<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, 1999
-------------
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)
Delaware 36-3144515
- ------------------------------------- ----------------------------------------
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation 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
---------------------------
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 1, 1999, there were 11,990,617 and 10,000 shares outstanding
of the Company's Common ($.0033 par value) and Redeemable Series A Preferred
($.01 par value) Stock, respectively.
TOTAL OF SEQUENTIALLY
NUMBERED PAGES: 18
----
<PAGE>
SYSTEM SOFTWARE ASSOCIATES, INC.
INDEX
<TABLE>
<CAPTION>
Page
No.
<S> <C> <C>
Part I Financial information
Consolidated Balance Sheets - 3-4
July 31, 1999 and October 31, 1998
Consolidated Statements of Operations - 5
three and nine months ended July 31, 1999 and 1998
Consolidated Statements of Cash Flows - 6
nine months ended July 31, 1999 and 1998
Notes to Consolidated Financial Statements 7 - 11
Management's Discussion and Analysis of Financial Condition 11 - 16
and Results of Operations
Quantitative and Qualitative Disclosures about Market Risk 16
Part II Other information 16 - 17
Signature Page 18
</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,
1999 1998
-------- -----------
<S> <C> <C>
CURRENT ASSETS:
Cash and equivalents $ 18.0 $ 52.4
Accounts receivable, less allowance for doubtful accounts of $13.6 and $16.5 113.2 144.4
Income taxes receivable 4.9 3.9
Deferred income taxes 6.5 31.2
Prepaid expenses and other current assets 26.0 27.6
-------- -----------
Total current assets 168.6 259.5
-------- -----------
PROPERTY and EQUIPMENT:
Data processing equipment 39.1 41.5
Furniture and office equipment 14.5 16.3
Leasehold improvements 7.2 8.4
Transportation equipment 1.8 1.7
-------- -----------
62.6 67.9
Less - Accumulated depreciation and amortization 49.6 48.8
-------- -----------
Total property and equipment 13.0 19.1
-------- -----------
OTHER ASSETS:
Software costs, less accumulated amortization of $53.2 and $42.9 33.0 39.5
Cost in excess of net assets of acquired businesses,
less accumulated amortization of $8.4 and $13.0 8.6 21.1
Deferred income taxes 15.5 16.6
Income taxes receivable 2.0 -
Investments in associated companies - 1.0
Miscellaneous 0.3 4.0
-------- -----------
Total other assets 59.4 82.2
-------- -----------
TOTAL ASSETS $241.0 $360.8
======== ===========
</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,
1999 1998
-------- -----------
<S> <C> <C>
CURRENT LIABILITIES:
Accrued commissions and royalties $ 17.2 $ 20.3
Accounts payable and other accrued liabilities 65.2 77.9
Accrued compensation and related benefits 18.0 23.1
Short-term borrowings 2.8 -
Deferred revenue 27.6 44.3
-------- -----------
Total current liabilities 130.8 165.6
-------- -----------
LONG-TERM OBLIGATIONS:
Convertible subordinated notes 137.5 137.3
Other 5.5 4.6
-------- -----------
Total long-term obligations 143.0 141.9
-------- -----------
DEFERRED REVENUE 22.9 29.9
-------- -----------
REDEEMABLE SERIES A PREFERRED STOCK, $.01 par value, convertible, 10,000
shares issued and outstanding (liquidation preference of $10.0 million) 9.5 9.3
-------- -----------
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 100,000 shares authorized,
10,000 shares issued as Series A Preferred Stock - -
Common stock, $.0033 par value, 250,000,000 shares authorized,
47,935,000 and 47,621,000 shares issued 0.2 0.2
Capital in excess of par value 73.5 72.5
Retained earnings (deficit) (132.5) (52.9)
Accumulated other comprehensive income - cumulative translation adjustment (6.4) (5.7)
-------- -----------
Total stockholders' equity (deficit) (65.2) 14.1
-------- -----------
TOTAL LIABILITIES and STOCKHOLDERS' EQUITY $241.0 $360.8
======== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
<PAGE>
SYSTEM SOFTWARE ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
July 31, July 31,
-------------------- --------------------
1999 1998 1999 1998
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
Revenues:
License fees $ 21.8 $ 50.6 $ 81.7 $ 161.1
Client services and other 51.3 56.3 167.8 147.2
