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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 6-K
REPORT OF FOREIGN ISSUER
PURSUANT TO RULE 13A-16 OR 15D-15 OF
THE SECURITIES EXCHANGE ACT OF 1934
For the month of May 16, 1998
Micro Focus Group Public Limited Company
(Translation of Registrant's Name Into English)
The Lawn, Old Bath Road, Newbury, England RG14 1QN
(Address of Principal Executive Offices)
(Indicate by check mark whether the registrant files or will file annual
reports under cover of Form 20-F or Form 40-F.)
Form 20-F X Form 40-F
--- ---
(Indicate by check mark whether the registrant by furnishing the
information contained in this form is also thereby furnishing the information to
the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of
1934.)
Yes X No
--- ---
(If "Yes" is marked, indicate below the file number assigned to the
registrant in connection with Rule 12g3-2 (b): 82-795.)
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MICRO FOCUS ANNUAL REPORT 1998
Transforming the Enterprise
MICRO FOCUS
[LOGO]
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"LIFE-CYCLE SOLUTIONS FOR ENTERPRISE COMPUTING"
CONTENTS
SELECTED FINANCIAL HIGHLIGHTS 1
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LETTER TO SHAREHOLDERS 2
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BUSINESS PROBLEMS, MICRO FOCUS SOLUTIONS 4
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FURTHER INFORMATION FOR SHAREHOLDERS 13
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FINANCIAL STATEMENTS - US FORMAT 15
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FINANCIAL STATEMENTS - UK FORMAT 37
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COMPANY INFORMATION INSIDE BACK COVER
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For the benefit of UK and US based shareholders and customers of Micro Focus,
the financial statements are presented in both UK and US formats in separate
sections of the report. The other sections are common to both sets of financial
statements.
The accounting policies adopted by Micro Focus are within the framework of UK
accounting standards and are also in line with US generally accepted accounting
principals as they apply to US software companies.
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FINANCIAL HIGHLIGHTS
[GRAPH]
Annualized Revenue Per Employee
(in thousands)
Q4 1997................192
Q1 1998................169
Q2 1998................191
Q3 1998................201
Q4 1998................235
[GRAPH]
Revenue - Trended Four Quarters Rolling
(in millions)
Q4 1996................118
Q1 1997................116
Q2 1997................119
Q3 1997................122
Q4 1997................123.3
Q1 1998................130
Q2 1998................138.4
Q3 1998................152.8
Q4 1998................167.3
[GRAPH]
Business Mix
Enterprise...................34%
Distributed Computing........33%
Year 2000....................20%
Other........................13%
[GRAPH]
Composition of Revenue
Product......................62%
Maintenance..................29%
Consulting....................9%
[GRAPH]
Sales by Region of the World
North America................58%
Europe.......................32%
Rest of World................10%
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TO OUR SHAREHOLDERS
Fiscal 1998 was a year of outstanding growth and performance for Micro Focus. It
was the best year in the Company's history. Our excellent financial results were
built upon unprecedented market acceptance for the Micro Focus solutions that
are helping our large and diversified customer base maintain and extend their
enterprise computing applications. We concluded fiscal 1998 with strong cash
reserves, sound business fundamentals and a diversified portfolio of new and
existing products; all of which position us well to serve the healthy and
growing market for high-end enterprise application development software.
Financial Performance
Micro Focus achieved strong revenue growth and record sales across all products
and territories in fiscal 1998. Of particular note was the strong performance of
our core products as well as our Year 2000 business. We also were pleased by the
substantial growth in our international markets, especially given the adverse
impact of exchange rate fluctuations during the year.
For the fiscal year ended January 31, 1998, Micro Focus' net revenue grew to a
record $167.3 million (GBP 97.0 million), up 36 percent from $123.2 million
in fiscal 1998. Net income was $14.6 million in fiscal 1998 versus a loss of
$14.7 million in fiscal 1997. Diluted earnings per share were $0.89 in the
current fiscal year compared to last year's loss of $0.94 per share (last year's
results included $0.37 per share million of non-recurring after-tax charges).
Building a Strong Organization
Micro Focus made several notable management changes over the past year that
brought new skills and industry experience into the Company. Martin Waters was
appointed President and Chief Executive Officer in July, following the departure
of Marcelo Gumucio. During his tenure, Mr. Gumucio restructured the Company's
business operations and returned the Company to profitability. We sincerely
thank him for his contributions to Micro Focus.
Also new to the executive management team are three experienced information
technology (IT) industry professionals. Richard Van Hoesen was named senior vice
president and chief financial officer (CFO). Buff Jones joined the Company as
senior vice president of business development, and Chris Sanders came aboard as
senior vice president of product operations. Together with the other members of
the executive staff, this management team is capable and eager to expand the
Company's presence in the IT market and to take Micro Focus to the next level of
success and profitability.
Transforming the Enterprise
With so much media focus on emerging software technologies such as Windows NT
and Java, it's easy to forget that there are over 700 billion lines of
mainframe-based COBOL code running the world's businesses today. From airline
reservation systems to insurance company claims processing systems, to the tax
authorities, the world remains dependent on the extensive business applications
running on, firmly-established computing systems.
The Micro Focus charter is to help companies leverage and exploit these
substantial IT assets to meet today's business challenges. By assisting our
customers in maximizing their investment in existing mainframe applications, we
provide a cost-efficient and highly effective path to increased productivity and
competitiveness.
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Micro Focus is firmly committed to providing "best-in-class" enterprise
application development solutions to help our customers realize the competitive
advantages of globally distributed computing.
An ever increasing number of customers are accepting our state-of-the-art
programming solutions that allow developers to manage and extend their
enterprise applications for client/server computing, Year 2000 assessment and
implementation, legacy maintenance and development and consulting services.
Looking Ahead
The fundamental driver for IT in the next decade is time-to-solution. The
competitive business environment is changing rapidly and users expect IT to
enable this pace. They need IT to operate in "web time" instead of "mainframe
time". Micro focus is committed to supplying tools and solutions which will
enable our customers to meet those expectations.
Our customers have billions of dollars and thousands of development years
invested in their legacy software. They are investing additional billions of
dollars to fix the Year 2000 problem in order to make these systems capable of
functioning in the next century. Micro Focus enables our customers to leverage
that investment by giving them the tools and solutions for analysis,
remediation, maintenance, extension, development and reuse of those systems both
in their traditional environment and, most importantly, in a distributed,
enterprise-wide environment.
By extending the mainframe environment out to the desktop through new products
in our Mainframe Maintenance Solution, Micro Focus will continue to improve the
productivity of programmers and developers.
Through innovation in our analysis tools, problems like common European currency
transition will be more easily resolved. And with the widespread acceptance of
our web development environment, access to legacy data through the World Wide
Web is available now.
We enter the new year with sincere appreciation for the dedication and
excellence of our employees, as well as the support and confidence of our
shareholders and customers. We look forward to reporting to you on our continued
progress in fiscal 1999, and beyond.
Sincerely,
/s/ Martin Waters
Martin Waters
President and Chief Executive Officer [Picture of Martin Waters]
/s/ J. Michael Gullard
J. Michael Gullard
Chairman of the Board [Picture of J. Michael Gullard]
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This Letter to Shareholders contains certain "forward-looking statements" that
are based on the beliefs of the Company's management, as well as assumptions
made by, and information currently available to, the Company's management. The
Company's actual results, performance or achievements in fiscal 1999 and beyond
could differ materially from those expressed in, or implied by, any such
forward-looking statements. Factors that could cause or contribute to such
material differences include, but are not limited to, those discussed below in
Management Discussion and Analysis under the heading "Factors that may influence
future operating results" as well as those discussed elsewhere in this Annual
Report. The Company undertakes no obligation to release publicly any updates or
revisions to any such forward-looking statements that may reflect events or
circumstances occurring after the date of this Annual Report. For more
information regarding "forward-looking statements," see "Further Information for
Shareholders-Special Note on Forward-Looking Statements."
DISTRIBUTED COMPUTING
Micro Focus Delivers Results - And Fast!
[Picture of Clyde Todd]
The Army & Air Force Exchange Service (AAFES) operates 10,878 facilities
worldwide, employs 55,600 people, and works with over 15,000 different vendors.
Aside from processing over five million invoices accounting for multiple
billions of dollars last year, AAFES decided to expand its mainframe accounts
payable system to handle alphanumeric-not just numeric-invoices. AAFES needed a
reliable, cost-effective solution that would not disrupt their operations, and
they found what they were looking for with Micro Focus.
With Micro Focus' NetExpress(a), AAFES turned its mainframe-based invoice
inquiry system into an Internet-capable operation in less than thirty days.
"Micro Focus was our first choice," states Clyde Todd, Section Chief of AAFES'
Fast Action Support Team (FAST), System Development Division. "We knew
NetExpress would work without problems and, based on the performance of Micro
Focus' other products, we knew it would be reliable."
AAFES' FAST team used NetExpress to quickly develop a Web browser interface that
allowed its vendors throughout the world to access invoice information within
minutes - numeric or not. "NetExpress is right on the money," continues Todd.
"This product appears to have truly been designed by developers who understand
their users' needs and requirements. In short, NetExpress is a pure pleasure to
use."
Clyde Todd
Army & Air Force Exchange Service
The Path To Distributed Computing
The world has become populated with a conglomeration of millions upon millions
of computers of all shapes and sizes. Incredibly complex networks connect
corporate mainframe systems to powerful workstations and personal computers for
the home or office. It's a heterogeneous and technologically complex world out
there, and the job of the IT professional is to deploy all manner of new
enterprise applications in this intricate computing environment.
The demand for distributed computing applications has never been higher as
organizations recognize the value of making more types of business information
available - regardless of the platform used to access it. Users want information
in the ways that are most convenient for them, whether they're accessing a
corporate intranet from a UNIX workstation or dialing into the home office from
a laptop PC running Windows.
From obtaining customized insurance quotes to checking the latest stock prices
to tracking the status of an international shipment, technology has opened the
door to increasingly complex variations on the distributed processing theme. The
faster companies are able to expand their operations to serve global markets,
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re-engineer their fundamental business systems and look for new ways to
strategically leverage their IT assets, the more pressure IT departments feel to
deliver new value to internal and external customers.
With time short and expectations high, traditional COBOL-based IT departments
are reluctant to re-tool their operations to deliver such capabilities. With
Micro Focus, they don't have to.
Micro Focus offers a software development environment that's completely
independent of its deployment platform. This means that COBOL programmers can
seamlessly transfer their skills and begin developing applications for other
platforms without having to learn new programming languages. Our NetExpress
integrated development environment is enabling Micro Focus customers to
dramatically reduce the cost and the time it takes to deploy new applications
for the Internet, corporate intranets and 32-bit Windows platforms. Applications
developed using NetExpress can even be deployed to high-performance UNIX
environments at the push of a button.
