<PAGE>
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D)
-
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO _______________
____________________________________
COMMISSION FILE NUMBER 0-21484
THE SANTA CRUZ OPERATION, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN THIS CHARTER)
CALIFORNIA 94-2549086
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
425 ENCINAL STREET, SANTA CRUZ, CALIFORNIA 95060
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code (831) 425-7222
Indicate by check mark whether the registrant (1) has filed all reports 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
--
The number of shares outstanding of the registrant's common stock as of June 30,
2000 was 35,947,635.
<PAGE>
THE SANTA CRUZ OPERATION, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
ITEM 1. FINANCIAL STATEMENTS PAGE
----
<S> <C>
A) CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2000 AND 1999 . .. . . . . . . . . . . . . .1
B) CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2000 AND SEPTEMBER 30, 1999 . . . . . . . . . . . . . . . . . . . . . . .2
C) CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED JUNE 30, 2000 AND 1999 . . . . . . . . . . . . . . . . . . . .3
D) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . .4
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK . . . . . . . . . . . . 13
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. . . . . . . . . . . . . . . . . . . . . . . . . 14
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
</TABLE>
<PAGE>
Part I. Financial Information
Item I. Financial Statements
THE SANTA CRUZ OPERATION, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except earnings per share)
----------------------------------------------
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999 2000 1999
(UNAUDITED) (UNAUDITED)
---------------------------------------------------------------------------------------------------------
NET REVENUES
<S> <C> <C> <C> <C>
Licenses $ 23,493 $ 53,218 $104,743 $154,263
Services 3,438 3,842 11,383 11,241
---------------------------------------------------------------------------------------------------------
Total net revenues 26,931 57,060 116,126 165,504
---------------------------------------------------------------------------------------------------------
COST OF REVENUES
Licenses 5,000 7,698 16,659 23,349
Services 4,680 4,976 15,110 14,149
---------------------------------------------------------------------------------------------------------
Total cost of revenues 9,680 12,674 31,769 37,498
---------------------------------------------------------------------------------------------------------
GROSS MARGIN 17,251 44,386 84,357 128,006
---------------------------------------------------------------------------------------------------------
OPERATING EXPENSES:
Research and development 9,532 10,772 31,742 31,630
Sales and marketing 20,969 24,657 69,991 71,982
General and administrative 5,348 4,473 13,856 12,957
Restructuring charges - - 5,887 -
---------------------------------------------------------------------------------------------------------
Total operating expenses 35,849 39,902 121,476 116,569
---------------------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS) (18,598) 4,484 (37,119) 11,437
OTHER INCOME (EXPENSE):
Interest income, net 408 458 1,600 1,532
Other income (expense), net (168) 598 1,577 1,034
---------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (18,358) 5,540 (33,942) 14,003
Income taxes 882 1,005 2,232 2,520
---------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) (19,240) 4,535 (36,174) 11,483
---------------------------------------------------------------------------------------------------------
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX
Unrealized gain (loss) on available-for-sale
equity securities (16,249) - 5,416 -
Foreign currency translation adjustment (226) (26) (304) (879)
---------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME (LOSS) $ (35,715) $ 4,509 $(31,062) $ 10,604
---------------------------------------------------------------------------------------------------------
EARNINGS (LOSS) PER SHARE:
Basic $ (0.54) $ 0.13 $ (1.02) $ 0.33
Diluted $ (0.54) $ 0.13 $ (1.02) $ 0.32
---------------------------------------------------------------------------------------------------------
SHARES USED IN EARNINGS (LOSS) PER SHARE CALCULATION:
Basic 35,860 33,951 35,390 34,351
Diluted 35,860 36,082 35,390 35,521
---------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
1
<PAGE>
THE SANTA CRUZ OPERATION, INC.
<TABLE>
<CAPTION>
JUNE 30, SEPTEMBER 30,
CONSOLIDATED BALANCE SHEETS 2000 1999
(In thousands) (UNAUDITED)
-----------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 12,078 $ 33,683
Short-term investments 19,267 29,161
Receivables, net 19,205 32,309
Available-for-sale equity securities 10,504 -
Deferred tax assets 3 1,202
Other current assets 5,042 6,310
--------------------------------------------------------------- ------------ ---------------
Total current assets 66,099 102,665
--------------------------------------------------------------- ------------ ---------------
Property and equipment, net 10,160 12,234
Purchased software and technology licenses, net 7,195 10,431
Long-term deferred tax assets 6,623 6,623
Other assets 7,349 7,331
--------------------------------------------------------------- ------------ ---------------
TOTAL ASSETS $ 97,426 $ 139,284
--------------------------------------------------------------- ------------ ---------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 5,057 $ 7,482
Royalties payable 4,194 7,217
Income taxes payable 3,638 1,983
Deferred income taxes 2,388 -
Restructuring charge 4,042 -
Accrued expenses and other current liabilities 24,135 32,314
Deferred revenues 8,346 8,856
--------------------------------------------------------------- ------------ ---------------
Total current liabilities 51,800 57,852
--------------------------------------------------------------- ------------ ---------------
Long-term lease obligations 840 2,332
Long-term deferred revenues 1,465 2,571
Other long-term liabilities 4,755 6,191
--------------------------------------------------------------- ------------ ---------------
Total long-term liabilities 7,060 11,094
--------------------------------------------------------------- ------------ ---------------
SHAREHOLDERS' EQUITY
Common stock, no par value, net, authorized 100,000 shares
Issued and outstanding 35,948 and 34,346 shares 105,491 106,201