-------- --------- -------- ---------
Total revenues 73.1 106.9 249.5 308.3
-------- --------- -------- ---------
Costs and Expenses:
Cost of license fees 10.8 16.0 36.9 56.1
Cost of client services and other 28.1 39.5 96.6 102.8
Sales and marketing 14.3 20.9 48.1 63.0
Research and development 10.4 17.4 35.9 43.2
General and administrative 16.2 24.3 55.6 65.4
Special charges - - - 1.1
Restructuring and other 22.8 122.5 22.8 122.5
-------- --------- -------- ---------
Total costs and expenses 102.6 240.6 295.9 454.1
-------- --------- -------- ---------
Operating income (loss) (29.5) (133.7) (46.4) (145.8)
Non-operating income (expense), net (2.7) (2.6) (8.1) (7.2)
Gain on sale of investment - - 2.8 -
-------- --------- -------- ---------
Income (loss) before income taxes (32.2) (136.3) (51.7) (153.0)
Provision (benefit) for income taxes 34.0 (21.6) 27.0 (27.6)
-------- --------- -------- ---------
Net income (loss) (66.2) (114.7) (78.7) (125.4)
Preferred dividends 0.3 0.3 1.0 1.0
-------- --------- -------- ---------
Net income (loss) available for common stockholders $ (66.5) $ (115.0) $ (79.7) $ (126.4)
======== ========= ======== =========
Basic and diluted earnings (loss) per share of common stock $ (5.54) $ (9.66) $ (6.70) $ (10.99)
======== ========= ======== =========
Weighted average common shares outstanding 12.0 11.9 11.9 11.5
======== ========= ======== =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
5
<PAGE>
<TABLE>
<CAPTION>
SYSTEM SOFTWARE ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
Nine Months Ended
July 31,
-----------------------------
1999 1998
---------- ----------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income (loss) $ (78.7) $ (125.4)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Net assets written off due to restructuring and other 15.2 76.3
Depreciation and amortization of property and equipment 5.8 6.8
Amortization of other assets 13.2 22.5
Provision for doubtful accounts - 0.8
Gain on sale of investment (2.8) -
Deferred tax valuation allowance 34.0 -
Deferred income taxes (8.2) (27.6)
Deferred revenue (22.5) (7.9)
Changes in operating assets and liabilities, net of acquisition:
Accounts receivable 28.5 27.6
Prepaid expenses and other current assets (1.6) 2.1
Miscellaneous assets 3.0 0.6
Accrued commissions and royalties (2.5) -
Accounts payable and other accrued liabilities (10.9) 36.4
Accrued compensation and related benefits (4.7) 0.9
Income taxes (3.0) (4.8)
----------- -------------
Net cash provided by (used in) operating activities (35.2) 8.3
----------- -------------
Cash Flows From Investing Activities:
Sales (purchases) of property and equipment, net 0.3 (2.0)
Software costs (3.9) (21.4)
Acquisition, net of cash acquired - (2.0)
Proceeds from sale of investment 3.8 -
----------- -------------
Net cash provided by (used in) investing activities 0.2 (25.4)
----------- -------------
Cash Flows From Financing Activities:
Amount borrowed (repaid) under bank line of credit, net 2.8 -
Principal payments under financing obligations (1.6) (2.5)
Proceeds from stock option and stock purchase plans 1.0 2.0
Dividends paid (1.0) (1.0)
----------- -------------
Net cash provided by (used in) financing activities 1.2 (1.5)
----------- -------------
Effect of exchange rate changes on cash (0.6) (2.2)
----------- -------------
Net decrease in cash and equivalents (34.4) (20.8)
Cash and equivalents:
Beginning of year 52.4 83.3
----------- -------------
End of period $ 18.0 $ 62.5
=========== ============
Non-cash investing and financing activities:
Leases capitalized $ 0.3 $ 0.7
Shares issued in business combination $ - $ 5.9
Issuance of common stock purchase warrants $ - $ 3.5
Conversion of private convertible subordinated note $ - $ 12.0
Cash paid during the period for:
Interest $ 5.1 $ 5.3
Income taxes $ 4.2 $ 4.2
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 -- Basis of Presentation
The condensed 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, 1998, the
financial information included herein is unaudited. However, such information
reflects all adjustments (consisting 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 condensed 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, 1998.
