision for doubtful accounts 3.3 3.5
Gain on sale of available-for-sale securities -- (3.6)
Deferred income taxes (1.2) (0.3)
Deferred revenue 2.5 3.0
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable (14.1) (4.9)
Prepaid expenses and other current assets 2.7 (4.8)
Miscellaneous assets 1.0 1.5
Accrued commissions and royalties (1.7) (7.0)
Accounts payable and other accrued liabilities 0.3 (0.9)
Accrued compensation and related benefits (3.2) (5.1)
Income taxes 0.6 (23.0)
------ ------
Net cash provided by (used in) operating activities 21.4 (45.4)
------ ------
Cash Flows From Investing Activities:
Purchases of property and equipment (2.9) (8.5)
Software costs (33.7) (31.1)
Investments and acquisitions, net of cash acquired -- (4.5)
Proceeds from sale of available-for-sale securities -- 9.0
------ ------
Net cash used in investing activities (36.6) (35.1)
------ ------
Cash Flows From Financing Activities:
Amount borrowed (repaid) under bank line of credit, net (0.4) 46.4
Principal payments under other financing obligations (1.8) (1.5)
Proceeds from exercise of stock options 0.2 2.0
Net proceeds from convertible subordinated promissory note 12.0 --
Dividends paid -- (4.2)
------ ------
Net cash provided by financing activities 10.0 42.7
------ ------
Effect of exchange rate changes on cash (0.8) (0.1)
------ ------
Net decrease in cash and equivalents (6.0) (37.9)
Cash and equivalents:
Beginning of year 38.1 57.1
------ ------
End of period $ 32.1 $ 19.2
====== ======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 -- Basis of Presentation
The consolidated financial statements include the accounts of System Software
Associates, Inc. and its majority owned subsidiaries ("SSA", or "the Company").
Except for the consolidated balance sheet at October 31, 1996, the financial
information included herein is unaudited. However, such information reflects all
adjustments (consisting solely of normal recurring adjustments) which are, in
the opinion of management, necessary for a fair statement of results for the
interim periods. Results shown for interim periods are not necessarily
indicative of the results to be obtained for a full fiscal year.
These interim financial statements should be read in conjunction with the
audited financial statements and notes thereto included in the Company's Annual
Report on Form 10-K for the fiscal year ended October 31, 1996.
Note 2 -- Long-Term Obligations and Capital Issuances
Private Convertible Subordinated Note
On March 27, 1997, the Company issued a convertible subordinated promissory note
(the "Private Convertible Subordinated Note") to a strategic investor in the
amount of $12 million, bearing interest at the prime rate plus 1% and
convertible into common stock of the Company at the lesser of $3.33 per share or
80% of the fair market value of the stock at the time of conversion. The loan is
due in three years and is not convertible during the first year, except in the
event of prepayment. The convertible subordinated promissory note has a
beneficial conversion feature because the fair market value of the Company's
stock was in excess of its per share conversion price at the issuance date. The
value of the beneficial conversion feature of $8.9 million was reflected as an
increase in additional paid in capital and other current assets is being
amortized as interest expense over a one year period beginning the date of
issuance.
Series A Preferred Stock and Private Warrants
On August 29, 1997, the Company agreed to issue 10,000 shares of Series A
Preferred Stock and 600,000 common stock purchase warrants (the "Private
Warrants") to a private investor ("Private Investor") in a private offering. The
Series A Preferred Stock and Private Warrants will be issued to the Private
Investor in exchange for a promissory note and warrants issued to the Private
Investor for $10.0 million in cash on August 27, 1997.
The $10.0 million received on August 27, 1997 was used to pay down $1.9 million
of the Company's Bank Line of Credit and $1.1 million of its Senior Notes, and
paid fees to these lenders of $1.0 million. The remaining balance of $6.0
million is available for working capital requirements.