Accumulated other comprehensive income 5,520 408
Accumulated deficit (72,445) (36,271)
--------------------------------------------------------------- ------------ ---------------
Total shareholders' equity 38,566 70,338
--------------------------------------------------------------- ------------ ---------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 97,426 $ 139,284
--------------------------------------------------------------- ------------ ---------------
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
THE SANTA CRUZ OPERATION, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-----------------------
JUNE 30,
2000 1999
(UNAUDITED)
------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (36,174) $ 11,483
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities -
Depreciation and amortization 8,827 9,434
Exchange (gain) loss (115) (166)
Changes in operating assets and liabilities -
Receivables 12,632 (3,253)
Other current assets 1,231 3,519
Other assets 1,370 1,224
Royalties payable (3,030) 1,397
Trade accounts payable (2,336) (113)
Income taxes payable 1,780 1,187
Restructuring charge 4,042 -
Accrued expenses and other current liabilities (6,783) 2,932
Deferred revenues (1,526) (3,968)
----------------------------------------------------------------------------------------
Net cash provided by (used for) operating activities (20,082) 23,676
----------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (2,601) (4,773)
Purchases of software and technology licenses (617) (2,266)
Sales of short-term investments 20,570 20,576
Purchases of short-term investments (10,676) (22,029)
Investments in other assets (3,554) (138)
----------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities 3,122 (8,630)
----------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital leases (2,274) (2,678)
Net proceeds from sale of common stock 11,978 1,690
Repurchases of common stock (12,786) (10,806)
Other long-term liabilities (1,339) (1,184)
----------------------------------------------------------------------------------------
Net cash used for financing activities (4,421) (12,978)
----------------------------------------------------------------------------------------
Effects of exchange rate changes on cash and cash equivalents (224) (716)
----------------------------------------------------------------------------------------
Change in cash and cash equivalents (21,605) 1,352
Cash and cash equivalents at beginning of period 33,683 23,758
----------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 12,078 $ 25,110
----------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Non-cash financing and investing activities-
Unrealized gain on available-for-sale equity securities $ 9,002 $ -
Assets recorded under capital leases 20 21
----------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
THE SANTA CRUZ OPERATION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited, consolidated
statements of operations, balance sheets and statements of cash flows have been
prepared in accordance with generally accepted accounting principles and include
all material adjustments (consisting of only normal recurring adjustments)
necessary for their fair presentation. The financial statements include the
accounts of the Company and its wholly owned subsidiaries after all material
intercompany balances and transactions have been eliminated. The Notes to
Consolidated Financial Statements contained in the fiscal year 1999 report on
Form10-K should be read in conjunction with these Consolidated Financial
Statements. The consolidated interim results presented are not necessarily
indicative of results to be expected for a full year. Certain reclassifications
have been made for consistent presentation. The September 30, 1999 balance
sheet was derived from audited financial statements, and is included for
comparative purposes.
2. RESTRUCTURING CHARGE
During the second quarter of fiscal 2000, the Company announced and completed a
restructuring plan, which resulted in a one-time charge of $5.9 million. The
charge included a reduction in headcount of approximately 70 employees,
write-offs of certain acquired technologies, write-offs of certain fixed assets,
and elimination of non-essential facilities. Of the $5.9 million charge, $4.6
million related to cash expenditures and $1.3 million related to non-cash
charges. The Company has restructured its business operations into three
independent divisions, each with a separate management team and dedicated
development, marketing and sales organizations - the Server Software Division,
the Tarantella Division and the Professional Services Division. The Company
believes this reorganization creates independent focused teams that can pursue
revenue in their respective markets and was effective April 1, 2000. The
Company believes that as a result of creating these independent, focused
organizations the Company will be better able to control and measure the success
of these businesses. The restructuring charge related to cash expenditures
included $3.6 million for severance costs and $1.0 million for facilities costs.
The majority of the reduction in force was in product development for the Server
Software Division. As of June 30, 2000, a total of 56 positions have been
eliminated. The Company anticipates that the majority of the payments will be
made by the end of fiscal 2000.
The restructuring charge payable can be summarized as follows:
<TABLE>
<CAPTION>
Reduction
(In thousands) in Force Facilities Technology Other Total
------------------------------- ----------- ------------ ----------- ------- --------
<S> <C> <C> <C> <C> <C>
Restructuring charge accrued $ 3,574 $ 1,052 $ 667 $ 594 $ 5,887
Quarterly payments/adjustments (1,740) (36) - (69) (1,845)
----------- ------------ ----------- ------- --------
Accrual at June 30, 2000 $ 1,834 $ 1,016 $ 667 $ 525 $ 4,042
=========== ============ =========== ======= ========
</TABLE>
1. SEGMENT INFORMATION
For the quarter ended June 30, 2000, the Company reviewed the performance of its
three divisions - the Server Software Division, the Tarantella Division, and the
Professional Services Division. Each segment markets the Company's software
products and services to companies in a number of industries including
telecommunications, manufacturing and government bodies. These products and
services are either sold directly by each segment's sales force or are sold to
end users through distributors or OEMs.