Note 2 -- Revenue Recognition Policy
American Institute of Certified Public Accountants Statement of Position 97-2,
"Software Revenue Recognition" (SOP 97-2) was issued in October 1997 and is
effective for transactions entered into in fiscal years beginning after December
15, 1997. SOP 97-2 addresses various aspects of the recognition of revenues on
software transactions and supersedes SOP 91-1, the policy previously followed by
the Company. SOP 97-2 provides guidance on software arrangements consisting of
multiple elements, evidence of fair value, delivery of elements, accounting for
service elements, and software arrangements requiring significant production,
modification, or customization of software. The Company adopted this statement
in fiscal year 1999, beginning November 1, 1998. The adoption of this statement
has not resulted in a material impact on the Company's financial statements.
Note 3 -- Comprehensive Income
As of November 1, 1998, the Company adopted Financial Accounting Standards Board
Statement 130 (FAS 130), "Reporting Comprehensive Income." FAS 130 establishes
new standards for the reporting and display of comprehensive income and its
components. However, it has no impact on the Company's net income/(loss) or
stockholders' equity. FAS 130 requires foreign currency translation adjustments
and changes in fair value for available-for-sale securities, which prior to
adoption were reported separately in stockholders' equity, to be included in
comprehensive income. The components of comprehensive net income (loss), are as
follows:
7
<PAGE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
July 31, July 31,
1999 1998 1999 1998
- ---------------------------------------------------------------------------------------------------------
(in millions)
<S> <C> <C> <C> <C>
Net income (loss) $(66.2) $(114.7) $(78.7) $(125.4)
Change in cumulative
translation adjustment 0.2 (0.4) (0.7) (3.6)
- ---------------------------------------------------------------------------------------------------------
Comprehensive net income (loss) $(66.0) $(115.1) $(79.4) $(129.0)
=========================================================================================================
</TABLE>
Note 4 -- Restructuring and other
In the third quarter ending July 31, 1999, the Company announced a restructuring
and other charge of $22.8 million. This restructuring was part of a series of
actions aimed at completing the Company's transition to a portfolio solutions
provider. The charge includes severance, reduction of office space in the
United States and Canada, assets and equipment rent related to workforce and
office space reductions, and a write-down of goodwill and assets relating to
partnerships no longer essential to the Company's new solutions strategy. The
workforce reduction represents approximately 320 employees or 16% of June 30,
1999 world-wide employees. The realignment and reorganization of the Company
affected all functional areas, field sales, services and support operations,
marketing, research and development and general and administrative.
Restructuring costs incurred in the third quarter ended July 31, 1999 were $17.4
million. The following table summarizes the significant components of the
restructuring reserve at July 31, 1999.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
Restructuring Restructuring Remaining Balance
and Other Costs at July 31,
Charge Incurred 1999
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
(in millions)
Severance $ 1.5 $ 1.4 $ 0.1
Write-down of assets 16.0 15.3 0.7
Office space 3.8 0.2 3.6
Equipment Rent 1.5 0.5 1.0
- -----------------------------------------------------------------------------------------
$22.8 $17.4 $ 5.4
=========================================================================================
</TABLE>
The Company expects to incur a significant amount of the remaining $5.4 million
accrued restructuring costs during the remainder of fiscal 1999 and fiscal 2000.