7
<PAGE>
Series A Preferred Stock
The 10,000 shares of Series A Preferred Stock have an initial liquidation
preference of $1,000 per share, increasing to $3,500 per share on or after the
earliest of (i) August 22, 2003, (ii) a Change in Control and (iii) certain
bankruptcy events (such event, a "Trigger Event") (such liquidation preference
as from time to time in effect, the "Liquidation Price"). The Series A Preferred
Stock accrue dividends, payable quarterly in arrears, at an annual rate of 12%
of the Liquidation Price per share, which increases to 14% of the Liquidation
Price per share upon a Trigger Event. The dividend rate will increase by 4% per
annum upon the occurrence and during the continuance of any payment default or
certain other material defaults under the Securities Purchase Agreement.
Each share of Series A Preferred Stock is convertible at the holder's option at
any time into 80.4 shares of Common Stock (subject to proportional and broad-
based weighted average anti-dilution).
The Series A Preferred Stock may be redeemed at the option of the holders
thereof at any time (i) on or after August 31, 2003 or (ii) following the
occurrence and continuance of a Redemption Event (as defined below) at a
redemption price equal to the greater of $1,000 per share, plus accrued and
unpaid dividends, or the amount that such holder would have received had such
holder converted the Series A Preferred Stock into Common Stock immediately
prior to the liquidation of the Company. The Series A Preferred Stock may be
redeemed by the Company at any time after the occurrence of a Trigger Event at a
redemption price equal to $3,500 per share, plus accrued and unpaid dividends.
Upon the occurrence of certain events, including, without limitation, payment
defaults, covenant defaults in the Securities Purchase Agreement, cross defaults
to acceleration of other material indebtedness, bankruptcy and a Change in
Control (each, a "Redemption Event"), the holders of the Series A Preferred
Stock may require the Company to redeem their shares of Series A Preferred Stock
at a redemption price equal to the greater of $1,000 per share, plus accrued and
unpaid dividends or the amount that such holder would have received had such
holder converted the Series A Preferred Stock into Common Stock immediately
prior to the liquidation of the Company.
For so long as at least 2,500 shares of Series A Preferred Stock are
outstanding, the Company must comply with various covenants, including, without
limitation, maintenance of fixed charge coverage ratios on a rolling four-
quarter basis and total debt to capital, and restrictions on mergers,
consolidations, sales of assets, liens, payment of dividends and other
distributions to, and redemptions of, other classes of equity and limitations on
the issuance of additional debt (other than the Public Convertible Subordinated
Notes, up to $40.0 million in additional senior indebtedness and certain other
exceptions). The Series A Preferred Stock cannot be transferred by the private
investor until September 1, 1998.
8
<PAGE>
Private Warrants
Pursuant to a Securities Purchase Agreement, the Company will issue to the
private investor the Private Warrants to purchase 600,000 shares of Common
Stock. Each holder of a Private Warrant is entitled to purchase shares of Common
Stock at an exercise price equal to $15.125 per share, the fair market value at
the date of issuance of the initial promissory note and warrants. The Private
Warrants are exercisable at any time until August 22, 2007, but the Private
Warrants and the Common Stock issuable upon the exercise thereof cannot be
transferred by the private investor until September 1, 1998. Following such
anniversary, the Private Warrants and underlying Common Stock are immediately
transferable separately from the Series A Preferred Stock.
Public Convertible Subordinated Notes
On September 12, 1997, the Company issued $138.0 million of convertible
subordinated notes due September 15, 2002 bearing interest at 7% (the "Public
Notes"). Interest will be paid March 15 and September 15 of each year beginning
March 15, 1998.
The Public Notes are convertible at the holders's option at any time into shares
of common stock of the Company at $18.06 per share, subject to adjustments in
certain events which are defined in the offering document. The Public Notes are
redeemable at the option of the Company after September 20, 2000 in whole or in
part at any time (103.5% beginning September 20, 2000 and 101.75% from September
20, 2001 and thereafter) plus accrued and unpaid interest. In the event that a
change in control occurs, each holder of a Public Note may require the Company
to repurchase all or a portion of such holder's Public Notes at a price equal to
100% of the principal amount thereof plus accrued and unpaid interest to the
purchase date.
The Public Notes are subordinated to all existing and future indebtedness of the
Company.