NetExpress enables Micro Focus customers to leverage their most important
corporate assets: people, code and data. We make it possible for our customers
to extend programs and data that already exist on their corporate mainframes to
multi-platform, distributed environments. We use the term "write once, run
anywhere" to describe a simple premise: by reusing and distributing existing
business logic, our customers are able to minimize risk and save thousands of
development hours, along with the dollars those hours cost.
Micro Focus is also helping companies extend their enterprise assets to multiple
platforms through our consulting services organization. Our consultants analyze
current development and production environments, develop transition strategies,
and recommend platforms that help Micro Focus customers achieve their business
goals with improved efficiency.
As organizations manage the multi-dimensional challenges of doing business in
today's global economy, Micro Focus is managing to smooth the path into the
increasingly complex world of distributed computing.
"Micro Focus is managing to smooth the path into the increasingly complex world
of distributed computing."
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TRANSFORMATION SOLUTIONS
Meeting The Year 2000 - Two Years Early
[Pitcure of Richard F. Fox]
St. Paul Federal Bank (SPFB) is facing the Year 2000 challenge with more
pressure than most. SPFB is a federal organization, and the U.S. government has
mandated that they achieve Y2K compliance by December 31, 1998. If SPFB misses
this deadline, substantial fines could be imposed. Is SPFB worried? To the
contrary, they are quite confident.
SPFB's IT department is right on schedule thanks to Micro Focus'
Revolve/2000(TM) and Workbench/2000(TM) solutions. "We've been using Micro Focus
products for about four years," comments Richard F. Fox, St. Paul Federal Bank.
"We couldn't be more impressed with the performance of these tools. Quite
frankly, from what I understand is out there on the market today, I can't
imagine using anything else."
Micro Focus' products have enabled SPFB's IT team to cut project time in half
while significantly reducing costs. "We've saved on consultant fees and employee
hours," continues Fox. "Plus, by completing the analysis so quickly, we were
able to identify obsolete code we didn't even know existed, which saves us
additional operational time and mainframe resources."
The federally mandated December 31st deadline may be approaching quickly for
SPFB, but thanks to a little help from Micro Focus, they're in fine shape.
Richard F. Fox
St.Paul Federal Bank
The Year 2000 and Beyond
The global IT industry is facing an enormous challenge, and the clock is
ticking. The challenge involves transforming current systems consisting of
millions of lines of computer code without introducing new risk to the
applications - before December 31, 1999!
Whether it's making systems ready for the Year 2000 or modifying them to
accommodate the new European currency (the Euro), the challenge is the same and
the range of possible solutions is limited. How organizations respond to the
transformation challenge will profoundly impact their business for years to
come.
Taken as a whole, the IT industry considerably underestimated the enormous size
and potential impact of these system-wide problems. In fact, some predictions
state that only 50% of the industry will be ready with adequate solutions by the
time the millennium arrives. Companies that thought they would simply replace
their aging mainframe-based systems with hot new technologies are running out of
time to exercise that option. Other companies that banked on converting existing
systems may have miscalculated the magnitude, difficulty, and cost of conversion
to the point of impending crisis. Still others are only now discovering that the
solutions they have already embraced are either taking too much time, or simply
are not accurate in solving the issues at hand.
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In the meantime, the Euro issue and Year 2000 conversion efforts are
exacerbating the strain on already limited IT resources. As the clock continues
ticking, the first phase for implementing the European Monetary Union currency
will begin on the first day of 1999. Unlike other development projects, these
impending deliverables have deadlines that cannot be re-negotiated.
Organizations throughout the world are therefore seeking products and support
from companies that will enable them to maximize the precious time remaining.
Micro Focus has a deep understanding of these issues, and we're helping an
increasing number of companies resolve them. Last year, Micro Focus introduced
SoftFactory/2000(TM) - a combination of technology and services that enable
organizations to reduce the time and business risk associated with bringing
their mission-critical applications to Year 2000 compliance. In addition, Micro
Focus is engaged in the development work necessary to leverage and extend this
technology to other transformation efforts, including the conversion of
applications to support the Euro.
The SoftFactory approach minimizes human intervention, saving money and staff
resources while increasing accuracy and dependability. This innovative
technology calls for changes only where failures will occur if no action is
taken. SoftFactory/2000 is intuitive enough to recognize a date field even if
it's labeled as something else. While most tools will find only 80 percent of
the dates that require changing, the sophisticated analysis engine in this
advanced Micro Focus product will find over 95 percent.
Because organizations have so much invested in their transformation projects,
Micro Focus is committed to ensuring that our transformation tools and
technologies can be used beyond the scope of these specific, one-time problems.
After these projects are complete, organizations will know the exact whereabouts
of its applications, making it an ideal time to perform upgrades and routine
maintenance. The Micro Focus family of products is well suited to the task.
"Micro Focus has a deep understanding of complex transformation issues, and
we're helping an increasing number of companies resolve them."
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MAINFRAME SOLUTIONS
When Productivity Counts . . . It's Micro Focus
[Picture of Richard Rogers]
American National Insurance Company is a leading provider of a broad line of
insurance services to individuals around the world. As one of the top 100
insurance companies in the United States, American National is committed to
providing quality services to its policy holders by integrating state-of-the-art
technologies with its business processes.
Legacy applications typically reside on the mainframe, but with
workstation-based technology from Micro Focus, applications can be fully
developed and maintained outside the mainframe environment. Micro Focus has
helped hundreds of world-class companies, including American National, to not
only reduce the overall system load on their mainframe, but to increase
programmer productivity as well.
"With Micro Focus, we achieved an increase in programmer productivity," said
Richard Rogers, senior staff analyst at American National. "The resulting time
savings is crucial to our programmers as it gives them the flexibility to focus
on other development and maintenance projects."
Workstation-based solutions from Micro Focus dramatically increase efficiency,
and conserve valuable IT resources in the process. "Micro Focus technology
reduces strain on our mainframe," concludes American National's Mr. Rogers "and
ultimately prolongs the life of this mission-critical system."
Richard Rogers
American National Insurance Company
Leveraging IT Resources
Electronic commerce. Corporate intranets. 24-hour remote access. Real-time
interactivity. As computing resources become capable of doing more, more is
continually asked and expected of IT organizations.
The reality is that most IT departments divert such a large portion of their
time and resources to addressing insatiable maintenance backlogs that they are
strained to adequately respond to new demands. Maintaining the vitality of
existing business applications is always a core objective, yet today's CIO wants
and needs innovative solutions to save money in this area in order to satisfy
the demand for new and improved computer-based services elsewhere in the
organization. The fact is, every dollar spent out of the IT budget to address a
maintenance backlog is a dollar that cannot be invested in creating new value.
Micro Focus Enterprise Solutions are directly focused on addressing IT
maintenance backlogs through the cheaper processing power and wide availability
of desktop workstations. By providing a complete IBM mainframe environment on
the workstation, Micro Focus allows entire project teams to achieve up to 90% of
their maintenance goals in a graphically-oriented PC or workstation environment,
away from the mainframe system.
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This dramatically improves the productivity of maintenance programmers,
conserves mainframe compute cycles for higher-value activities and saves our
customers big dollars in overall maintenance costs.
Our new Mainframe Express(TM) product, for example, is enabling programmers to
download legacy applications onto a work- station or a PC that seamlessly
emulates the original mainframe environment. This advanced technology offers
programmers the ability to make changes to an application, exhaustively test the
changes and then preview how the altered application will perform before it is
ported back to the mainframe. Prior to this Micro Focus innovation, programmers
had to wait in line to gain access to their applications and then bargain for
the time and computing power they needed to accomplish their work. Furthermore,
before Mainframe Express was introduced, the only way to test a revised
application was to let it run on the mainframe and hope that it didn't crash.
Micro Focus maintenance solutions are being embraced by "Global 5000" IT
departments at the most successful companies around the world. Mainframe
maintenance programmers are discovering that our comprehensive,
workstation-based application analysis tools are far more efficient than
comparable tools on the mainframe, reducing a routine that might take 25 steps
on a mainframe down to 5 steps on a workstation. Yet the learning curve for
these tools is relatively easy. Even new programmers and contractors can become
productive with Micro Focus tools within a short time.
What are our customers doing with the substantial savings, increased efficiency
and enhanced IT competitiveness we're making possible? One thing is certain:
with less staff time and fewer dollars needed to resolve maintenance backlogs,
they're able to better leverage and exploit ongoing advances in computer
technology for their customers.
"The Micro Focus maintenance solution is being embraced by IT departments at the
most successful companies around the world."
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CORPORATE IT
The Experts Agree . . . Leverage Your Assets
[Picture of Judith Hurwitz]
It is a time of massive changes in IT organizations that will continue over the
next five years and beyond. In the past, the IT investment was a necessary
expense focused on accounting and data acquisition. As we move into the decade
of the virtual corporation that is driven by an Internet-driven business model,
all this is changing. One only has to look at emerging companies such as
Amazon.com to recognize that competitors are evolving based on an entirely
different business model. In brief, this business model is predicated on leading
with a strong technology infrastructure and sophisticated application. The
applications driving this brave new virtual business model are not standalone.
Organizations that will succeed are the ones that leverage existing application
logic and data. This existing investment is leveraged to understand the complex
relationships between different lines of business and customer buying patterns.
In addition, organizations will begin to form more and more alliances with
partners. These partnerships to sell goods and services will manifest themselves
within an electronic business context. Therefore, the systems that bring
together data and logic from several partners will be designed to live on the
Internet. It will be an exciting period for the IT industry.
There is the clear opportunity to leverage existing and new IT investments to
revolutionize and transform business. In order for this goal to be realized, IT
management needs to work closely on the business planning side as well as the
technology planning side. IT management must pay attention to how to translate
the rapid changes in business policy and business processes into actionable
systems that can forecast a dramatic return on investment.
Judith Hurwitz
The Hurwitz Group
The Transformation Has Just Begun
The #1 challenge faced by IT departments around the world remains the same year
after year: maximize the Return On Investment of IT resources. No matter how big
or small the organization, everyone wants to achieve a reasonable return on
their technology investment in the form of cost efficiency, productivity, and
competitive advantage as they respond to the evolving needs of their customers.
Technology is driving massive change throughout the IT industry, and for many
years, Micro Focus has participated in introducing many technological changes
ourselves. But we also have a deep understanding of the need to manage change
and the associated risks. This is why we are committed to helping our customers
establish a path into the future that leverages their mainframe-based enterprise
applications as part of their overall IT strategy.
The worldwide investment in COBOL-based applications is not about to simply go
away. The fact is, organizations have too much invested in them, and that
investment has increased radically in recent years as companies have put massive
resources into solving such issues such as the Year 2000 problem.
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What did they get for that investment? Continuity, stability - and millions of
lines of dependable computer code that are running their core business
applications
Going forward, Micro Focus will continue to build on our strong technology base
to create solutions that help our customers transform their enterprise in
innovative yet secure ways. We will help our customers evolve their existing
mainframe-centric software resources to a central role in the distributed
enterprise-wide applications of the future. With Micro Focus products, our
customers will be able to seamlessly combine their IT "crown jewels" with the
best of the new technologies, such as the Internet, Java, and distributed object
technology.