The only restructuring costs expected to be incurred in fiscal 2000 are office
space. The office space costs will cease when the office space is sublet or
leases are cancelled.
In addition, the Company recognizes certain deferred tax assets based upon
management's assessment that these assets will "more likely than not" be
realized in the future in accordance with SFAS 109, "Accounting for Income
Taxes". This assessment is based primarily on estimates of future operating
results.
8
<PAGE>
During the quarter, the Company increased the valuation allowance related to
deferred tax assets by $34.0 million. The increase in the valuation allowance
reflects a change in judgment about the realizability of the related deferred
tax assets in future years.
The Company announced a restructuring and other charge of $122.5 million in the
third quarter ending July 31, 1998. The charge includes a write-down of
capitalized and locally developed software products, a write-down of goodwill
and equipment, certain warranty commitments, a 25% reduction of office space and
severance benefits for approximately 300 employees. The reduction in workforce
represents approximately 12% of June 30, 1998, world-wide employees.
Restructuring costs incurred in the first nine months of 1999 were $17.6
million. The following table summarizes the significant components of the
restructuring reserve at July 31, 1999.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
Restructuring Remaining
Accrual Adjustments to Restructuring Balance
Balance at October 31, 1998 Costs at July 31,
October 31, 1998 Balance Incurred 1999
- -----------------------------------------------------------------------------------------------------
(in millions)
<S> <C> <C> <C> <C>
Severance and benefits $ 1.8 $(0.7) $ 0.5 $ 0.6
Write-down of assets 0.7 (0.7) - -
Office space 8.4 0.5 2.3 6.6
Warranty 28.0 0.9 14.7 14.2
Other 0.1 - 0.1 -
- -----------------------------------------------------------------------------------------------------
$39.0 $ 0.0 $17.6 $21.4
=====================================================================================================
</TABLE>
The original restructuring balance of $122.5 million was based on estimates made
at the time. Adjustments between categories are made to reflect the Company's
current assessment of the category balances at July 31, 1999. The Company
expects to incur a significant amount of the remaining $21.4 million of accrued
restructuring costs during the remainder of fiscal 1999 and the first half of
fiscal 2000.
Note 5 - Line of Credit
On March 25, 1999, the Company secured a $5 million committed revolving line of
credit and a $10 million uncommitted revolving line of credit. Both agreements
mature on January 31, 2000, and borrowings under the agreements bear interest at
the prime or LIBOR rate. At July 31, 1999, $2.8 million was borrowed and
outstanding under the committed revolving line of credit.
On August 11, 1999 the line of credit was retired with proceeds from the $41.0
million loan and security agreement (see note 6).
9
<PAGE>
Note 6 - Long-Term Obligations
On August 11, 1999 the Company closed a $41.0 million loan and security
agreement with a group of lenders headed by Foothill Capital Corporation, a
Wells Fargo Company. The agreement provides for a (i) maximum revolving loan of
$30.0 million which initially includes a term loan of $15.0 million ("Term Loan
A"), (ii) a term loan of $8.5 million ("Term Loan B") and (iii) a term loan of
$2.5 million ("Term Loan C").
Borrowing availability under the $30.0 million revolving loan, after netting out
Term Loan A, is based primarily on the Company's eligible United States,
Canadian, and United Kingdom accounts receivable balances and may be limited by
certain provisions in the agreement. The rate of interest charged on the
revolving loan is 1% above the Prime Rate of Wells Fargo Bank.
The Company has received proceeds of $26.0 million from Term Loans A, B, and C.
The proceeds were used to retire the Company's line of credit (see Note 5) and
to provide working capital for general corporate purposes.
Outstanding principal under Term Loan A ($15.0 million) is to be repaid monthly
beginning October 1, 1999 until August 31, 2002, the maturity date of the loan.
The rate of interest charged on Term Loan A is 15.0% per annum, a portion of
which may be added to the outstanding principal at the option of the Company.