4
<PAGE>
The following table presents information about reportable segments
(in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30, June 30,
2000 1999 2000 1999
-------- -------- -------- -------
(unaudited)
Net Revenues:
<S> <C> <C> <C> <C>
Server software division $24,757 $54,346 $107,129 $155,908
Tarantella division 2,528 2,223 8,519 7,795
Professional services division 842 912 3,018 2,222
Corporate adjustments (1,196) (421) (2,540) (421)
-------- -------- -------- -------
Total net revenues $26,931 $57,060 $116,126 $165,50
======= ======== ======== =======
Gross Margin:
Server software division $16,715 $43,215 $80,598 $123,792
Tarantella division 1,854 1,734 6,412 5,982
Professional services division (591) (563) (1,926) (1,768)
Corporate adjustments (727) --- (727) ---
-------- -------- -------- -------
Total gross margin $17,251 $44,386 $84,357 $128,006
======= ======== ======== =======
Operating Income (Loss):
Server software division $(8,510) $7,626 $(15,909) $19,116
Tarantella division (8,538) (2,271) (11,895) (5,011)
Professional services division (1,550) (871) (3,428) (2,668)
Corporate adjustments --- --- (5,887) ---
-------- -------- -------- -------
Total operating income (loss) $(18,598) $4,484 $(37,119) $11,437
======= ======== ======== =======
</TABLE>
4. COMPREHENSIVE INCOME
The components of other comprehensive income are as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30, June 30,
2000 1999 2000 1999
--------- --------- --------- ---------
(unaudited)
<S> <C> <C> <C> <C>
Net income (loss) $(19,240) $4,535 $(36,174) $11,483
Other comprehensive income (loss):
Foreign currency translation adjustment (226) (26) (304) (879)
Unrealized gain (loss) on equity security (20,122) -- 9,002 --
Gross tax benefit (provision) on 9,212 -- (2,388) --
unrealized loss/gain
Reversal (provision) of deferred
tax valuation allowance (5,339) -- (1,198) --
--------- ------- --------- ------
Total comprehensive income (loss) $(35,715) $4,509 $(31,062) $10,604
========= ======= ========= =======
</TABLE>
5. EARNINGS (LOSS) PER SHARE (EPS) DISCLOSURES
The Company calculates earnings (loss) per share in accordance with the
provisions of Statement of Financial Accounting Standards No. 128 (SFAS 128),
Earnings Per Share. SFAS 128 requires the presentation of basic and diluted
earnings per share. Basic EPS is computed by dividing income available to
common shareholders by the weighted average number of common shares outstanding
for the period. Diluted EPS is computed giving effect to all dilutive potential
common shares that were outstanding during the period. Dilutive potential
common shares consist of the incremental common shares issuable upon the
exercise of stock options for all periods. Basic and diluted earnings per share
were calculated as follows during the three month and nine month periods ended
June 30, 2000 and 1999:
5
<PAGE>
<TABLE>
<CAPTION>
(In thousands, except per share data) Three Months Ended Nine months Ended
June 30, June 30,
2000 1999 2000 1999
-------- -------- --------- --------
(unaudited)
<S> <C> <C> <C> <C>
Basic:
Weighted average shares 35,860 33,951 35,390 34,351
======== ====== ====== ======
Net income (loss) $(19,240) $ 4,534 $(36,174) $11,483
========= ======= ========= =======
Earnings (loss) per share $ (0.54) $0.13 $(1.02) $0.33
========= ======= ========= =======
Diluted:
Weighted average shares 35,860 33,951 35,390 34,351
Common equivalent shares from
stock options and warrants 0 2,131 0 1,170
------- ------- ------- -------
Shares used in per share calculation 35,860 36,082 35,390 35,521
========= ======= ========= =======
Net income (loss) $(19,240) $ 4,534 $(36,174) $11,483
========= ======= ========= =======
Earnings (loss) per share $ (0.54) $0.13 $(1.02) $0.33
========= ======= ========= =======
Options outstanding at 6/30/00 and at 6/30/99
not included in computation of diluted
EPS because the exercise price was greater
than the average market price. 3,103 1,608 1,644 2,381
Options outstanding at 6/30/00 and at 6/30/99
not included in computation of diluted
EPS because their inclusion would have
an anti-dilutive effect. 7,537 ---- 8,996 ----
</TABLE>
6. SUBSEQUENT EVENT
On August 1, 2000, the Company entered into an agreement with Caldera Systems,
Inc. in which Caldera Systems, Inc. will acquire the Company's Server Software
and Professional Services Divisions. Caldera Systems, Inc. will form a new
holding company, Caldera, Inc., to acquire assets from the Company's Server
Software Division and the Company's Professional Services Division, including
its employees, products and channel resources. Caldera, Inc. will have
exclusive distribution rights for the SCO OpenServer product line. SCO will
receive a 28% ownership interest in Caldera, Inc., which is estimated to be an
aggregate of approximately 17.54 million shares of Caldera stock (including
approximately 2 million shares reserved for employee options assumed by Caldera,
Inc. for options currently held by SCO employees joining Caldera, Inc.), and
$7.0 million in cash. In conjunction with the acquisition, The Canopy Group,
Inc., a major stockholder of Caldera Systems, Inc., has agreed to loan $18.0
million to the Company. The terms of this loan are still to be negotiated but
both parties have agreed the terms will be reasonable and customary. Further,
Caldera Systems, Inc. has agreed to loan $7.0 million to the Company in the form
of a short-term note repayable at the consummation of the transaction between
SCO and Caldera Systems, Inc. SCO will retain its Tarantella Division and the
SCO OpenServer revenue stream and intellectual properties. The boards of
directors of both companies have unanimously approved the acquisition which is
subject to the approval of Caldera Systems, Inc. and The Santa Cruz Operation,
Inc. stockholders, and regulatory agencies, as well as meeting certain other
closing conditions. The companies anticipate closing the transaction during
October 2000.
7. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2000, the Financial Accounting Standards Board issued Financial
Accounting Standard No. 138 (FAS 138), Accounting for Certain Derivative
Instruments - an amendment of FAS 133, Accounting for Derivative instruments and
Hedging Activities. FAS 138 shall be effective for all fiscal quarters of all
fiscal years beginning after June 15, 2000. The Company does not expect this to
have a material impact on our financial position and results of operations.
In March 2000, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation - an interpretation of APB Opinion No. 25. FIN 44 clarifies the
application of Opinion 25 for (a) the definition of employee for purposes of
applying Opinion 25, (b) the criteria for determining whether a plan qualifies
as a noncompensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
6
<PAGE>
combination. FIN 44 is effective July 1, 2000, but certain conclusions cover
specific events that occur after either December 15, 1998, or January 12, 2000.
The adoption of the conclusions covering the specific events after either
December 15, 1998 or January 12, 2000 did not have a material effect on the
financial position or results of operations of the Company. Management believes
that the impact of the remaining provisions of FIN 44 will not have a material
effect on the financial position or results of operations of the Company.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in Financial
Statements, which provides guidance on the recognition, presentation and
disclosure of revenue in financials filed with the SEC. SAB 101 outlines the
basic criteria that must be met to recognize revenue and provides guidance for
disclosures related to revenue recognition policies. The Company must adopt SAB
101 in the first quarter of fiscal 2001. Management believes that the impact of
SAB 101 will not have a material effect on the financial position or results of
operations of the Company. However, the interpretation of SAB 101 is still
under discussion by the Securities and Exchange Commission and may be revised.
Such revisions could have a material effect on the financial position or results
of operations of the Company.
In December 1998, the Accounting Standards Executive Committee issued Statement
of Position 98-9 (SOP 98-9), Modification of SOP 97-2 Software Revenue
Recognition. SOP 98-9 amends SOP 97-2 to require that an entity recognize
revenue for multiple element arrangements by means of the "residual method" when
(1) there is vendor-specific objective evidence ("VSOE") of the fair values of
all 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. The provisions of SOP 98-9 that extend the deferral of
certain paragraphs of SOP 97-2 became effective December 15, 1998. These
paragraphs of SOP 97-2 and SOP 98-9 were effective for transactions entered into
for fiscal years beginning after March 15, 1999. Retroactive application is
prohibited. The adoption of SOP 98-9 did not have a significant impact on the
Company's financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative
Instruments and Hedging Activities, which establishes accounting and reporting
standards for derivative instruments and hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. In
June 1999, the FASB issued Statement of Financial Accounting Standards No. 137
(No. 137), Accounting for Derivative Instruments - Deferral of the Effective
Date of SFAS Statement No. 133. SFAS 137 defers the effective date of SFAS 133
until June 15, 2000. Management does not believe this will have a material
effect on the Company's financial statements. The Company will adopt SFAS 133 as
required for its first quarterly filing of fiscal year 2001.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In addition to historical information contained herein, this Discussion and
Analysis contains forward-looking statements. These statements involve risks
and uncertainties and can be identified by the use of forward-looking
terminology such as "estimates," "projects," "anticipates," "plans," "future,"
"may," "will," "should," "predicts," "potential," "continue," "expects,"
"intends," "believes," and similar expressions. Examples of forward-looking
statements include those relating to financial risk management activities and
the adequacy of financial resources for operations. These and other
forward-looking statements are only estimates and predictions. While the
Company believes that the expectations reflected in the forward-looking
statements are reasonable, the Company's actual results could differ materially.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which reflect management's expectations only as of the date hereof.
The Company undertakes no obligation to publicly release the results of any
revision to these forward-looking statements, which may be made to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
RESULTS OF OPERATIONS
NET REVENUES
The Company's net revenues are derived from two primary sources, software
licenses and fees for services which include engineering services, consulting,
custom engineering, support and training.
Net revenues for the three months ended June 30, 2000 decreased 53% to $26.9
million from $57.0 million in the same period in fiscal 1999. For the nine
months ended June 30, 2000, net revenues decreased 30% to $116.1 million from
$165.5 million for the nine months ended June 30, 1999. The decline in revenue
performance was worldwide across most geographies and is attributable to delays
in large project deals as well as continued customer delays due to Year 2000
issues and other market factors. The recovery of the customer channel from the
impact of Year 2000 has been slower than expected. No one customer accounted
for more than 10% of net revenues in the third quarter ended June 30, 2000 or in
the same period in the prior year.
License revenue for the three months ended June 30, 2000 was $23.5 million
compared to $53.2 million in the same quarter of fiscal 1999. For the nine
months ended June 30, 2000, license revenue was $104.7 million compared to
$154.3 million for the same period in 1999. This decline is attributed to the
lack of channel recovery from the impact of Y2K as well as delays in large
project deals.