The $138.0 million received on September 12, 1997 was used to pay $4.1 million
of underwriting fees for the Public Notes, repay $44.1 million outstanding under
the Company's Bank Line of Credit, repay $24.7 million outstanding on its Senior
Notes, and fees to the Company's Bank Line of Credit and Note Holders for
prepayment of balances due on November 1, 1997. The Company expects to use the
remaining net proceeds, which is approximately $60.0 million, together with
existing resources, to fund an accelerated growth strategy for the Company's new
version of its client/server software product and other general corporate
purposes.
9
<PAGE>
Issuance of Financial Advisor Warrants
In consideration of certain financial advisory services, the Company has agreed
to sell to a financial advisor for a nominal amount, warrants to purchase from
the Company up to 664,452 shares of Common Stock (the "Financial Advisor
Warrants"). The Financial Advisor Warrants are initially exercisable at $18.06
per share and may be exercised for a period of five years commencing on the
first anniversary of the issuance of such Warrants.
Note 3 -- Legal Proceedings
On August 20, 1997, the Company terminated its engagement of the underwriter of
the Company's initial proposed offering of $90.0 million of convertible
subordinate notes and concurrently elected not to proceed with its private
offering of securities to a group of private investors led by Bain Capital, Inc.
("Bain"). On August 27, 1997, Bain filed a complaint in the Superior Court of
Massachusetts against SSA, Roger E. Covey and Hambrecht & Quist, LLC, one of the
Representatives of the Underwriters in the Company's current offering of $138.0
million of convertible subordinated notes. The complaint seeks damages from SSA
in excess of $117.5 million for alleged breach of contract, breach of implied
covenant of good faith and fair dealing, misrepresentation and unfair and
deceptive business acts and practices.
The Company believes, based upon the advice of counsel, that pursuant to its
terms letter with Bain, the Company should have no liability to Bain beyond
reimbursement of Bain's expenses, limited to $250,000, and payment of a "break-
up" fee in the amount of $3.0 million. Any charge related to such "break-up" fee
and reimbursement of expenses would likely be recorded in the Company's fourth
fiscal quarter. Although the Company denies Bain's allegations and intends to
vigorously defend itself against Bain's lawsuit, there can be no assurance that
this action will not have a material adverse impact on the Company.
In January 1997, class action lawsuits were filed in state court in Illinois and
in the federal court in Chicago, Illinois against the Company and certain of its
officers. The federal actions allege damages to persons who purchased the
Company's common stock during the period August 22, 1994 through January 7, 1997
arising from alleged violations of the federal securities laws and associated
common laws. The state court action alleges damages to persons who purchased the
Company's common stock during the period November 21, 1994 through January 7,
1997 arising from alleged violations of the Illinois securities laws and
associated common and statutory law.
10
<PAGE>
The Company has executed a settlement agreement with the class plaintiffs in the
Illinois state court action titled Steinberg v. SSA, 97 CH 287 (the
"Settlement"). The Company has agreed to pay $1.7 million in cash and the
director and officer defendants collectively have agreed to contribute 100,000
shares of Common Stock. In the quarter ended July 31, 1997, the Company recorded
a $1.7 million charge related to the Settlement. The presiding judge in the
Illinois case granted preliminary approval to the Settlement on June 27, 1997. A
final hearing on the Settlement is scheduled for September 30, 1997. There can
be no assurance that the Settlement will be approved, nor can there be any
assurance that the Settlement, if approved, will legally bar the federal claims
described above. In addition, even if the Settlement bars the federal claims
described above, because the class period of the federal claim is slightly
larger than the class period of the state claim, the Settlement may not result
in the dismissal of the federal action. The failure to achieve a dismissal of
any of these actions or the failure to settle them on sufficiently advantageous
terms could have a material adverse effect on the business, operating results
and financial condition of the Company.
The Company is also subject to other legal proceedings and claims which arise in
the normal course of business. Although the outcome of these proceedings cannot
be determined with certainty, management believes that the final outcomes of
these proceedings should not have a material adverse effect on the Company's
operations or financial position.
Note 4 -- Common Stock
The stockholders voted on May 28, 1997 to amend Article Fourth of the Company's
Certificate of Incorporation to increase the Company's authorized shares of
Common Stock to 250 million shares.
11
<PAGE>
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion should be read in conjunction with the consolidated
financial statements and notes thereto.