Outstanding principal under Term Loan B ($8.5 million) and Term Loan C ($2.5
million) is due at maturity, August 31, 2002. Term Loan C is convertible, at
the option of the lender, into common stock of the Company. The rate of
interest charged on Term Loans B and C is 15.0% per annum, a portion of which
may be added to the outstanding principal at the option of the Company.
The loan agreement is secured by a first priority interest in substantially all
of the Company's assets, including, but not limited to accounts receivable,
general intangibles, and fixed assets.
The agreement contains financial covenants including a minimum level of EBITDA
(earnings before interest, taxes, depreciation and amortization) and a minimum
level of recurring services and maintenance revenues.
Note 7 - Redeemable Series A Preferred Stock
As a result of the third quarter 1999 and 1998 restructuring and other charge of
$22.8 million and $122.5 million, respectively, the Company has not complied
with the fixed charge coverage ratio and debt to capital ratio covenants since
October 31, 1998. The Company received a waiver from its preferred stockholder
on November 19, 1998, waiving compliance for October 31, 1998, and January 31,
1999. This waiver has been extended through July 31, 1999. The Company was in
compliance with all other
10
<PAGE>
covenants at July 31, 1999. On August 11, 1999, the preferred stockholder
agreement was amended and restated. The new agreement contains financial
covenants including a minimum level of EBITDA and minimum services and
maintenance revenues.
Note 8 - Stockholders' Equity
On August 17, 1999, the Company's stockholders approved a proposal to amend the
Certificate of Incorporation to effect a 1 for 4 reverse stock split of the
Company's outstanding common stock, effective September 2, 1999. All per share
data has been restated to reflect the split.
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, 1999
to the Three Months Ended July 31, 1998
---------------------------------------
Total revenues recorded in the third quarter of 1999 decreased 31.6% to $73.1
million versus total revenues of $106.9 million recorded during the third
quarter of 1998. License fees were $21.8 million, a 56.9% decline when compared
to the same period of 1998. The decrease in license fee revenues was due to the
continued slowdown in demand for software in the ERP market as clients have
temporarily postponed contract decisions due to a variety of factors, including
final remediation of year 2000 issues. Client services revenues for the quarter
were $51.3 million, a decrease of 8.9% when compared to the same prior year
period. The decrease experienced in services revenues is related to the lower
level of license fee revenues experienced thus far in 1999.
Cost of license fees as a percentage of related revenues was 49.5% for the third
quarter of 1999, up from 31.6% for the corresponding prior year period. The
increase is due to a significant decline in BPCS license fees sold, resulting in
a greater proportion of third quarter 1999 revenues being generated by the sale
of third party products and hardware. In addition, a significant fixed
component of cost of license fee revenues is amortization of capitalized
software which was $3.4 million and $3.2 million in the third quarters of 1999
and 1998 respectively.
Cost of client services and other as a percentage of related revenues was 54.8%
in the third quarter of 1999 as compared to 70.2% in the third quarter of 1998.
The improvement is primarily due to increased productivity of client services
personnel.
11
<PAGE>
Sales and marketing expenses decreased $6.6 million in the third quarter of 1999
to $14.3 million from $20.9 million in the third quarter of 1998. The decrease
in the current quarter was primarily due to a reduction of direct sales
incentives as a result of lower direct license fee revenues as well as the
positive impact of the third quarter 1998 and 1999 restructuring initiatives.
Gross research and development (R&D) expenditures in the third quarter of 1999
decreased $7.7 million or 40% when compared to the third quarter of 1998. The
reduction is due, primarily, to reduced development activities related to BPCS
Client/Server Version 6.0 as well as the positive impact of the third quarter
1998 and 1999 restructuring initiatives.