Beyond offering an integrated portfolio of "best-in-class" products, Micro Focus
is currently expanding our range of services, consulting and customer education
opportunities. The stakes are extremely high for the customers we serve, and we
recognize that it's insufficient to only offer them great tools. It is by
offering our customers multiple dimensions of solutions and support that Micro
Focus can fully optimize our contribution to their success.
As an agent of change, Micro Focus is committed to delivering a path forward
that maximizes the return on the enormous investment our customers have made in
their mainframe applications. By choosing the Micro Focus path, our customers
will significantly reduce the cost of implementing new solutions as they
minimize their overall risk by not having to re-implement what already works.
Best of all, because we understand how important "time to solution" is to our
customers, the Micro Focus path of least resistance
The time is now, and we're leading the way to intelligent IT solutions for the
new millennium.
"Micro Focus is committed to delivering a path forward that maximizes the
return on the enormous investment our customers have made in their
mainframeapplications."
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PARTNERS
The backbone of the electronic industry has been the ability for companies to
'partner for success.' Let us take this opportunity to thank some of the many
partners who work with Micro Focus to build a strong future.
MICRO FOCUS PARTNERS
Analysts International Corporation
Butler Technology Solutions
Computer Task Group, Inc.
C.W. Costello & Associates
HCL James Martin, Inc.
KPMG Peat Marwick LLP
Computer Aid, Incorporated
Computer Management Sciences, Inc.
Conley, Canitano & Associates, Inc.
SPR, Inc.
The Titan Corporation
TECHLINK PROGRAM MEMBERS
Allinson-Ross Corporation
Ardent Software, Inc.
Borland International, Inc.
Bridgewater Consultants, Inc.
C-Cubed, Inc.
CSI
Cyberscience Corporation
Data Junction Corporation
Innovative Routines International
Kingsley Technologies Limited
LexiBridge Corporation
NeoMedia Technologies, Inc.
Netron, Inc.
Princeton Softech, Inc.
SERENA Software International
Silicon Valley Networks
Sybase, Inc.
UniKix Technologies
UV Software Inc.
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FURTHER INFORMATION FOR SHAREHOLDERS
US Securities Law Matters
Micro Focus is required to comply with various U.S. securities laws and
regulations, because it has American Depository Shares registered with the U.S.
Securities and Exchange Commission ("SEC") which are traded in the U.S. on the
Nasdaq Stock Market.
Sec Filings. As a foreign private issuer in the U.S., the Company is required to
make certain filings with the SEC, including periodic filings on Form 6-K and an
annual report on Form 20-F.
The Company is required to file with the SEC by means of Form 6-K any
information that Micro Focus makes or is required to make public pursuant to the
laws of the U.K., files or is required to file with the London Stock Exchange,
or distributes or is required to distribute to its shareholders.
Form 20-F is similar to the annual Form 10-K filing required of U.S. public
companies, except that Form 20-F makes allowances for the differences in legal
and regulatory obligations applicable to non-U.S. companies. Portions of this
Annual Report will be incorporated by reference into the Company's next Form
20-F. Unless a portion of this Annual Report is specifically incorporated by
reference into the Form 20-F, this Annual Report is not considered to be a part
of the Company's Form 20-F filing. The filing includes a general introduction to
Micro Focus, and sections discussing, among other items, a description of its
business, its property, its principal shareholders, the nature of the trading
markets, taxation issues, information regarding its directors and officers, as
well as risk factors regarding the Company.
The Company currently plans to file its next Form 20-F with the SEC in May,
1998. A copy of such Form 20-F may be obtained without charge by contacting
"Investor Relations" at Micro Focus offices in either Newbury or Mountain View
listed at the back of this Annual Report.
Special Note on Forward-Looking Statements. Micro Focus is also subject to
various U.S. securities laws and regulations relating to the disclosure of
information. In particular, the Private Securities Litigation Reform Act of
1995, which became effective in the United States as of January 1, 1996
("Securities Litigation Reform Act"), applies to the Company and its disclosure
of information and provides that the Company can be exempt from liability for
making forward-looking statements if certain cautionary language is included
along with such statements. This Annual Report contains certain "forward-looking
statements" (as such term is defined in Section 27A of the U.S. Securities Act
of 1933, as amended) that are based on the beliefs of the Company's management,
as well as assumptions made by and information currently available to the
Company's management. Such forward-looking statements are subject to the safe
harbor created by the Securities Litigation Reform Act. When used in this
document, the words "anticipate," "believe," "estimate," "expect," "intend" and
similar expressions, as they relate to the Company or its management, are
intended to identify such forward-looking statements. Such statements reflect
the current views of the Company or its management with respect to future events
and are subject to certain risks, uncertainties and assumptions. Should one or
more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, the Company's actual results, performance or
achievements in fiscal 1999 and beyond could differ materially from those
expressed in, or implied by, any such forward-looking statements. Factors that
could cause or contribute to such material differences include, but are not
limited to, those discussed below in Management Discussion and Analysis under
the heading "Factors that may influence future operating results", as well as
those discussed elsewhere in this Annual Report. The inclusion of such
forward-looking information should not be regarded as a representation by the
Company or any other person that the future events, plans or expectations
contemplated by the Company will be achieved. The Company undertakes no
obligation to release publicly any updates or revisions to any such
forward-looking statements that may reflect events or circumstances occurring
after the date of this Annual Report.
Electronic Filings. The SEC maintains a World Wide Web site located at
http://www.sec.gov. that contains a searchable database of filings, reports,
proxy and information statements, and other information regarding issuers that
file electronically with the SEC. Foreign private issuers such as Micro Focus
are not currently required to file electronically with the SEC but may choose to
do so. As of March 1997, Micro Focus began voluntarily submitting its filings
electronically to the SEC.
Annual General Meeting of Shareholders
The 1998 annual general meeting of Micro Focus Group Plc will be held at its
registered office, The Lawn, 22-30 Old Bath Road, Newbury, Berkshire, UK. The
full notice of meeting will be sent to shareholders in due course.
Ordinary shares
The Company's ordinary shares have been listed on the London Stock Exchange
since 1983 under the symbol MICF. Since 1992 the Company's ordinary shares have
also been traded on the Nasdaq Stock Market in the U.S. in the form of American
Depository Shares ("ADSs"), evidenced by American Depository Receipts, under the
symbol MIFGY. Effective as of the close of business on March 13, 1998, the
Company undertook a subdivision (or stock split) of its ordinary shares on a
5-for-1 basis. The Company's ADSs have been adjusted such that each ADS
represents 5 ordinary shares. All share and per-share references included in the
U.S. format section of this Annual Report have been restated to reflect the
impact of the above-mentioned stock split. In addition, share and per share data
have been shown in the U.S. format on a basis consistent with reporting prior to
the share split.
The table below shows, in respect of each of the Company's last eight fiscal
quarters, the highest and lowest middle market quotation as reported in the
Daily Official List of the London Stock Exchange (in respect of ordinary shares)
and the highest and lowest closing sales price as reported by the Nasdaq
National Market (in respect of ADSs, each of which represents 5 ordinary shares
following the stock split of the Company's ordinary shares which was effective
as of the close of business on March 13, 1998).
London Stock Exchange Nasdaq
Micro Focus (in GBP) (in U.S. dollars)
fiscal quarters: High Low High Low
- --------------------------------------------------------------------------------
1997
First Quarter 2.67 1.12 19.50 8.38
Second quarter 2.02 1.29 15.75 9.75
Third quarter 2.08 1.40 16.13 10.50
Fourth quarter 2.28 1.58 19.13 13.00
1998
First Quarter 2.75 2.04 22.50 16.35
Second quarter 3.85 2.65 33.40 21.25
Third quarter 4.66 3.27 39.15 26.25
Fourth quarter 5.66 3.88 47.50 32.90
- --------------------------------------------------------------------------------
13
<PAGE> 17
[blank page]
14
<PAGE> 18
FINANCIAL STATEMENTS
US FORMAT
FINANCIAL STATEMENTS PREPARED IN ACCORDANCE
WITH U.S. GAAP (IN U.S. DOLLARS)
SELECTED CONSOLIDATED FINANCIAL DATA 16
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS 17
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME 23
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS 24
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOW 25
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY 26
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 Significant accounting policies 27
2 Business combinations 30
3 Financial instruments 31
4 Research and development costs 31
5 Non-recurring items 31
6 Property, plant and equipment 32
7 Lines of credit 32
8 Commitments 32
9 Income taxes 32
10 Business segment information 33
11 Employee share and retirement plans 34
12 Subsequent event - stock split 35
13 Quarterly financial information (unaudited) 36
- --------------------------------------------------------------------------------
REPORT OF THE INDEPENDENT AUDITORS 36
15
<PAGE> 19
SELECTED CONSOLIDATED FINANCIAL DATA (US FORMAT)
The following selected financial data should be read in conjunction with, and is
qualified in its entirety by reference to, the financial statements of Micro
Focus, expressed in U.S. dollars, set forth on pages 23 to 36 of this report.
<TABLE>
<CAPTION>
.......................................................................................................................
(In thousands of U.S. dollars -
except per share and ADS data, percentages and employees)
Years ended January 31, 1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Results of Operations:
Net revenue 167,309 123,227 134,784 151,012 137,164
Non-recurring items (note 2 below) - (8,670) (9,469) (18,265) -
Income (loss) before income taxes 21,841 (13,972) (11,245) 3,757 35,801
Net income (loss) 14,633 (14,690) (11,156) (3,507) 24,015
Net income (loss) per share:
Basic $0.19 ($0.19) ($0.14) ($0.05) $0.33
Diluted $0.18 ($0.19) ($0.14) ($0.05) $0.32
Basic - per ADS (note 3 below) $0.93 ($0.95) ($0.72) ($0.23) $1.65
Diluted - per ADS: (note 3 below) $0.89 ($0.94) ($0.72) ($0.23) $1.61
Weighted average number of shares outstanding, in thousands
Basic 78,735 77,675 77,395 75,420 72,830
Diluted 82,635 78,060 77,395 75,420 74,565
Basic - ADS equivalent 15,747 15,535 15,479 15,084 14,566
Diluted - ADS equivalent 16,527 15,612 15,479 15,084 14,913
Financial Position at January 31:
Cash and short-term investments 84,490 75,696 63,857 94,511 92,732
Total assets 200,397 161,870 161,606 197,713 176,335
Long-term obligations 20 24 100 307 605
Shareholders' equity 114,834 92,744 107,275 124,831 120,602
Financial Condition:
Working capital 59,256 44,374 45,761 61,034 75,591
Current ratio 1.78 1.74 1.77 1.96 2.61
Return on net revenue: excluding non-recurring items 8.7% n/a n/a n/a 17.5%
Return on average equity: excluding non-recurring items 14.1% n/a n/a n/a 19.9%
Employee Information:
Average number of employees 805 786 858 871 764
Number of employees at year-end 827 712 831 908 795
Net revenue per employee 208 157 157 173 180
.........................................................................................................................