Service revenues decreased to $3.4 million for the three months ended June 30,
2000, from $3.8 million in the same period in 1999, a decline of 11%. For the
nine months ended June 30, 2000, service revenue totaled $11.4 million compared
to $11.2 million in the same period of fiscal 1999, a 1% increase. Service
revenue was 13% of the total revenue for the third quarter, compared to 7% in
the prior fiscal year.
International revenues continue to represent a significant portion of total net
revenues comprising 54% of the revenues for the third fiscal quarter of 2000 and
56% for the same quarter in fiscal 1999.
COSTS AND EXPENSES
Cost of revenues as a percentage of net revenues increased to 36% in the third
quarter of fiscal 2000 from 22% in the same period of 1999. For the nine month
periods ended June 30, 2000 and 1999, cost of revenues represented 27% and 23%
of net revenues, respectively. A significant portion of cost of goods sold is
fixed and the decrease in revenue seriously impacted gross margin. These fixed
costs include technology and overhead costs. Additionally, there was an
increase in the royalty expense due to a higher-royalty bearing product mix.
Research and development expenses decreased 12% to $9.5 million in the third
quarter of fiscal 2000 from $10.8 million in the comparable quarter of fiscal
1999, or 35% and 19% of net revenues, respectively. The decrease in spending
was primarily due to lower labor costs driven by lower headcount as a result of
a planned reduction in force. For the nine months ended June 30, 2000, research
and development expenses increased to $31.7 million compared to $31.6 million
for the same period in 1999. This represented 27% of net revenues in fiscal
2000 and 19% in fiscal 1999. The increase in spending for the nine month period
relates primarily to one-time technology charges.
8
<PAGE>
Sales and marketing expenses decreased 15% to $21.0 million in the third quarter
of fiscal 2000 from $24.7 million for the comparable quarter of the prior year.
Sales and marketing expenses represented 78% of net revenues in the third
quarter of fiscal 2000 and 43% in 1999. For the nine months ended June 30,
2000, sales and marketing expenses decreased to $70.0 million (60% of net
revenues) from $72.0 million (43% of net revenues) for the same period of the
prior fiscal year. The decline is due to reductions in sales program costs
that vary directly with revenue, including commissions and cooperative
advertising.
General and administrative expenses increased to $5.3 million for the third
quarter of fiscal 2000 from $4.5 million for the comparable quarter of fiscal
1999, representing 20% and 8% of net revenues, respectively. For the nine
months ended June 30, 2000, general and administrative expenses increased to
$13.9 million, or 12% of net revenues, compared to $13.0 million, or 8% of net
revenues, for the same period in 1999. The increase in general and
administrative expenses is primarily driven by the transfer of certain staff
from other functions due to the creation of the Company's divisions.
Non-recurring charges of $5.9 million were incurred in the second quarter of
fiscal 2000 related to a worldwide restructuring, representing 5% of net
revenues for the nine month period ending June 30, 2000. The charge included a
reduction in headcount of approximately 70 employees, write-offs of certain
acquired technologies, write-offs of certain fixed assets, and elimination of
non-essential facilities. Of the $5.9 million, $4.6 million related to cash
expenditures and $1.3 million related to non-cash charges. The Company has
restructured its business operations into three independent divisions, each with
a separate management team and dedicated development, marketing and sales
organizations - the Server Software Division, the Tarantella Division and the
Professional Services Division. The Company believes this reorganization
creates independent focused teams that can pursue revenue in their respective
markets and was effective April 1, 2000. The Company believes that as a result
of creating these independent, focused organizations the Company will be better
able to control and measure the success of these businesses. The restructuring
charge related to cash expenditures included $3.6 million for severance costs
and $1.0 million for facilities costs. The majority of the reduction in force
was in product development for the Server Software Division. As of June 30,
2000, a total of 56 positions have been eliminated. The Company anticipates
that the majority of the payments will be made by the end of fiscal 2000.
Other income consists of net interest income, foreign exchange gain and loss,
and realized gain and loss on investments, as well as other miscellaneous income
and expense items. For the third quarter of fiscal 2000, net interest income
was $0.4 million, compared to $0.5 million for the same quarter of fiscal 1999.
For the nine months ended June 30, 2000, net interest income was $1.6 million as
compared to $1.5 million for the same period in 1999. Other expense was $0.2
million in the third quarter of fiscal 2000, compared to income of $0.6 million
for the same period of fiscal 1999. For the nine months ended June 30, 2000,
other income was $1.6 million as compared to $1.0 million for the same period in
1999. The year to date growth in other income was due to the gain on the sale
of an equity security investment.
The provision for income taxes was $0.9 million for the third quarter of fiscal
2000 compared to $1.0 million for the same period of the prior fiscal year, and
$2.2 million for the nine months ended June 30, 2000, compared to $2.5 million
for the corresponding fiscal 1999 period. The tax provisions for the third
quarter and nine month periods of the current fiscal year reflect foreign taxes
payable. The tax provisions for the third quarter and nine month periods of
fiscal 1999 reflects foreign taxes payable and the realization of certain U.S.
deferred tax assets for which a valuation allowance was previously established.
Net loss for the third quarter of fiscal 2000 was $19.2 million compared to net
income of $4.5 million for the same quarter in fiscal 1999. For the nine
months ended June 30, 2000, net loss was $36.2 million compared to net income of
$11.5 million in the same period in 1999.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company's future operating results may be affected by various uncertain
trends and factors which are beyond the Company's control. These include
adverse changes in general economic conditions and rapid or unexpected changes
in the technologies affecting the Company's products. The process of developing
new high technology products is complex and uncertain and requires accurate
anticipation of customer needs and technological trends. The industry has
become increasingly competitive and, accordingly, the Company's results may also
be adversely affected by the actions of existing or future competitors,
including the development of new technologies, the introduction of new products,
and the reduction of prices by such competitors to gain or retain market share.