The Company capitalizes software development costs once technological
feasibility is established, in accordance with Statement of Financial Accounting
Standard (SFAS) No. 86. In connection with the 1998 restructuring of
operations, the Company determined that it was more appropriate to begin
capitalization of software development costs subsequent to a working model being
developed. The Company capitalized $1.1 million of software development costs
in the third quarter of 1999 compared to $1.8 million in the third quarter of
1998. The capitalization ratio (capitalized software as a percentage of gross
R&D) in the third quarters of 1999 and 1998 was 10% and 9%, respectively.
The following table sets forth R&D expenditures and related capitalized amounts
for the periods indicated.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------
Percentage
Three Months Ended Change
July 31, 1999 July 31, 1998 1999 vs. 1998
- --------------------------------------------------------------------------------------------------
(in millions)
<S> <C> <C> <C>
Gross R&D expenditures $11.5 $19.2 (40%)
Less amount capitalized (1.1) (1.8) (39%)
- --------------------------------------------------------------------------------------------------
Net R&D expenses $10.4 $17.4 (40%)
==================================================================================================
</TABLE>
General and administrative expenses were $16.2 million and $24.3 million in the
third quarters of 1999 and 1998, respectively. The $8.1 million decline
resulted from the positive impact of the third quarter 1998 and 1999
restructuring initiatives.
Operating loss in the third quarter of 1999, before the restructuring and other
charges (see Notes to Consolidated Financial Statements - Note 4) was ($6.7)
million, a $4.5 million decrease when compared to the comparably calculated
operating loss of ($11.2) million recorded in the third quarter of 1998. The
major reasons for the reduction were significant improvements in both client
services gross profit and operating expenses partially offset by lower license
fee revenues and gross profit. Operating loss in the third quarter of 1999
after restructuring and other charges of $22.8 million was ($29.5) million.
12
<PAGE>
Non-operating expenses, which primarily represent interest expense, were $2.7
million and $2.6 million in the third quarter of 1999 and 1998, respectively.
During the third quarter of 1999, the Company recorded an additional valuation
allowance of $34.0 million against the Company's deferred tax assets (see Note
to Consolidated Financial Statements - Note 4).
Comparison of the Nine Months Ended July 31, 1999
to the Nine Months Ended July 31, 1998
--------------------------------------
The principle variations for the nine months ended July 31, 1999, when
supplemented with the following comments, are relatively consistent with the
discussion of the third quarter results.
Total revenues decreased 19.1% to $249.5 million for the first nine months of
1999 as compared to total revenues of $308.3 million recorded during the first
nine months of 1998. The revenue decrease was attributable to a decline in
license fees revenues of 49.3% when compared to the prior year, however, offset
by an increase in client services revenues of 14.0%.
Cost of license fees as a percentage of related revenues increased to 45.2% in
1999 as compared to 34.8% for the first nine months of 1998.
Cost of client services and other as a percentage of related revenues was 57.6%
and 69.8% for the first nine months of 1999 and 1998, respectively.
The following table sets forth R&D expenditures and related capitalized amounts
for the first nine months of 1999 and 1998.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------
Percentage
Nine Months Ended Change
July 31, 1999 July 31, 1998 1999 vs. 1998
- --------------------------------------------------------------------------------------------------
(in millions)
<S> <C> <C> <C>
Gross R&D expenditures $39.8 $ 62.7 (37%)
Less amount capitalized (3.9) (19.5) (80%)
- --------------------------------------------------------------------------------------------------
Net R&D expenses $35.9 $ 43.2 (17%)
==================================================================================================
</TABLE>
The special charge of $1.1 million in the first nine months of 1998 related to
the final settlement of the Bain Investors lawsuit.
The gain on sale of investment of $2.8 million in the first nine months of 1999
resulted from the sale of the Company's 25% ownership of CS Controlling Software
Systeme. The cash proceeds were $3.8 million.
13
<PAGE>
Year 2000
BPCS product line - The Company offers comprehensive services, education,
project management and migration strategies to ready clients for the Year 2000.