Notes:
1. Data for all periods presented has been restated to reflect the pooling of
interest accounting in connection with the Company's acquisition of XDB Systems,
Inc. on January 20, 1998 (see note 2 to the consolidated financial statements on
page 30).
2. Details of the non-recurring items are set out in note 5 to the consolidated
financial statements on page 31.
3. Share and per-share data for all periods presented has been restated to
reflect the 5-for-1 stock split which occurred effective as of the close of
business on March 13, 1998 (see note 12 to the consolidated financial statements
on page 35). The Company's American Depository Shares ("ADSs") did not split,
although the conversion rights of such ADSs have been adjusted such that each
ADS represents five ordinary shares. Per share earnings are also shown in the
U.S.format on an ADS equivalent basis, consistent with pre-split reporting.
</TABLE>
16
<PAGE> 20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION (US FORMAT)
The following discussion should be read in conjunction with the financial
statements of Micro Focus Group Plc and its subsidiaries ("Micro Focus" or "the
Company") in U.S. dollars, on pages 23 to 36.
The Company has previously referred to its current fiscal yearending January 31,
1998 as "fiscal year 1997." In the future, the Company will designate each
fiscal year by reference to the calendar year in which the last month of the
fiscal year occurs. Accordingly, the Company's current fiscal year ending
January 31, 1998 is referred to as "fiscal year 1998", "fiscal 1998" and "1998"
in this report, and prior fiscal years are referenced accordingly.
Results of Operations
On January 20, 1998, the Company acquired XDB Systems, Inc.("XDB"). The
transaction was accounted for using the pooling of interests method and
accordingly the Company's financialstatements for all periods have been restated
to include the results of XDB. For further information on the XDB acquisition,
see the sections entitled "Business combinations" on pages 20 and 30.
Micro Focus reported net income for fiscal 1998 of $14.6 million or $0.18 per
share diluted as compared to a net loss of $14.7 million or $0.19 per share in
1997 and a net loss of $11.2 million or $0.14 per share in 1996. Results for the
prior years include non-recurring charges of $8.7 million and $9.5 million in
1997 and 1996, respectively.
The table below sets forth results of operations as a percentage of net revenue
for the three fiscal years ended January 31, 1998, 1997 and 1996.
<TABLE>
........................................................................................................................
Year to year
Percentage of net revenue percentage change
Years ended January 31 1997 1996
1998 1997 1996 to 1998 to 1997
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net revenue
Product revenue 62 58 58 46 (9)
Service revenue 38 42 42 21 (9)
- -------------------------------------------------------------------------------------------------------------------------
Total net revenue 100 100 100 36 (9)
- -------------------------------------------------------------------------------------------------------------------------
Costs and expenses
Cost of product revenue 6 7 9 28 (35)
Cost of service revenue 16 16 15 36 (5)
- -------------------------------------------------------------------------------------------------------------------------
Total cost of revenue 22 23 24 33 (16)
- -------------------------------------------------------------------------------------------------------------------------
Gross profit 78 77 76 36 (6)
- -------------------------------------------------------------------------------------------------------------------------
Operating expenses
Research and development 21 31 29 (9) -
Sales and marketing 38 43 43 16 (7)
General and administrative 9 10 8 32 6
Non-recurring items 0 7 7 n/a (8)
- -------------------------------------------------------------------------------------------------------------------------
Total operating expenses 68 91 87 - (3)
- -------------------------------------------------------------------------------------------------------------------------
Income (loss) from operations 10 (14) (11) n/a 14
Interest income 3 3 3 41 (18)
Interest expense - - - 70 (38)
.........................................................................................................................
Income (loss) before income taxes 13 (11) (8) n/a (24)
Income taxes (4) (1) - n/a n/a
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) 9 (12) (8) n/a (32)
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
Net revenue
Micro Focus derives its net revenue from the license of software products and
related support, maintenance and consulting services ("direct revenue") and from
the licensing of distribution rights to software products to original equipment
manufacturers ("OEM revenue"). Direct revenue represents approximately 90% of
total net revenue.
Net revenue is analyzed between product revenue, which consists of the licensing
of software product to end-users and OEMs, and service revenue, consisting of
maintenance and other support services, including training and consulting.
17
<PAGE> 21
Total net revenue increased by $44.1 million or 36% to $167.3 million in fiscal
1998, having previously decreased by $11.6 million or 9% to $123.2 million in
fiscal 1997. The increase in 1998 reflected initial worldwide sales of the
Company's SoftFactory/2000 and NetExpress products, increased UNIX product sales
and revenue from consulting services. The decrease in revenue in fiscal 1997
arose during the first two quarters with relatively flat sales in comparison to
the third and fourth quarters. Factors contributing to the decline in the first
two quarters of 1997 included slow conversion of theMicro Focus installed base
to 32-bit products and continuing uncertainties arising from the fundamental
changes caused by the Internet. The improved performance in the second half of
1997 reflected increased sales of products to address the "Year 2000" problem.
Product revenue increased by $32.9 million or 46% to $104.0 million in fiscal
1998, having previously decreased by $6.6 million or 9% to $71.1 million in
fiscal 1997. The increase in product licensing revenue in 1998 reflected higher
sales of Year 2000 products, UNIX products, NetExpress and other product lines.
Service revenue increased by $11.2 million or 21% to $63.3 million in fiscal
1998, having previously decreased by $4.9 million or 9% to $52.1 million in
fiscal 1997. The increase in service revenue in 1998 resulted from increased
software maintenance revenue and from consulting revenue.
Net revenue by customer location was contributed as follows:
- --------------------------------------------------------------------------------
Fiscal years: 1998 1997 1996
- --------------------------------------------------------------------------------
United States 51% 54% 57%
United Kingdom 12% 10% 10%
Other 37% 36% 33%
- --------------------------------------------------------------------------------
100% 100% 100%
- --------------------------------------------------------------------------------
In fiscal 1998, U.S. revenue increased by 38% over 1997. Revenue from non-U.S.
territories increased by 34% over 1997.
In fiscal 1997, U.S. revenue decreased by 7%, while non-U.S. territories showed
a 3% increase, with growth in the United Kingdom, France and Japan being
partially offset by decreased sales to certain distributors, notably in Italy
and
Brazil.
There can be no assurance that the market for the Company's products will grow
in future periods at its historical rate of growth, that certain segments will
not decline, or that the Company will be able to increase or maintain its market
share in the future or achieve its historical revenue growth rates.
Cost of product revenue
Cost of product revenue is comprised principally of the cost of product
materials (including the purchase of disks and CDs, transfer of data to
electronic media, and printing of manuals), packaging and distribution costs,
and royalties to third party software developers for the licensing of certain
add-on softwarE products.
Such costs increased by $2.2 million or 28% to $10.3 million in fiscal 1998,
having previously decreased by $4.3 million in fiscal 1997 and represented 10%,
11% and 16% of product revenue in 1998, 1997 and 1996, respectively. Decreases
in product costs as a percentage of product revenue principally reflected
savings in product materials arising from the documentation being supplied on
CD-ROM.
Cost of service revenue
Cost of service revenue is comprised principally of compensation for technical
support personnel, plus the costs associated with training and consulting.
Such costs increased by $7.0 million or 36% to $26.6 million in fiscal 1998,
having previously decreased by $1.1 million in fiscal 1997 and represented 42%,
38% and 36% of service revenue in 1998, 1997 and 1996, respectively. The
increase in such costs in 1998 arose mainly from the expansion of the consulting
organization, including the acquisition of Millennium UK Limited ("Millennium").
For further information on the Millennium acquisition, see the sections entitled
"Business combinations" on pages 20 and 30.
The decrease in 1997 reflected reductions taken to better align expenses with
revenue.
Gross profit
Gross profit represented 78%, 77% and 76% of net revenue in 1998, 1997 and 1996,
respectively. The improvement primarily reflected proportionately higher product
sales which carry higher margins and savings attributable to the
replacement of printed software documentation with electronic versions.
The Company's gross margin can be affected by a number of factors, including
changes in product or distribution channel mix, the mix of product and service
revenue, and competitive pressures on pricing. Gross margin is also dependent on
discounts selectively provided to customers in competitive sales situations. In
addition, gross margin may be adversely affected by expansion of the Company's
consulting organization and the to deploy its capacity to revenue generating
projects. As a result of the above factors, gross margin fluctuations are
difficult to predict, and gross margins may decline from current levels in
future periods.
18
<PAGE> 22
Research and development
Research and development costs consist principally of compensation for software
developers and related costs incurred, after adjusting for the proportion of
such costs capitalized (in accordance with Statement of Financial Accounting
Standard No. 86) and the amortization of previously capitalized software costs.
Research and development spending supports the development and enhancement of
new and existing products and is consistent with the Company's strategy of
investing heavily to improve and expand its product lines.
Research and development spending in fiscal 1998 was directed principally
towards further development of SoftFactory/2000 products which address the Year
2000 problem; NetExpress, a complete set of tools for developing business
applications targeted at graphical PC workstations, distributed computer
environments and the Internet; and tools to enhance the functionality and
capability of the COBOL Workbench product line for workstation development of
IBM mainframe applications.
Research and development spending in 1997 and 1996 was directed towards
SoftFactory/2000 and NetExpress, development of new 32-bit products; further
development of client/server solutions; object oriented programming in COBOL;
and tools for downsizing from IBM mainframes.
Expenditure on internal software research and development, before
capitalization, decreased by $2.5 million or 7% to $31.6 million in fiscal 1998,
and by $6.2 million or 15% to $34.1 million in 1997 and represented 19%, 28% and
30% of net revenue in fiscal 1998, 1997 and 1996, respectively. The decrease in
research and development costs reflects a lower relative cost structure
following last year's restructuring of operations.
In fiscal 1998, 1997 and 1996, $9.3 million, $8.3 million and $15.6 million,
representing 29%, 24% and 39%, respectively, of these costs, were capitalized as
software product assets. Provisions for amortization in those years, excluding
non-recurring items, amounted to $12.7 million, $12.7 million and $13.9 million,
resulting in a net charge to income in 1998 of $3.4 million, compared to $4.4
million in fiscal 1997 and a net credit of $1.7 million in 1996.
The Company believes that ongoing development of new products and features is
required to maintain and enhance its competitive position. Accordingly, while
the Company will continue to control expenses where possible, the Company
anticipates that aggregate research and development expenses will increase over
time, and may not be directly related to the level of revenue realized in future
quarters.
Sales and marketing
Sales and marketing costs include compensation, travel and facility costs for
sales, pre-sales and marketing personnel, and publicity costs such as
advertising and trade shows.
Such costs increased by $8.7 million or 16% to $62.2 million in fiscal 1998,
having previously decreased by $4.0 million or 7% to $53.5 million in fiscal
1997, and represented 38%, 43% and 43% of revenue in 1998, 1997 and 1996,
respectively. The increase in sales and marketing costs reflected sales force
expansion, higher commissions and higher advertising and marketing expenses,
including those associated with new product launches. The decrease in fiscal
1997 reflected the worldwide cost reduction initiatives implemented in the first
quarter of that year.