The Company's results of operations could be adversely affected if it were
required to lower its prices significantly.
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The Company participates in a highly dynamic industry and future results could
be subject to significant volatility, particularly on a quarterly basis. The
Company's revenues and operating results may be unpredictable due to the
Company's shipment patterns. The Company operates with little backlog of orders
because its products are generally shipped as orders are received. In general,
a substantial portion of the Company's revenues have been booked and shipped in
the third month of the quarter, with a concentration of these revenues in the
latter half of that third month. In addition, the timing of closing of large
license contracts and the release of new products and product upgrades increase
the risk of quarter to quarter fluctuations and the uncertainty of quarterly
operating results. The Company's staffing and operating expense levels are
based on an operating plan and are relatively fixed throughout the quarter. As
a result, if revenues are not realized in the quarter as expected, the Company's
expected operating results and cash balances could be adversely affected, and
such effect could be substantial and could result in an operating loss and
depletion of the Company's cash balances. In such event, it may not be possible
for the Company to secure sources of cash to maintain operations.
The Company experiences seasonality of revenues for both the European market and
the U.S. federal government market. European revenues during the quarter ending
June 30 are historically lower or relatively flat compared to the prior quarter.
This reflects a reduction of customer purchases in anticipation of reduced
selling activity during the summer months. Sales to the U.S. federal government
generally increase during the quarter ending September 30. This seasonal
increase is primarily attributable to increased purchasing activity by the U.S.
federal government prior to the close of its fiscal year. Additionally, net
revenues for the first quarter of the fiscal year are typically lower or
relatively flat compared to net revenues of the prior quarter.
The overall cost of revenues may be affected by changes in the mix of net
revenue contribution between licenses and services, product families,
geographical regions and channels of distribution, as the costs associated with
these revenues may have substantially different characteristics. The Company
may also experience a change in margin as net revenues increase or decrease
since technology costs, service costs and production costs are fixed within
certain volume ranges.
The Company's results of operations could be adversely affected if it were to
lower its prices significantly. In the event the Company reduced its prices,
the Company's standard terms for selected distributors provide credit for
inventory ordered in the previous 180 days, such credits to be applied against
future purchases. The Company, as a matter of policy, does not allow product
returns for refund. Product returns are generally allowed for stock balancing
and are accompanied by compensating and offsetting orders. Revenues are net of a
provision for estimated future stock balancing and excess quantities above
levels the Company believes are appropriate in its distribution channels. The
Company monitors the quantity and mix of its product sales.
The Company depends on information received from external sources in evaluating
the inventory levels at distribution partners in the determination of reserves
for the return of materials not sold, stock rotation and price protection.
Significant effort has gone into developing systems and procedures for
determining the appropriate reserve level.
Substantial portions of the Company's revenues are derived from sales to
customers outside the United States. Trade sales to international customers
represented 54% and 56% of total revenues for the third quarter of fiscal 2000
and 1999, respectively. A substantial portion of the international revenues of
the Company's U.K. subsidiary are denominated in the U.S. dollar, and operating
results can vary with changes in the U.S. dollar exchange rate to the U.K. pound
sterling. The Company's revenues can also be affected by general economic
conditions in the United States, Europe and other international markets. The
Company's operating strategy and pricing take into account changes in exchange
rates over time. However, the Company's results of operations may be
significantly affected in the short term by fluctuations in foreign currency
exchange rates.
The Company's policy is to amortize purchased software and technology licenses
using the straight-line method over the remaining estimated economic life of the
product, or on the ratio of current revenues to total projected product
revenues, whichever is greater. Due to competitive pressures, it is reasonably
possible that those estimates of anticipated future gross revenues, the
remaining estimated economic life of the product, or both, will be reduced
significantly in the near future. As a result, the book value of the Company's
purchased software and technology licenses may be reduced materially in the near
future and, therefore, could create an adverse impact on the Company's future
reported earnings.
On August 1, 2000, the Company entered into an agreement with Caldera Systems,
Inc. ("Caldera") in which Caldera will acquire the Company's Server Software
Division and its Professional Services Division. This transaction involves a
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number of risks, including but not limited to i) the potential disruption of the
Company's business that might result from employee or customer uncertainty, and
lack of focus following announcement of the transaction in connection with
integrating the operations of Caldera and the Company; ii) the risk that the
announcement of the transaction could result in decisions by customers to defer
purchases of products; iii) the substantial charges to be incurred due to the
transaction; iv) the difficulties of managing geographically dispersed
operations; and v) the possibility that the transactions contemplated in the
agreement with Caldera might not be consummated.
Further, once the aforesaid transaction is consummated, the ongoing operations
will be significantly altered. The Company's revenues will be derived from only
two product lines - Tarantella products, which have only been recently
introduced by the Company, and OpenServer products, which are mature products to
be distributed on the Company's behalf by Caldera. While the Company believes
that its staffing plan following the consummation of the transaction is
reasonable, it is possible that the Company may find itself to be overstaffed
or, on the other hand, unable to retain sufficient staff to sustain efficient
operations. Following the close of the transaction, the company will hold in
its treasury a significant investment in Caldera, the value of which may be
subject to significant fluctuations.