Results of Operations
Comparison of the Three Months Ended July 31, 1997
to the Three Months Ended July 31, 1996
---------------------------------------
Total revenues increased 59% to $114.7 million during the third quarter of 1997
over total revenues of $72.3 million during the third quarter of 1996. All
regions of the world recorded higher revenues: the Americas, Europe/Middle
East/Africa and Asia/Pacific. License fees of $83.2 million grew 84% over the
same prior year quarter which reflected increasing market acceptance of Version
6.0, which was released for general availability in the fourth quarter of 1996.
Client services revenues for the quarter of $31.5 million increased 16% compared
to the prior year period. The increase in services revenues is attributable to
an increase in the number of billable services personnel following significant
investments in training in open systems and object skills accompanying the
development and release of Version 6.0.
Cost of license fees as a percentage of related revenues was 23% for the third
quarter of 1997, down from 40% for the corresponding prior year period.
Substantially all costs in this area decreased as a percentage of related
revenues due to the significant increase in revenues. In addition, increased
productivity of the direct sales organization combined with a higher mix of
revenue from this channel produced higher margins.
Client services as a percentage of related revenues was 78% and 86% for the
third quarter of 1997 and 1996, respectively. The decrease is primarily
attributable to increased utilization of client services personnel.
Sales and marketing as a percentage of license fee revenues was 27% and 58% in
the third quarters of 1997 and 1996, respectively. The decrease in the current
quarter was primarily due to increased productivity of the Company's direct
sales organization and decreased marketing expenditures.
12
<PAGE>
Gross (total) research and development (R&D) expenditures in the third quarter
of 1997 decreased $4.9 million or 18% when compared to the third quarter of
1996. R & D spending related to the Company's development of its new product
line based upon distributed object computing technology peaked during the last
half of 1996 and has been declining since, as was reflected in Q3 1997, as
various projects related to such development wind down.
The Company capitalizes software development costs once technological
feasibility is established, in accordance with Statement of Financial Accounting
Standard (SFAS) No. 86. These costs generally include a portion of construction
costs as well as costs incurred during final product testing prior to full
product release. The Company capitalized $9.9 million of software development
costs in the third quarter of 1997 as compared to $12.0 million in the third
quarter of 1996. The capitalization ratio (capitalized software as a percentage
of gross R&D) in the third quarters of 1997 and 1996 was 45%.
The following table sets forth R&D expenditures and related capitalized amounts
for the periods indicated.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------
(in millions) Percentage
Quarter Ended July 31, Change
- -------------------------------------------------------------------------
<S> <C> <C> <C>
1997 vs.
1997 1996 1996
- -------------------------------------------------------------------------
Gross R&D $22.0 $ 26.9 (18%)
expenditures
Less amount (9.9) (12.0) (18%)
capitalized
- -------------------------------------------------------------------------
Net R&D costs $12.1 $ 14.9 (19%)
- -------------------------------------------------------------------------
</TABLE>
General and administrative expenses of $24.7 million increased $0.7 million over
the prior year to support the Company's growth and includes increased costs for
computer equipment.
The special charge of $1.7 million in the current quarter relates to the
proposed settlement of the Company's class action lawsuits. See Note 3 in Notes
To Consolidated Financial Statements.
Operating income in the current quarter of $9.8 million increased $43.9 million
from the operating loss of ($34.1) million in the corresponding quarter of the
previous year due to both increased revenues and reduced expenses.
13
<PAGE>
Non-operating expense of $4.6 million in the current quarter increased $3.4
million over the prior year quarter due to higher borrowing levels under the
Company's multi-bank line of credit, higher interest rates applicable to the
multi-bank line of credit and the Senior Notes, interest and amortization of the
beneficial conversion feature related to the Company's Private Convertible
Subordinated Note issued in March 1997 and reduced interest income related to
lower cash balances.
Comparison of the Nine Months Ended July 31, 1997
to the Nine Months Ended July 31, 1996
--------------------------------------
The principal variations for the nine months ended July 30, 1997, when
supplemented with the following comments, are relatively consistent with the
discussion of the third quarter results.
Total revenues increased 32% to $305.0 million for the first nine months over
total revenues of $231.4 million recorded during the first nine months of 1996.
The revenue increase was attributable to higher license fees which were up 47%
when compared to the prior year, combined with a 6% increase in client services
revenues.