The Company believes that continued investments in sales, marketing, customer
support and promotional activities are essential to maintaining its competitive
position. The Company is expanding its sales and support staffs and,
accordingly, anticipates that aggregate sales and marketing expenses will be
higher in future periods, but as a function of revenue will remain about the
same.
General and administrative
General and administrative costs include the corporate management, finance,
legal and human resources operations of Micro Focus.
Such costs increased by $3.7 million or 32% to $15.6 million in fiscal 1998, and
by $0.7 million or 6% to $11.8 million in fiscal 1997 and represented 9%, 10%
and 8% of revenue in 1998, 1997 and 1996, respectively. The increase in fiscal
1998 reflected higher bonus accruals, staff additions and related recruitment
expenses, goodwill amortization arising from the acquisition of Millennium UK
Limited and costs incurred in connection with the acquisition of XDB Systems,
Inc. The increase in 1997 resulted principally from the strengthening of the
Micro Focus management team.
The Company is investing to strengthen its infrastructure and anticipates that
aggregate general and administrative expenses will increase in future quarters,
but decrease as a percentage of revenue.
Non-recurring items
No non-recurring items were separately reported in fiscal 1998.
In fiscal 1997, Micro Focus incurred restructuring charges of $8.7 million.
These charges consisted of the costs associated with a reduction in the
Company's workforce of approximately 95 people, facility closures and
consolidations, and asset write-downs.
Non-recurring items recorded in 1996 consisted of a charge of $10.5 million for
restructuring and a credit of $1.0 million in respect of an employer loan to the
Micro Focus Group Employee Benefit Trust 1994. Restructuring costs of $5.0
million incurred in the first quarter of 1996 principally related to employee
terminations (including salary, benefit continuation and outplacement costs for
approximately 75 employees), closure of surplus office facilities, and
write-downs of related fixed assets. An additional charge of $5.5 million,
booked in the fourth quarter of 1996, reflected a reduction in the carrying
values of software product assets in line with future revenue expectations from
certain products.
19
<PAGE> 23
Interest income
Interest earned on cash and short-term investments increased by $1.3 million or
41% to $4.4 million in fiscal 1998, having previously decreased by $0.7 million
or 18% to $3.1 million in fiscal 1997 and represented 3% of net revenue in each
of the last three years. The increase in fiscal 1998 reflected higher average
cash balances and higher investment yields resulting from the investment of
funds in money market instruments instead of bank certificates of deposit. The
decrease in 1997 reflected lower average cash balances and, to a lesser degree,
lower interest rates.
Income taxes
The Company's tax rate in fiscal 1998 was 33%, which compares to the statutory
U.K. rate applicable to the Company of 31.3%. The excess principally reflects
the impact of permanent differences between accounting profits and taxable
profits, primarily the amortization of goodwill.
The tax rate in both 1997 and 1996 was significantly affected by the
distribution of taxable profits and losses among the tax jurisdictions in which
the Company operates and by restructuring charges, certain of which were not
deductible for tax purposes.
An analysis of the charge for income taxes, including an analysis of differences
between the effective rate and the U.K. statutory rates, is given in note 9 to
the consolidated financial statements pages 32 and 33.
Business combinations
During fiscal 1998, Micro Focus completed two acquisitions.
On April 30, 1997, the Company acquired all of the outstanding stock of
Millennium UK Limited ("Millennium"), a privately-held consulting firm, in
exchange for 745,710 ordinary shares in the Company and a cash payment of $3.2
million. Millennium provided consulting and project management services and had
specialized expertise in the estimating, planning and management of Year 2000
compliance projects for large scale systems, as well as development expertise in
Web-based applications. Effective January 31, 1998, Millennium's consulting
services were integrated with the professional services operations of the
Company.
The transaction has been accounted for as a purchase. Accordingly, the excess of
the purchase price over the estimated fair value of the net tangible assets has
been allocated to goodwill, and the net assets and results of operations of
Millennium have been combined with those of Micro Focus as of April 30, 1997 and
for the nine-month period subsequent to April 30, 1997, respectively. Where
appropriate the accounting policies of Millennium have been amended to conform
with those of Micro Focus. The effects of the resulting changes to the financial
statements were not material. The goodwill, which amounted to $6.7 million, is
being amortized primarily over three years. On January 20, 1998, the Company
acquired XDB Systems, Inc ("XDB") in exchange for 1,891,975 ordinary shares in
the Company. XDB, a privately-held corporation based in Maryland, USA, is a
provider of DB2 database development, maintenance and connectivity solutions.
The combination has been accounted for using the pooling of interests method and
accordingly all financial data presented herein has been restated to include the
results of XDB. Where appropriate, the accounting policies of XDB have been
amended to conform with those of Micro Focus. The effects of the resulting
changes to the financial
statements were not material.
In 1996, Micro Focus completed the acquisition of Burl Software Laboratories,
Inc. The transaction was accounted for as a purchase.
Further information on these transactions is given in note 2 to the consolidated
financial statements on page 30.
Risk factors that may influence future operating results
Micro Focus operates in a rapidly changing environment that involves a number of
risks, some of which are beyond the Company's control. This section of the
discussion highlights some of these risks and the possible impact of
these factors on future results from operations.
The factors set forth below as well as statements made elsewhere in this Report
contain certain forward-looking statements that are based on the beliefs of the
Company's management, as well as assumptions made by, and information currently
available to, the Company's management. The Company's actual results,
performance or achievements in fiscal 1999 and beyond could differ materially
from those expressed in, or implied by, any such forward-looking statements.
Factors that could cause or contribute to such material differences include, but
are not limited to, those discussed in this section, as well as those in the
Letter to Shareholders and those discussed elsewhere in this Annual Report. The
Company undertakes no obligation to release publicly any updates or revisions to
any such forward-looking statements may reflect events or circumstances
occurring after the date of this Annual Report. For more information regarding
forward-looking statements, see "Further Information for Shareholders - Special
Note on Forward-Looking Statements"on page 13.
The Company's future operating results are subject to quarterly and annual
fluctuations due to a variety of factors, including demand for the Company's
products, the size and timing of customer orders, product life cycles, the
ability of the Company to develop, introduce and market new and enhanced
versions of the Company's products on a timely basis, the introduction and
acceptance of new products and product enhancements by the Company or its
competitors, customer order deferrals in anticipation of enhancements or new
products, changes in the mix of distribution channels through which the
Company's products are offered, purchasing patterns of distributors and
20
<PAGE> 24
retailers, quality control of products sold, price and other competitive
conditions in the industry, changes in the Company's level of operating
expenses, changes in the Company's sales incentive plans, budgeting cycles of
its customers, the cancellation of licenses during the warranty period,
nonrenewal of maintenance agreements, economic conditions generally or in
various geographic areas, and other factors discussed in this section.
A high percentage of Micro Focus' operating expenses is fixed over the short
term and if anticipated revenue does not occur or is delayed, the operating
results for that quarter will be immediately and adversely affected. In
addition, a substantial portion of the Company's revenue for most quarters is
booked and shipped in the last month of the quarter such that the magnitude of
the quarterly fluctuations may not become evident until late in or even at the
end of the particular quarter. Furthermore, the Company's customers tend to make
product purchase decisions in the fourth quarter of the Company's fiscal year as
a result of purchase cycles related to expiration of budgetary authorizations.
As a result, the Company has historically experienced lower revenue for the
first quarter of a fiscal year than in the fourth quarter of the prior fiscal
year.
The Company's revenue is also affected by seasonal fluctuations resulting from
lower sales that typically occur during the summer months in Europe and other
parts of the world. Due to all of the foregoing factors, it is possible that in
some future quarters the Company's operating results will be below the
expectations of stock market analysts and investors and that the share price
would likely be materially adversely affected.
Micro Focus is in a market that is subject to rapid technological change. The
Company must continually adapt to that change by improving its products and
introducing new products and technologies. The growth and financial performance
of Micro Focus will depend upon its ability, on a timely and cost-effective
basis, to develop and introduce enhancements of existing products and new
products that accommodate the latest technological advances and standards,
customer requirements and market conditions. The Company's ability to develop
and market enhancements of existing products and new products depends upon its
ability to attract and retain qualified employees. In the past, Micro Focus has
experienced delays and increased expenses in developing new products. Any
failure by the Company to anticipate or respond adequately to changes in
technology and market conditions, to complete product development and introduce
new products on a timely basis or to attract and retain qualified employees,
could materially adversely affect the Companys business, results of operations
and financial condition.
Substantially all of the Company's revenue is currently, and is expected to
continue in the future to be, derived from products and services related to
applications development in the COBOL language. As a result, the Company's
future operating results depend upon market acceptance of the COBOL language.
Any decline in the demand for or market acceptance of the COBOL language or
mainframe computers where COBOL is a dominant language as a result of
competition, technological change or other factors would have a material adverse
effect on Micro Focus' business, financial condition and results of operations.
The markets in which the Company competes are characterized by rapid
technological change and aggressive competition. The Company believes that the
principal competitive factors in the Company's markets are product performance
and reliability, functionality, product quality, application portability,
product enhancement, price, training, support and the quality of service
offerings. The Company expects competition to increase in the future from
existing competitors and from other companies that may enter the Company's
existing or future markets with similar or substitute solutions including
database vendors of tools and other programming languages that may be less
costly or provide better performance or functionality. Some of the Company's
current and prospective competitors in the products and services markets have
greater financial, marketing or technical resources than Micro Focus and may be
able to adapt more quickly to new or emerging technologies, or devote greater
resources to the promotion and sale of their products than can Micro Focus.
There can be no assurance that other companies will not develop competitive
products in the future. In addition, the software industry is characterized
generally by low barriers to entry, as a result of which new competitors
possessing technological, marketing or other competitive advantages may emerge
and rapidly acquire market share. Furthermore, there can be no assurance that
the Company will be able to compete effectively in the future in the
professional services market and, particularly, the Year 2000 professional
services market.
The market price of the Company's securities has experienced significant price
volatility and such volatility may occur in the future. Factors such as actual
or anticipated fluctuations in the Company's operating results, announcements of
technological innovations, new products or new contracts by the Company or its
competitors, conditions and trends in the software and other technology
industries, adoption of new accounting standards affecting the software
industry, general market conditions and other factors may have a significant
impact on the market price of the Company's securities. Furthermore, the stock
market has experienced extreme volatility that has particularly affected the
market prices of equity securities of many high technology companies. These
market fluctuations, as well as general economic, political and market
conditions, may adversely affect the market price of the Company's securities.
Micro Focus is subject to the general economic climate in the various areas of
the world in which it does business. The risks inherent in conducting
international business generally include exposure to exchange rate fluctuations
(see "Exchange rate fluctuations" below), longer payment cycles, greater
difficulties in accounts receivable collection and enforcing agreements, tariffs
and other restrictions on foreign trade, U.S. export requirements, economic and
political instability, withholding and other tax consequences, restrictions on
repatriation of earnings and the burdens of complying with a wide variety of
foreign laws.