The Company continually evaluates potential acquisition candidates. Such
candidates are selected based on products or markets which are complementary to
those of the Company's. Acquisitions involve a number of special risks,
including the successful combination of the companies in an efficient and timely
manner, the coordination of research and development and sales efforts, the
retention of key personnel, the integration of the acquired products, the
diversion of management's attention to assimilation of the operations and
personnel of the acquired companies, and the difficulty of presenting a unified
corporate image. The Company's operations and financial results could be
significantly affected by such an acquisition.
The Company is exposed to equity price risk regarding the marketable portion of
equity securities in its portfolio of investments entered into for the promotion
of business and strategic objectives. This risk will increase significantly
after the consummation of the transaction with Caldera. The Company is exposed
to fluctuations in the market values of our portfolio investments. The Company
maintains investment portfolio holdings of various issuers, types and
maturities. These securities are generally classified as available for sale and
consequently, are recorded on the balance sheet at fair value with unrealized
gains or losses reported as a separate component of accumulated other
comprehensive income, net of tax. Part of this portfolio includes minority
equity investments in several publicly traded companies, the values of which are
subject to market price volatility. The Company has also invested in several
privately held companies, many of which can still be considered in the startup
or development stages. These investments are inherently risky as the market for
the technologies or products they have under development are typically in the
early stages and may never materialize. The Company could lose its entire
initial investment in these companies. The Company typically does not attempt
to reduce or eliminate its market exposure pertaining to these equity
securities.
As the Company determines whether its tax carryforwards will more likely than
not be utilized in the future, or as new tax legislation is enacted, the
Company's effective tax rate is subject to change. In the event that the Company
does not show sufficient profitability in the future, the Company may be
required to write off portions of the net deferred tax assets previously
recognized in income up to the entire amount of $7.8 million.
The Company's continued success depends to a significant extent on senior
management and other key employees. None of these individuals is subject to a
long-term employment contract or a non-competition agreement. Competition for
qualified people in the software industry is intense. The loss of one or more
key employees or the Company's inability to attract and retain other key
employees could have a material adverse effect on the Company.
The stock market in general, and the market for shares of technology companies
in particular, have experienced extreme price fluctuations, which have often
been unrelated to the operating performance of the affected companies. In
addition, factors such as new product introductions by the Company or its
competitors may have a significant impact on the market price of the Company's
Common Stock. Furthermore, quarter-to-quarter fluctuations in the Company's
results of operations caused by changes in customer demand may have a
significant impact on the market price of the Company's stock. These
conditions, as well as factors which generally affect the market for stocks of
high technology companies, could cause the price of the Company's stock to
fluctuate substantially over short periods.
The Company is aware of the issues associated with the new European economic and
monetary union (the "EMU"). One of the changes resulting from this union
required EMU member states to irrevocably fix their respective currencies to a
new currency, the Euro, on January 1, 1999. On that day, the Euro became a
functional legal currency within these countries. During the next two years,
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business in the EMU member states will be conducted in both the 25 existing
national currencies, such as the Franc or Deutsche Mark, and the Euro. As a
result, companies operating in or conducting business in EMU member states will
need to ensure that their financial and other software systems are capable of
processing transactions and properly handling these currencies, including the
Euro. The Company has done a preliminary assessment of the impact the EMU
formation will have on both its internal systems and the products it sells and
has commenced appropriate actions. The Company has not yet determined all of
the cost related to addressing this issue, and there can be no assurance that
this issue and its related costs will not have a materially adverse affect on
the Company's business, operating results and financial condition.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and short-term investments were $31.3 million at June 30,
2000, representing 32% of total assets. The six month decrease in cash and
short-term investments of $31.5 million was primarily attributable to the
decrease in revenue and a decrease in sales linearity, resulting in lower cash
collections. The Company's operating activities used cash of $20.1 million for
the first nine months of fiscal 2000, compared to $23.7 million provided by
operating activities for fiscal 1999. Cash provided by investing activities
during the nine month period was $3.1 million in fiscal 2000 compared to $8.6
million used for investing activities in fiscal 1999. In both fiscal 2000 and
1999 cash was used for purchases of property and equipment, common stock
repurchases and short-term investments. The sales of short-term investments
contributed to the cash provided by investing activities for fiscal 2000. Cash
used for financing activities was $4.4 million for the first nine months of
fiscal 2000 compared with $13.0 million for the same period in fiscal 1999. In
both fiscal 2000 and 1999, proceeds from the issuance of common stock were more
than offset by the Company's stock repurchases and payments on capital lease
obligations.
The Company's financial position may be improved by one or any combination of
the following: an increase in revenues, a decrease in expenses or by raising
additional working capital from external sources. The Company believes that the
sale of the Server and Professional Services Divisions to Caldera will
substantially reduce expenses, but not in the short-term as the Company will be
required to maintain staffing until the consummation of the transaction.