Cost of license fees as a percentage of related revenues decreased to 25% from
30% for the first nine months of 1997 and 1996, respectively. The decrease was
primarily attributable to decreased affiliate commissions because of a higher
mix of direct channel sales.
Cost of client services as a percentage of related revenues was 78% for the
first nine months of 1997 compared to 75% during the corresponding prior year
period. The moderately higher costs in the current year period resulted from the
allocation of technical personnel to perform warranty work and from an increase
in the number of newly hired technical professionals around the world, in
particular those with open systems and object skills.
Gross (total) research and development (R&D) expenditures in the first nine
months of 1997 increased $3.7 million, or 6% to $70.8 million from $67.1 million
in the corresponding prior period. The increase was due to the Company's
continuing development of its distributed object computing technology and
enhancements of its existing product line.
14
<PAGE>
The following table sets forth R&D expenditures and related capitalized amounts
for the first nine months of 1997 and 1996.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------
(in millions) Percentage
Nine Months Ended July 31, Change
- ------------------------------------------------------------------------
1997 vs.
1997 1996 1996
- ------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gross R&D $ 70.8 $ 67.1 6%
expenditures
Less amount (31.8) (28.8) 10%
capitalized
- ------------------------------------------------------------------------
Net R&D costs $ 39.0 $ 38.3 2%
- ------------------------------------------------------------------------
</TABLE>
The operating income in the first nine months of the current year of $9.1
million improved $53.2 million from the operating loss of ($44.1) million in the
corresponding period of the previous year due to increased revenue and decreased
expenses.
Non-operating expense of $11.6 million in the first nine months of 1997
increased $9.6 million from $2.0 million due to higher borrowing levels under
the Company's existing multi-bank line of credit, higher interest rates
applicable to the multi-bank line of credit and senior notes, interest and
amortization of the beneficial conversion feature on the Company's convertible
subordinated promissory note issued in March 1997 and reduced interest income
related to lower cash balances.
Liquidity and Capital Resources - Subsequent Events
Cash and equivalents of $32.1 million at July 31, 1997 decreased $6 million from
October 31,1996 and borrowings increased by $11.4 million on a net basis during
the same period. Cash usage was primarily due to continued investment in product
development, an operating loss during the first three months of 1997 and
interest payments. At July 31, 1997, $46.0 million was outstanding under the
Company's multi-bank line of credit and $25.8 million was outstanding on the
Company's Senior Notes payable. On March 27, 1997, the Company issued a $12.0
million convertible subordinated three year promissory note to a strategic
investor to meet anticipated cash requirements. At October 31, 1996, $46.4
million was outstanding under the Company's multi-bank line of credit and $26.0
was outstanding on the Company's Senior Notes payable. Outstanding letters of
credit issued against the bank line were $.6 million and $1.2 million at July
31, 1997 and October 31, 1996, respectively.
15
<PAGE>
On August 27, 1997, the Company issued $10.0 million of subordinated notes and
warrants to a private investor, for which the Company agreed to exchange for
10,000 shares of Series A Preferred Stock and 600,000 Private Warrants. With the
proceeds of $10.0 million, the Company paid down $1.9 million of the Company's
Bank Line of Credit and $1.1 million of its Senior Notes and paid fees to these
lenders of $1.0 million. The remaining balance of $6.0 million is available for
working capital requirements.
On September 12, 1997, the Company issued $138.0 million of convertible
subordinated notes due September 15, 2002 bearing interest at 7% (the "Public
Notes"). The $138.0 million received on September 12, 1997 was used to pay $4.1
million of underwriting fees for the Public Offering, repay $44.1 million
outstanding under the Company's Bank Line of Credit, repay $24.7 million
outstanding on its Senior Notes, and fees to the Company's Bank Line of Credit
and Note Holders for prepayment of balances due on November 1, 1997. The Company
expects to use the remaining net proceeds, which is approximately $60.0 million,
together with existing resources to fund an accelerated growth strategy for the
Company's new version of its client/server software product and other general
corporate purposes.
Management believes that based upon its anticipated operating results, cash
generated from operations, combined with current working capital and the
proceeds from the Company's $138.0 million offering of Public Notes, will
provide sufficient liquidity to meet the Company's capital requirements for the
foreseeable future.