21
<PAGE> 25
There can be no assurance that the factors described above will not have an
adverse effect on the Company's future international revenue and expenses.
The Company markets certain of its products and services to customers for
managing development and maintenance of mission-critical computer software
systems. In addition, an increasing portion of the Company's business is devoted
to addressing the Year 2000 problem which affects the performance and
reliability of many mission-critical systems. The Company's agreements with its
customers typically contain provisions designed to limit the Company's exposure
to potential product and service liability claims. It is possible, however, that
the limitation of liability provisions contained in the Company's customer
agreements may not be effective as a result of existing or future federal,
state, local or foreign laws or ordinances or unfavorable judicial decisions.
Although the Company has not experienced any product or service liability claims
to date, the sale and support of its products and services may entail the risk
of such claims, particularly in the Year 2000 market. A successful product or
service liability claim brought against the Company could have a material
adverse effect upon the Company's business, operating results and financial
condition. Furthermore, the Company anticipates that demand in the Year 2000
market will decline, perhaps rapidly, following the year 2000 and the demand for
the Company's Year 2000 solutions, products and services may also decline as a
result of new technologies, competition or other factors. If this decline in
demand were to occur, the Company's license revenues and professional services
fees could be materially and adversely affected.
Micro Focus is in the process of reviewing all of its major internal corporate
systems for any potential Year 2000 compliance issues and will take appropriate
corrective action based on the results of such review. In doing so, Micro Focus
does not anticipate that it will incur material operating expenses or be
required to invest heavily in internal system improvements as a result of Year
2000 compliance issues. In addition, Micro Focus believes that the current
versions of its software products are Year 2000 compliant. Notwithstanding the
foregoing, there can be no assurance that the Year 2000 problem will not have an
adverse effect on the Company's business, financial condition or results of
operations, due to external factors relating to the Year 2000 problem which are
not controlled by Micro Focus, but on which Micro Focus may rely with respect to
its business and operations.
Micro Focus completed two significant business combinations during fiscal 1998,
as previously noted. The Company is in the process of integrating the operations
acquired in these transactions with its own. There can be no assurance that the
anticipated benefits of recently concluded business combinations will be
realized. In addition, these acquisitions could require significant additional
management attention. The Company expects to continue growing its business
through acquisitions. If Micro Focus is unsuccessful in integrating and managing
the recently acquired businesses or other businesses it may acquire in the
future, the Company's business, results of operations and financial condition
could be adversely affected in future periods.
Exchange rate fluctuations
Micro Focus prepares separate consolidated financial statements expressed in
U.S. dollars and G.B. pounds. Revenue, costs and expenses arising in currencies
other than the reporting currency are translated using average exchange rates.
Assets and liabilities denominated in currencies other than the reporting
currency are translated at exchange rates in effect at the balance sheet date.
The majority of the Company's net revenue arises in U.S. dollars (approximately
two-thirds in 1998), whereas its costs are incurred approximately equally in
U.S. dollars and other currencies, predominately G.B. pounds. Consequently,
fluctuations in exchange rates, particularly between the U.S. dollar and the
G.B. pound, may have a significant impact on the Company's operating results,
notably when expressed in G.B. pounds.
In 1998 and 1997, fluctuations between the U.S. dollar and the G.B. pound have
not been significant, and net exchange rate gains or losses on operational
transactions have been immaterial.
Liquidity and capital resources
Micro Focus continues to fund its activities through cash from operations. In
1998, cash provided by operating activities was $31.1 million (1997: $22.8
million).
In 1998, Micro Focus invested $13.8 million (1997: $4.2 million) in property,
plant and equipment and $9.3 million (1997: $8.3 million) in software product
assets. Investment in 1998 included $4.3 million in connection with the
relocation of the Company to new U.S. facilities in Mountain View, California
and Wayne, Pennsylvania, and $5.1 million for communications and enterprise
systems. In 1998, the Company also paid $3.2 million in cash in connection with
the acquisition of Millennium.
Net of these expenditures, cash and short-term investments increased by $8.8
million to $84.5 million (1997: increased by $10.4 million to $75.7 million).
The Company has in place a line of credit under the terms of which unsecured
financing of up to $8.0 million is available until January 2001. At January 31,
1998, borrowings totalling $1.7 million had been made against this line of
credit (1997: $0).
Micro Focus believes it is important to maintain a conservative capital
structure and a strong cash position. Cash is primarily invested in liquid money
market investments. The Company's investment policy is designed to minimize risk
while maximizing return on cash given such levels of risk, and to keep
uninvested cash at a minimum. Cash management is centralized, although some cash
is held at various subsidiaries around the world to meet local operating
requirements.
The Company believes that existing cash balances, in combination with internally
generated funds and its available bank lines of credit, will be more than
sufficient to meet cash requirements in fiscal 1999.
22
<PAGE> 26
CONSOLIDATED STATEMENTS OF INCOME (US FORMAT)
<TABLE>
<CAPTION>
.................................................................................................................
(In thousands of U.S. dollars -
except share and per share data)
Years ended January 31, 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net revenue
Product revenue $104,041 $71,115 $77,725
Service revenue 63,268 52,112 57,059
- ------------------------------------------------------------------------------------------------------------------
Total net revenue 167,309 123,227 134,784
- ------------------------------------------------------------------------------------------------------------------
Cost of revenue
Cost of product revenue 10,309 8,075 12,416
Cost of service revenue 26,593 19,586 20,642
- -------------------------------------------------------------------------------------------------------------------
Total cost of revenue 36,902 27,661 33,058
- -------------------------------------------------------------------------------------------------------------------
Gross profit 130,407 95,566 101,726
- -------------------------------------------------------------------------------------------------------------------
Operating expenses
Research and development (note 4) 35,040 38,556 38,573
Sales and marketing 62,214 53,519 57,494
General and administrative 15,559 11,814 11,102
Non recurring items (note 5) - 8,670 9,469
- -------------------------------------------------------------------------------------------------------------------
Total operating expenses 112,813 112,559 116,638
- -------------------------------------------------------------------------------------------------------------------
Income (loss) from operations 17,594 (16,993) (14,912)
Interest income 4,370 3,094 3,784
Interest expense (123) (73) (117)
- -------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 21,841 (13,972) (11,245)
Income taxes (note 9) (7,208) (718) 89
- -------------------------------------------------------------------------------------------------------------------
Net income (loss) $14,633 ($14,690) ($11,156)
- -------------------------------------------------------------------------------------------------------------------
Net income (loss) per share - basic (note below) $0.19 ($0.19) ($0.14)
Net income (loss) per ADS - basic $0.93 ($0.95) ($0.72)
..................................................................................................................
Weighted average number of shares outstanding -
basic (thousands) 78,735 77,675 77,395
Shares converted to ADS equivalent 15,747 15,535 15,479
- -------------------------------------------------------------------------------------------------------------------
Net income (loss) per share - diluted (note below) $0.18 ($0.19) ($0.14)
Net income (loss) per ADS - diluted $0.89 ($0.94) ($0.72)
...................................................................................................................
Weighted average number of shares outstanding -
diluted (thousands) 82,635 78,060 77,395
Shares converted to ADS equivalent 16,473 15,612 15,479
- -------------------------------------------------------------------------------------------------------------------
Note:
Shares and per share data for all periods presented has been restated to reflect
the 5-for-1 stock split of the Company's ordinary shares, which was effective as
of the close of business on March 13, 1998 (see note 12 to the consolidated
financial statements on page 35). The Company's American Depository Shares
("ADSs") did not split, although the conversion rights of such ADSs have been
adjusted such that each ADS represents five ordinary shares. Per share earnings
are also shown sin the U.S.format on an ADS equivalent basis, consistent with
pre-split reporting.
See accompanying notes to consolidated financial statements on pages 27 to 36.
</TABLE>
23
<PAGE> 27
CONSOLIDATED BALANCE SHEETS (US FORMAT)
<TABLE>
<CAPTION>
..................................................................................................................
(In thousands of U.S. dollars -
except per share data January 31, January 31,
1998 1997
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $48,174 $73,119
Short-term investments 36,316 2,577
Accounts receivable, net of allowances for doubtful accounts
of $2,499 ($1,731 in 1997) 47,798 22,390
Inventories 519 774
Prepaid expenses and other assets 2,833 5,870
- -------------------------------------------------------------------------------------------------------------------
Total current assets 135,640 104,730
- -------------------------------------------------------------------------------------------------------------------
Fixed assets:
Property, plant and equipment, net (note 6) 39,083 33,796
Goodwill, net of accumulated amortization of $1,391 ($nil in 1997) 5,346 0
Software product assets, net of accumulated amortization of $108,871 ($95,402 in 1997) 20,328 23,344
- -------------------------------------------------------------------------------------------------------------------
Total assets $200,397 $161,870
- -------------------------------------------------------------------------------------------------------------------
Liabilities and shareholders' equity
Current liabilities:
Bank loan $1,652 $1,500
Accounts payable 6,957 5,732
Product and royalties payable 1,386 963
Accrued employee compensation and commissions 12,383 5,811
Accrued payroll taxes 1,142 838
Income taxes payable 10,459 4,142
Deferred revenue 32,848 31,155
Other current liabilities 9,557 10,215
- -------------------------------------------------------------------------------------------------------------------
Total current liabilities 76,384 60,356
- -------------------------------------------------------------------------------------------------------------------
Long term debt and other liabilities 20 24
Deferred income taxes (note 9) 9,159 8,746
- -------------------------------------------------------------------------------------------------------------------
Total liabilities 85,563 69,126
- -------------------------------------------------------------------------------------------------------------------
Commitments (note 8)
Shareholders' equity:
Ordinary shares: 2 pence (G.B.) par value 112,500,000 shares authorized,
79,417,000 shares issued and outstanding (75,840,000 in 1997) $2,508 $2,452
Additional paid-in capital 33,362 27,468
Unrealised gain (loss) on available-for-sale securities, net of tax 44 (90)
Treasury stock (7,769) (8,959)
Retained earnings 89,019 74,386
Currency translation adjustment (2,330) (2,513)
- -------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 114,834 92,744
- -------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $200,397 $161,870
- -------------------------------------------------------------------------------------------------------------------
Note: Share data for all periods presented has been restated to reflect the
5-for-1 stock split of the Company's ordinary shares, which was effective as of
the close of business on March 13, 1998 (see note 12 to the consolidated
financial statements on page 35). The Company's American Depository Shares
(""ADSs"") did not split, although the conversion rights of such ADSs have been
adjusted such that each ADS represents five ordinary shares.
See accompanying notes to consolidated financial statements on pages 27 to 36.
</TABLE>
24
<PAGE> 28
CONSOLIDATED STATEMENTS OF CASH FLOW (US FORMAT)
<TABLE>
<CAPTION>
.......................................................................................................................