Century date options include BPCS Client/Server Version 6.0, BPCS Century Dated
("CD"), or BPCS Millennium Toolset. All versions of BPCS Client/Server V6.0 are
Year 2000 compliant, BPCS CD century dates V4.05 and the BPCS Millennium
Toolset will century date client's current version of BPCS Client/Server,
modifications and related applications.
Third parties - Identification of areas of third party risk is complete. Due to
the nature of the business, the risk to continuing operations in this area is
minimal. However, the Company is still taking steps to ensure that critical
suppliers will continue to function after the change of the millennium.
Internal systems - The Company has completed the core business systems upgrades
for its United States Operations. The Company's operations in South America,
Asia Pacific and Canada will be completed and on-line by the end of September.
The European core business systems will be compliant by October 31 of this year.
In addition, the Company is still identifying contingency plans for critical
processes in Europe due to the timing of the systems upgrades. The Company is
also finalizing its upgrades for all non-critical personal computing devices and
software.
At this time, the Company believes that there will be minimal cost associated
with ensuring Year 2000 compliance of its internal systems.
Management believes that it has successfully addressed the Year 2000 issues.
However, there are no assurances that the above assessment of the Company's Year
2000 readiness and estimate of costs will prove to be accurate and actual
results could differ materially from such assessment. The Company's most likely
worst case Year 2000 scenario would require some automated processes to be
temporarily performed manually, requiring additional resources and cost, until
the Year 2000 issue is resolved.
Liquidity and Capital Resources
Cash and equivalents at July 31, 1999 totaled $18.0 million, a decrease of $34.4
million when compared to October 31, 1998 cash and equivalents of $52.4 million.
Cash usage was primarily due to operating losses, payments related to the
Company's third quarter 1998 and 1999 restructuring activities and biannual
interest payment on the Company's convertible subordinated notes.
Operating cash flows. Net cash and equivalents from operating activities
decreased $35.2 million during the first nine months of 1999. The $35.2 million
decrease resulted from a net loss adjusted for non-cash charges and credits of
$44.0 million and a decrease in
14
<PAGE>
accrued commissions and royalties, accounts payable and other accrued
liabilities, and accrued compensation and related benefits totaling $18.1
million offset by a $28.5 million decrease in accounts receivable.
Investing cash flows. Investing activities increased net cash and equivalents
$0.2 million during the first nine months of 1999. The $0.2 million increase
was generated from proceeds from the sale of an investment ($3.8 million) and
sale of property and equipment ($0.3 million) offset by $3.9 million of
software development costs.
Financing cash flows. The Company generated $1.2 million of positive cash flow
from financing activities in the first nine months of 1999. In the third
quarter ending July 31, 1999 the Company borrowed $2.8 million (net) under the
Company's $5.0 million committed revolving line of credit and generated $1.0
million from the stock option and stock purchase plans offset by $1.6 million of
financing obligation payments and $1.0 of dividend payments.
On August 11, 1999 the Company closed a $41.0 million loan and security
agreement with a group of lenders headed by Foothill Capital Corporation, a
Wells Fargo Company. The agreement provides for a (i) maximum revolving loan of
$30.0 million which initially includes a term loan of $15.0 million ("Term Loan
A"), (ii) a term loan of $8.5 million ("Term Loan B") and (iii) a term loan of
$2.5 million ("Term Loan C").
Borrowing availability under the $30.0 million revolving loan, after netting out
Term Loan A, is based primarily on the Company's eligible United States,
Canadian, and United Kingdom accounts receivable balances as described in the
loan agreement and may be limited by certain provisions in the agreement. The
rate of interest charged on the revolving loan is 1% above the Prime Rate of
Wells Fargo Bank.
The Company has received proceeds of $26.0 million from Term Loans A, B, and C.
The proceeds were used to retire the Company's line of credit and to provide
working capital for general corporate purposes.
Outstanding principal under Term Loan A ($15.0 million) is to be repaid monthly
beginning October 1, 1999 until August 31, 2002, the maturity date of the loan.