Part II - Other Information
Item 1. Legal Proceedings
On August 20, 1997, the Company terminated its engagement of the underwriter of
the Company's initial proposed offering of $90.0 million of convertible
subordinate notes and concurrently elected not to proceed with its private
offering of securities to a group of private investors led by Bain Capital, Inc.
("Bain"). On August 27, 1997, Bain filed a complaint in the Superior Court of
Massachusetts against SSA, Roger E. Covey and Hambrecht & Quist, LLC, the
Representative of the Underwriters in the Company's current offering of $138.0
million of convertible subordinated notes. The complaint seeks damages from SSA
in excess of $117.5 million for alleged breach of contract, breach of implied
covenant of good faith and fair dealing, misrepresentation and unfair and
deceptive business acts and practices.
16
<PAGE>
The Company believes, based upon the advice of counsel, that pursuant to its
terms letter with Bain, the Company should have no liability to Bain beyond
reimbursement of Bain's expenses, limited to $250,000, and payment of a "break-
up" fee in the amount of $3.0 million. Any charge related to such "break-up" fee
and reimbursement of expenses would likely be recorded in the Company's fourth
fiscal quarter. Although the Company denies Bain's allegations and intends to
vigorously defend itself against Bain's lawsuit, there can be no assurance that
this action will not have a material adverse impact on the Company.
In January 1997, class action lawsuits were filed in state court in Illinois and
in the federal court in Chicago, Illinois against the Company and certain of its
officers. The federal actions allege damages to persons who purchased the
Company's common stock during the period August 22, 1994 through January 7, 1997
arising from alleged violations of the federal securities laws and associated
common laws. The state court action alleges damages to persons who purchased the
Company's common stock during the period November 21, 1994 through January 7,
1997 arising from alleged violations of the Illinois securities laws and
associated common and statutory law.
The Company has executed a settlement agreement with the class plaintiffs in the
Illinois state court action titled Steinberg v. SSA, 97 CH 287 (the
"Settlement"). The Company has agreed to pay $1.7 million in cash and the
director and officer defendants collectively have agreed to contribute 100,000
shares of Common Stock. In the quarter ended July 31, 1997, the Company recorded
a $1.7 million charge related to the Settlement. The presiding judge in the
Illinois case granted preliminary approval to the Settlement on June 27, 1997. A
final hearing on the Settlement is scheduled for September 30, 1997. There can
be no assurance that the Settlement will be approved, nor can there be any
assurance that the Settlement, if approved, will legally bar the federal claims
described above. In addition, even if the Settlement bars the federal claims
described above, because the class period of the federal claim is slightly
larger than the class period of the state claim, the Settlement may not result
in the dismissal of the federal action. The failure to achieve a dismissal of
any of these actions or the failure to settle them on sufficiently advantageous
terms could have a material adverse effect on the business, operating results
and financial condition of the Company.
The Company is also subject to other legal proceedings and claims which arise in
the normal course of business. Although the outcome of these proceedings cannot
be determined with certainty, management believes that the final outcomes of
these proceedings should not have a material adverse effect on the Company's
operations or financial position.
17
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) None
<TABLE>
<S> <C> <C>
Item 2. Changes in Securities None
Item 3. Defaults Upon Senior Securities None
Item 4. Submission of Matters to a Vote of Security Holders None
Item 5. Other Information None
Item 6. Exhibits and Reports on Form 8K
</TABLE>
(a) None
(b) On July 14, 1997, the Company filed a Report on Form 8-K listing as
an "Other Event" the commencement of a $90 million registered underwritten
offering of subordinated convertible notes due 2002 and the purchase of
approximately $47 million in junior subordinated notes and stock purchase
warrants of the Company by a group of private investors. No financial reports
were filed with this Report.
18
<PAGE>
Signature Page
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.
Date September 15, 1997
------------------
System Software Associates, Inc.
/s/ Roger E. Covey
---------------------------------
Roger E. Covey
Chairman and
Chief Executive Officer
/s/ Joseph J. Skadra
---------------------------------
Joseph J. Skadra
Chief Financial Officer
19
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