(In thousands of U.S. dollars) Years ended January 31, 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating activities
Net income (loss) $14,633 ($14,690) ($11,156)
Adjustments to reconcile net income (loss) to cash provided by operations
Depreciation of fixed assets 7,706 9,410 10,290
Amortization of software product assets 12,716 12,690 19,862
Amortization of goodwill 1,391 0 0
Loss on sale of fixed assets 207 504 237
Deferred income taxes 1,846 (1,622)
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (26,506) 13,691 4,339
Decrease in inventories 247 1,895 185
(Increase) decrease in prepaid expenses and other assets 2,955 1,011 149
Increase (decrease) in accounts payable 1,607 (2,560) 1,002
Increase (decrease) in product royalties payable 1,034 (18) 312
Increase (decrease) in accrued employee compensation 6,581 (890) (908)
Increase (decrease) in accrued payroll taxes 381 158 (105)
Increase (decrease) in income taxes payable 6,219 (2,204) (4,786)
Increase (decrease) in deferred revenue 2,000 (1,481) (3,709)
(Decrease)increase in other current liabilities (49) 3,413 (1,117)
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 31,122 22,775 12,973
- -------------------------------------------------------------------------------------------------------------------------
Investing activities
Purchases of property, plant and equipment, net of capital lease (13,782) (4,235) (14,065)
obligations incurred
Software product assets (9,321) (8,261) (15,989)
Own shares 1,190 0 (7,954)
Acquisition of subsidiary, net of cash balances acquired (3,437) 0 0
Settlement of deferred purchase consideration 0 0 (6,252)
Disposals of property, plant and equipment 570 916 478
Short-term investments (33,639) 1,654 1,056
- -------------------------------------------------------------------------------------------------------------------------
Net cash (used) by investing activities (58,419) (9,926) (42,726)
- -------------------------------------------------------------------------------------------------------------------------
Financing activities
Issuance of ordinary shares, net of expenses 2,439 215 446
Borrowings 152 1,500 0
Repayment of capital leases (73) (233) (467)
- -------------------------------------------------------------------------------------------------------------------------
Net cash (used) by financing activities 2,518 1,482 (21)
- -------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash (166) (687) (117)
(Decrease) increase in cash (24,945) 13,644 (29,891)
Cash at beginning of year 73,119 59,475 89,366
- -------------------------------------------------------------------------------------------------------------------------
Cash at end of year $48,174 $73,119 $59,475
- -------------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Income taxes paid during the year $817 $1,022 $6,460
Interest paid during the year 87 72 172
See accompanying notes to consolidated financial statements on pages 27 to 36.
</TABLE>
25
<PAGE> 29
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (US FORMAT)
<TABLE>
<CAPTION>
....................................................................................................................................
Unrealized
Ordinary Additional gain on Deferred Currency
(In thousands) Number shares pain-in marketable Treasury purchase Retained translation
of shares amount capital securities stock consideration earnings adjustment Total
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 31, 1995 73,710 $2,323 $19,549 ($311) - $5,311 $100,232 ($2,412) $124,692
Share options exercised 575 19 474 - - - - - 493
Agreed acquisition of Burl 3,325 107 7,234 - - (5,311) - - 2,030
Unrealized gain on marketable
securities, net of taxes - - - 313 - - 313 - -
Treasury stock - - - - (8,959) - - - (8,959)
Net loss - - - - - - (11,156) - (11,156)
Currency translation adjustment - - - - - - - (1,370) (1,370)
....................................................................................................................................
BALANCE, JANUARY 31, 1996 77,610 2,449 27,257 2 8,959) - 89,076 (3,782) 106,043
Share options exercised 120 3 211 - - - - - 214
Unrealized loss on marketable
securities, net of taxes - - - - (92) - - - (92)
Net loss - - - - - - (14,690) - (14,690)
Currency translation adjustment - - - - - - - 1,269 1,269
....................................................................................................................................
BALANCE, JANUARY 31, 1997 77,730 2,452 27,468 (90) (8,959) - 74,386 (2,513) 92,744
Share options exercised 941 31 2,408 - 1,190 - - - 3,629
Issued for acquisitions 746 25 3,486 - - - - - 3,511
Unrealized gain on marketable
securities, net of taxes - - - 134 - - - - 134
Net income - - - - - 14,633 - 14,633
Currency translation adjustment - - - - - - - 183 183
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, JANUARY 31, 1998 79,417 $2,508 $33,362 $44 ($7,769) $- $89,019 ($2,330) $114,834
- ------------------------------------------------------------------------------------------------------------------------------------
Note: Share data for all periods presented has been restated to reflect the
5-for-1 stock split of the Company's ordinary shares, which was effective as of
the close of business on March 13,1998 (see note 12 to the consolidated
financial statements on page 35). The Company's American Depository Shares
("ADSs") did not split, although the conversion rights of such ADSs have been
adjusted such that each ADS represents five ordinary shares.
See accompanying notes to consolidated financial statements on pages 27 to 36.
</TABLE>
26
<PAGE> 30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (US FORMAT)
The statutory financial statements of Micro Focus Group Plc, within the meaning
of section 240 of the Companies Act 1985 of Great Britain, for the year ended
January 31, 1998 are contained on pages 51 to 67.
The Company has previously referred to its current fiscal year ending January
31, 1998 as "fiscal year 1997." In the future, the Company will designate each
fiscal year by reference to the calendar year in which the last month of the
fiscal year occurs. Accordingly, the Company's current fiscal year ending
January 31, 1998 is referred to as "fiscal year 1998", "fiscal 1998" and "1998"
in this report, and prior fiscal years are also referenced accordingly.
Note 1 Significant accounting policies
To enable the reader to see immediately any information provided in addition to
the common policy statements, the text of this note and the corresponding note 1
to the U.K. format financial statements on page 57 is italicised where the text
is identical.
Nature of operations
Micro Focus designs and develops computer software products. Approximately 90%
of its revenue is derived from the sale of software product licenses and related
support and maintenance to end users. The remaining 10% is derived from the
licensing of distribution rights to software products to original equipment
manufacturers.
Product licenses are sold and supported in more than 60 countries. The principal
market is the United States, which accounts for approximately 50% of revenue.
Approximately 30% of revenue is derived from customers in Europe and
approximately 20% is earned in the rest of the world.
Principles of consolidation
The consolidated financial statements are those of the Company and all of its
subsidiaries. They have been prepared under the historical cost convention and
in accordance with U.S. generally accepted accounting principles ("GAAP"),
which, as applied by Micro Focus, do not differ in any significant respect from
U.K. GAAP, except with regard to the treatment of acquisitions and goodwill and
the presentation of certain items in the financial statements.
As more fully described in Note 2, on January 20, 1998, the Company acquired XDB
Systems, Inc. ("XDB"). The transaction was accounted for using the pooling of
interests method and accordingly all financial data presented herein includes
the results of XDB. All significant inter-company balances and transactions have
been eliminated on consolidation.
The Company has revised the presentation of its income statement to show gross
profit by segregating direct costs of revenue from operating costs. This
revision does not affect the results of operations of the Company.
The preparation of financial statements in accordance with U.S. GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
Revenue recognition
Net revenue represents the amounts derived from the provision of goods and
services which fall within the Company's ordinary activities, stated net of
applicable sales taxes.
Revenue from licensing software packaged products to end users and resellers is
recognized on delivery, provided that no significant vendor obligations exist
and collection of the resulting receivable is deemed probable.
Revenue from sales to original equipment manufacturers ("OEM's") under
non-cancelable license agreements generally provide for development fees and
initial license fees, which are recognized at the later of: (a) the date product
is delivered to the OEM; (b) the date payment becomes due within twelve months;
and (c) the date of receipt of monies if collection cannot be assessed with
reasonable assurance. When sales by the OEM exceed the initial license fee
commitment, revenue is recognized as unit shipments are reported by the OEM.
Revenue from maintenance agreements is recognized pro-rata over the life of the
agreement corresponding to notional delivery of the service.
Software product assets (capitalized software development costs)
Costs related to the initial development and design of new software products
prior to the establishment of technological feasibility are written off as
research and development costs. Once technological feasibility has been
reasonably established, either by the completion and successful testing of a
detailed program design, or by the creation and testing of an operative working
model, further development costs incurred are capitalized as software product
assets, in compliance with Statement of Financial Accounting Standards No. 86
("SFAS 86") "Accounting for the Cost of Computer Software to be Sold, Leased or
Otherwise Marketed".
27
<PAGE> 31
Software licensed for inclusion in the Micro Focus product set, including
software acquired through acquisitions which meets the provisions for
capitalization under SFAS 86, is also included in software product assets.
During the years ended January 31, 1998, 1997 and 1996 purchased software
totaling $0, $0 and $350,000, respectively, was added to software product
assets.
Software product assets are amortized using the straight line method over the
estimated economic life of the products, which in most cases is assumed to be
four years. Where a shortfall in future revenue from a product is anticipated,
amortization is accelerated.
Amortization of software product assets is included in research and development
costs.
Goodwill
Goodwill represents the excess of the amount paid on the acquisition of a
business over the aggregate fair value of the net assets acquired. Goodwill
arising on a purchase is capitalized as an intangible fixed asset and amortized
over its estimated useful life.
The estimated lives will depend on the length of the future period expected to
benefit from the purchase. Where there is a potential impairment of goodwill,
based on cash flow projections of the businesses acquired, amortization is
accelerated.
Property, plant and equipment
Property, plant and equipment is stated at cost less accumulated depreciation
and amortization. Depreciation and amortization is computed using the
straight-line method over estimated economic lives from the time the asset is
put into use. Present estimated economic lives are as follows:
Office buildings 40 years
Leasehold improvements over the lease term
Computer equipment 3 - 5 years
Office equipment 7 years
Transportation equipment 3 - 4 years
Leasing
Leases which transfer substantially all the benefits and risks of ownership of
an asset to Micro Focus are capitalised as fixed assets. The amount capitalised
is that sum for which the leased asset could be purchased at the start of the
lease, this sum also being treated as a liability.
Depreciation on such leased assets is provided at rates calculated to write off
the capitalized cost over the shorter of the lease term and the asset's economic
life. Lease payments are apportioned between finance charges (computed on the
basis of implicit interest rates) and a reduction in the original liability.
Rentals paid under operating leases are expensed on a straight line basis over
the term of the lease.
Income taxes
The provision for income taxes includes U.S., U.K. and other income taxes
currently payable and those deferred because of temporary differences between
financial and tax reporting.
Inventories
Inventories, consisting principally of diskettes and technical manuals, are
stated at the lower of cost or market, using the first-in, first-out method.
Contracts in progress, representing engineering costs associated with
non-cancelable license agreements prior to delivery, are included in inventories
and expensed when the related revenue is recognized.
Cash and short-term investments
Cash and cash equivalents include cash placed on short-term deposit and
short-term money market instruments where the
maturity date is less than three months from the initial date of deposit.