The rate of interest charged on Term Loan A is 15.0% per annum, a portion of
which may be added to the outstanding principal at the option of the Company.
Outstanding principal under Term Loan B ($8.5 million) and Term Loan C ($2.5
million) is due at maturity, August 31, 2002. Term Loan C is convertible, at
the option of the lender, into common stock of the Company. The rate of
interest charged on Term Loans B and C is 15.0% per annum, a portion of which
may be added to the outstanding principal at the option of the Company.
The loan agreement is secured by a first priority interest in substantially all
of the Company's assets, including, but not limited to accounts receivable,
general intangibles, and fixed assets.
15
<PAGE>
The agreement contains financial covenants including a minimum level of EBITDA
(earnings before interest, taxes, depreciation and amortization) and a minimum
level of recurring services and maintenance revenues.
Item 3 - Quantitative and Qualitative Disclosures about Market Risk
There have been no material changes in the Company's market risk during the nine
month period ended July 31, 1999. For additional information refer to Item 7A
in the Company's Annual Report on Form 10-K for the fiscal year ended October
31, 1998.
Part II - Other Information
Item 1. Legal Proceeding
In January 1997, class actions lawsuits against the Company and certain of its
officers were filed in state court in Illinois and in the federal court in
Chicago, Illinois. The Company executed a settlement agreement with the class
plaintiffs in the Illinois state court action. The presiding judge in the
Illinois case approved the settlement on September 30, 1997. Certain individual
objectors to the Settlement appealed the fairness of the settlement.
On June 18, 1999, the Illinois Appellate Court affirmed the settlement of the
state court class action. Plaintiffs did not seek leave to appeal to the
Illinois Supreme Court. Accordingly, the state court action has concluded. The
Company has filed a motion to dismiss in the Federal action, arguing that the
claims in Federal court have already been settled in state court and are barred
by the doctrine of res judicata. That motion is pending.
Item 2. Changes in Securities
(a) As described in Item 4 below, on August 17, 1999, the stockholders
of the Company voted in favor of a one for four reverse stock split of
the Company's common stock, par value $0.0033 per share (the "Reverse
Stock Split"). On September 1, 1999, the Company filed an amendment to
its Certificate of Incorporation with the Delaware Secretary of State
to effect the Reverse Stock Split, and to decrease the authorized
shares of common stock from 250,000,000 to 62,500,000. Following the
Reverse Stock split, every 4 shares of the Company's common stock
previously outstanding were converted into one new share. All
fractional shares resulting from the Reverse Stock Split were converted
into the right to receive cash equal to the fair market value of such
fractional shares.
16
<PAGE>
(b) N/A
(c) N/A
(d) N/A
Item 3. Defaults Upon Senior Securities None
Item 4. Submission of Matters to a Vote of Security Holders
(a) On August 17, 1999, the Company held a special meeting of the
Company's stockholders.
(b) N/A
(c) The stockholders considered two items at the special meeting. The
stockholders voted in favor of amending the Company's Certificate of
Incorporation to effect the Reverse Stock Split, described above in
Item 2. With regard to the Reverse Stock Split, 31,026,025 shares (or
64.7% of the outstanding shares) were voted in favor of the amendment.
At the special meeting, the stockholders also approved a new employee
stock option plan. Holders of 17,863,185 shares, or 57.3% of the votes
cast, voted in favor of the adoption of the employee stock option plan.
(d) N/A
Item 5. Other Information
On September 2, 1999, the Company was notified by the Nasdaq National Market
that the listing of the Company's Common Stock would be moved from the Nasdaq
National Market to the Nasdaq SmallCap Market, effective with the open of
business on Tuesday, September 7, 1999.
Item 6. Exhibits and Reports on Form 8-K None
17
<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 14, 1999
------------------
System Software Associates, Inc.
/s/ William M. Stuek
------------------------------
William M. Stuek
Chief Executive Officer and
President
/s/ Joseph J. Skadra
--------------------------------
Joseph J. Skadra
Interim Chief Financial Officer
18
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