At June 30, 2000, the Company had available lines of credit of approximately
$15.9 million. The Company maintains a $0.9 million line of credit
internationally under which the Company had $0.8 million in outstanding
borrowings. The domestic line of credit of $15.0 million required that the
Company maintain certain financial ratios with which the Company was not in
compliance as of June 30, 2000, and received a waiver for the specific
violation. The Company does not have any outstanding borrowings against this
line of credit. The Company believes that its existing cash and short-term
investments, funds generated from operations and available borrowing
capabilities will be sufficient to meet its operating requirements through at
least the end of the fiscal year. Further, the Company is engaged in
transactions with Caldera and the Canopy Group, Inc. regarding loans of up to
$25.0 million, as well as potential equity financing provided by other parties.
The Company's third quarter ended June 30, 2000 Days Sales Outstanding (DSO) was
64.2 days, a decrease of 0.8 days from the second quarter of fiscal 2000, and an
increase of 14.2 days when compared to September 30, 1999 DSO.
The Company is engaged in a systematic repurchase of the Company's Common Stock
for the funding of its employee stock programs. Additionally, the Company is
authorized to buy back up to 6,000,000 additional shares under a non-systematic
repurchase program. As of June 30, 2000, 3,104,050 shares had been repurchased
and retired under this non-systematic program.
As of June 30, 2000, the Company had an equity investment in Rainmaker Systems,
Inc. having a fair market value of $8.7 million and a cost basis of $1.3
million. The fair market value of this investment could fluctuate substantially
due to changing stock prices. This investment is available-for-sale, and the
Company may choose to sell a portion of this investment position in the future.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2000, the Financial Accounting Standards Board issued Financial Account
Standard No. 138 (FAS 138), Accounting for Certain Derivative Instruments - an
amendment of FAS 133, Accounting for Derivative Instruments and Hedging
Activities. FAS 138 shall be effective for all fiscal quarters of all fiscal
years beginning after June 15, 2000. The Company does not expect this to have a
material impact on our financial position and results of operations.
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In March 2000, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation - an interpretation of APB Opinion No. 25. FIN 44 clarifies the
application of Opinion 25 for (a) the definition of employee for purposes of
applying Opinion 25, (b) the criteria for determining whether a plan qualifies
as noncompensatory plan, (c) the accounting consequence of various modifications
to the terms of a previously fixed stock option or award, and (d) the accounting
for an exchange of stock compensation awards in a business combination. FIN 44
is effective July 1, 2000, but certain conclusions cover specific events that
occur after either December 15, 1998 or January 12, 2000. The adoption of the
conclusions covering the specific events after either December 15, 1998 or
January 12, 2000 did not have a material effect on the financial position or
results of operations of the Company. Management believes that the impact of
the remaining provisions of FIN 44 will not have a material effect on the
financial position or results of operations of the Company.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in Financial
Statements, which provides guidance on the recognition, presentation and
disclosure of revenue in financials filed with the SEC. SAB 101 outlines the
basic criteria that must be met to recognize revenue and provides guidance for
disclosures related to revenue recognition policies. The Company must adopt SAB
101 in the first quarter of fiscal 2001. Management believes that the impact of
SAB 101 will not have a material effect on the financial position or results of
operations of the Company. However, the interpretation of SAB 101 is still
under discussion by the Securities and Exchange Commissions and may be revised.
Such revisions could have a material effect on the financial position or results
of operations of the Company.
In December 1998, the Accounting Standards Executive Committee issued Statement
of Position 98-9 (SOP 98-9), Modification of SOP 97-2 Software Revenue
Recognition. SOP 98-9 amends SOP 97-2 to require that an entity recognize
revenue for multiple element arrangements by means of the "residual method" when
(1) there is vendor-specific objective evidence ("VSOE") of the fair values of
all 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. The provisions of SOP 98-9 that extend the deferral of
certain paragraphs of SOP 97-2 became effective December 15, 1998. These
paragraphs of SOP 97-2 and SOP 98-9 were effective for transactions entered into
for fiscal years beginning after March 15, 1999. Retroactive application is
prohibited. The adoption of SOP 98-9 did not have a significant impact on the
Company's financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative
Instruments and Hedging Activities, which establishes accounting and reporting
standards for derivative instruments and hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. In
June 1999, the FASB issued Statement of Financial Accounting Standards No. 137
(No. 137), Accounting for Derivative Instruments - Deferral of the Effective
Date of SFAS Statement No. 133. SFAS 137 defers the effective date of SFAS 133
until June 15, 2000. Management does not believe this will have a material
effect on the Company's financial statements. The Company will adopt SFAS 133 as
required for its first quarterly filing of fiscal year 2001.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by this item is provided under the paragraph
beginning with the sentence "The Company is exposed to equity price risk
regarding the marketable portion of equity securities in its portfolio of
investments entered into for the promotion of business and strategic
objectives," under the caption "Factors That May Affect Future Results" under
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
(a) Exhibits
27 Financial Data Schedule.
(b) Report on Form 8-K
On August 11, 2000, the Company filed a Current Report on Form 8-K to report
that the Company and Caldera Systems, Inc. (Caldera) entered into an Agreement
and Plan of Reorganization dated August 1, 2000, in which Caldera will acquire
the Company's Server Software and Professional Services Divisions.
ITEMS 1, 2, 4 AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
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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.
The Santa Cruz Operation, Inc.
Date: August 14, 2000 By: /s/Randall Bresee
------------------------------------
Randall Bresee
Senior Vice President,
and Chief Financial Officer
By: /s/ Jenny Twaddle
------------------------------------
Jenny Twaddle
Vice President, Corporate Controller
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EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibits
<S> <C>
27 Financial Data Schedule.
</TABLE>