In accordance with SFAS 115 "Accounting for Certain Investments in Debt and
Equity Securities," the appropriate classification of debt securities is
determined at the time of purchase and re-evaluated at each balance sheet date.
Debt securities that the Company has the intent and the ability to hold until
maturity are classified as held-to-maturity, and all other debt securities are
classified as available-for-sale.
28
<PAGE> 32
Short-term investments represents cash placed on deposit where the maturity date
exceeds three months from the initial date of deposit.
Other financial instruments
The Company enters into forward foreign currency contracts to hedge the value of
assets and liabilities recorded in
foreign currencies against fluctuations in exchange rates.
Translation of foreign currencies
Micro Focus' policy on foreign currency translation complies with SFAS 52
"Foreign Currency Translation".
Assets and liabilities denominated in currencies other than U.S. dollars are
translated at exchange rates in effect at the balance sheet date. Closing U.S.
dollar to G.B. pound rates at January 31, 1998, 1997 and 1996 were $1 = GBP
0.610, $1 = GBP 0.625 and $1 = GBP 0.662, respectively. Revenue, costs and
expenses are translated using average rates. Monthly average U.S. dollar to G.B.
pound rates used during fiscal 1998 range between $1 = GBP 0.599 and $1 = GBP
0.625, and average $1 = GBP 0.611, $1 = GBP 0.633 and $1 = GBP 0.634 in fiscal
1998, 1997 and 1996, respectively. Translation adjustments resulting from the
process of translating financial statements denominated in currencies other than
U.S. dollars are dealt with separately in shareholders' equity.
Net income (loss)/per share
Net income (loss) per share is computed in accordance with SFAS 128 "Earnings
per Share" which is required to be adopted in financial statements for periods
ending on or after December 15, 1997. Accordingly, net income (loss) per share
is disclosed in accordance with SFAS 128 for all periods presented.
Basic net income (loss) per share is based on net income (loss) and on the
weighted average number of ordinary shares outstanding during the period.
Diluted net income per share is based on net income and on the weighted average
number of ordinary shares outstanding during the period, including common share
equivalents, represented by shares issuable upon exercise of share options. The
computation assumes the proceeds from the exercise of share options are used to
repurchase the Company's ordinary shares at their average market price during
each period. In 1996 and 1997, common stock equivalents were antidilutive and
therefore excluded from the computation.
Shares and per share data for all periods presented has been restated to reflect
the 5-for-1 Stock Split (see note 12 on page 35). The Company's American
Depository Shares ("ADSs") did not split, although the conversion rights of such
ADSs have been adjusted such that each ADS represents five ordinary shares. Per
share earnings are also shown in the U.S.format on an ADS equivalent basis,
consistent with pre-split reporting.
Pro-forma net income (loss) per share calculated on the fair-value-based method
is disclosed in accordance with SFAS 123 "Accounting for Stock Based
Compensation" (see "Stock based compensation" below).
Concentration of credit risk
Financial instruments which potentially subject the Company to concentrations of
credit risk consist principally of short-term investments, foreign exchange
contracts and trade receivables.
Micro Focus places its short-term investments only in financial high quality
instruments and, by policy, limits the amounts invested with any one issuer. The
counterparties to the agreements relating to the Company's foreign exchange
contracts are financial institutions of high credit standing. Concentrations of
credit risk with respect to trade receivables are limited due to the large,
widespread customer base which encompasses many different industries and
countries. No single customer represented more than 5% of Micro Focus' revenue
in 1998, 1997 and 1996.
Other risks and uncertainties
The Company amortizes capitalized software using the straight-line method over
the remaining estimated economic life of the product. In the event that the
remaining estimated economic life of a product is judged to be reduced
significantly, the carrying amount of the capitalized software costs may be
reduced.
Stock based compensation
The Company adopted SFAS 123 "Accounting for Stock-Based Compensation" in fiscal
1997. As permitted by SFAS 123, the Company continues to measure compensation
expense for its stock-based employee compensation plans using the intrinsic
value method prescribed by APB Opinion No. 25 "Accounting for Stock Options
Issued to Employees", and accordingly, since all options are granted with an
exercise price equal to the fair value of the shares at the date of grant,
recognizes no compensation expense for share option grants.
Pro-forma disclosures of net income (loss) and net income (loss) per share
computed as if the fair-value-based method prescribed by SFAS 123 had been
applied are provided in Note 11.
Advertising costs
Advertising costs are charged to operations when incurred. Advertising expense,
which includes media, agency and promotional expenses, amounted to $2,086,000,
$5,897,000 and $7,097,000 in fiscal 1998, 1997 and 1996, respectively.
29
<PAGE> 33
Other recent pronouncements
In June 1997, the Financial Accounting Standards Board issued SFAS 130
"Reporting Comprehensive Income" and SFAS 131 "Disclosures About Segments of an
Enterprise and Related Information". In October 1997, the American Institute of
Certified Public Accountants issued Statement of Position 97-2 "Software Revenue
Recognition". All of these statements are effective for fiscal years beginning
after December 15, 1997. The Company will comply with the requirements of these
statements in fiscal 1999. The future adoption of these statements is not
expected to have a material effect on the Company's results from operations or
financial position.
Note 2 Business combinations
During fiscal 1998, Micro Focus completed two acquisitions.
On April 30, 1997, the Company acquired all of the outstanding stock of
Millennium UK Limited ("Millennium"), a privately-held consulting firm, for a
total consideration of $6,400,000, satisfied by a cash payment of $3,200,000 and
the issuance of 149,142 ordinary shares of the Company (equivalent to 745,710
ordinary shares following the Stock Split - see note 12 on page 35). Millennium
provided specialised consulting and project management services.
The transaction has been accounted for as a purchase. Accordingly, the excess of
the purchase price over the estimated fair value of the net tangible assets has
been allocated to goodwill, and the net assets and results of operations of
Millennium have been combined with those of Micro Focus as of April 30, 1997 and
for the nine-month period subsequent to April 30, 1997, respectively. Where
appropriate, the accounting policies of Millennium have been amended to conform
with those of Micro Focus. The effects of the resulting changes to the financial
statements were not material. The goodwill, which amounted to $6,737,000, is
being amortised primarily over three years.
The following table presents pro forma information on the results of operations
as though the acquisition had occurred at the beginning of the periods shown:
- --------------------------------------------------------------------------------
(in thousands) 1998 1997
- --------------------------------------------------------------------------------
Net revenue $168,462 $124,885
Income (loss) before income taxes 21,795 (14,334)
Net income (loss) 14,602 (15,052)
Net income per share (diluted) $0.19 ($0.19)
Net income per share (basic) $0.18 ($0.19)
- --------------------------------------------------------------------------------
On January 20, 1998, the Company acquired all of the outstanding stock of XDB
Systems, Inc. ("XDB") in exchange for 378,395 ordinary shares of the Company
(equivalent to 1,891,975 ordinary shares following the Stock Split) which
represented a value of $14,243,000 on the date the merger was completed. XDB, a
privately-held corporation based in Maryland, USA, is a provider of DB2 database
development, maintenance and connectivity solutions.
The Company incurred charges in the fourth quarter of 1998 of approximately $1.6
million in connection with activities to complete this acquisition. The
combination has been accounted for using the pooling of interests method and
accordingly all financial data presented herein has been restated to include the
results of XDB. The following table sets forth the composition of combined net
revenue and net income (loss) for the periods indicated. Information for 1998
with respect to XDB reflects the period from February 1, 1997 to January 20,
1998, the date XDB was acquired.
- --------------------------------------------------------------------------------
(In thousands) 1998 1997 1996
- --------------------------------------------------------------------------------
Net revenue:
Micro Focus $159,033 $115,409 $121,956
XDB 9,477 10,042 14,241
Elimination (1,201) (2,224) (1,413)
- --------------------------------------------------------------------------------
As restated $167,309 $123,227 $134,784
- --------------------------------------------------------------------------------
Net income (loss):
Micro Focus $15,731 ($10,508) ($10,436)
XDB (1,098) (4,182) (720)
- --------------------------------------------------------------------------------
As restated $14,633 ($14,690) ($11,156)
- --------------------------------------------------------------------------------
Where appropriate, the accounting policies of XDB have been amended to conform
with those of Micro Focus. The effects of the resulting changes to the financial
statements were not material.
In fiscal 1996, Micro Focus completed the acquisition of Burl Software
Laboratories, Inc. for a total of $13,500,000 which was satisfied by the payment
of $6,251,000 in cash and the issuance of 664,979 ordinary shares of the Company
(equivalent to 3,324,895 ordinary shares following the Stock Split). The
acquisition was accounted for as a purchase.
30
<PAGE> 34
Note 3 Financial instruments
The Company invests its excess cash in accordance with an investment policy
approved by the Board of Directors and implemented as of the beginning of the
current fiscal year. This policy authorizes investment in U.S. government
securities, municipal bonds, certificates of deposit with highly-rated financial
institutions and other specified money market instruments of similar liquidity
and credit quality.
The Company has determined that all of its investment securities are to be
classified as available-for-sale. Such securities are stated at amounts which
approximate fair value, based on quoted market prices, with the unrealized gains
and losses reported as a separate component of shareholders' equity.
Available-for-sale securities with original maturities of less than three months
are classified as cash equivalents.
Estimated fair values of financial instruments are based on quoted market
prices. The carrying amounts and fair value of the Company's financial
instruments are as follows:
- --------------------------------------------------------------------------------
(In thousands) 1998 1997
- --------------------------------------------------------------------------------
Cash $24,773 $73,119
Available for sale securities 59,717 2,577
Forward foreign currency contracts - -
- --------------------------------------------------------------------------------
Available-for-sale securities are analysed as follows:
................................................................................
Gross
unrealized Estimated
(In thousands) Cost gains(losses) fair value
- --------------------------------------------------------------------------------
At January 31, 1998:
Money market funds $815 $ - $815
Commercial paper 20,722 10 20,732
Certificates of deposit 7,971 10 7,981
Agency 3,870 5 3,875
Auction rate securities 3,319 - 3,319
Corporates 22,953 42 22,995
- --------------------------------------------------------------------------------
$59,650 $67 $59,717
- --------------------------------------------------------------------------------
At January 31, 1997:
Mutual funds $1,912 ($152) 1,760
Bonds 683 3 686
Other 131 - 131
- --------------------------------------------------------------------------------
$2,726 ($149) $2,577
- --------------------------------------------------------------------------------
The cost and estimated fair values of available-for-sale securities by
contractual maturity are as follows:
................................................................................
Estimated
(In thousands) Cost fair value
- --------------------------------------------------------------------------------
At January 31, 1998:
Less than three months $24,498 $23,501
Between 3 - 12 months 25,551 25,558
Over 12 months 10,601 10,658
- --------------------------------------------------------------------------------
$59,650 $59,717
- --------------------------------------------------------------------------------
The notional amounts of foreign currency contracts were $4,800,000 and $nil at
January 31, 1998 and January 31, 1997, respectively, and were predominantly to
exchange U.S. dollars for G.B. pounds sterling. Substantially all forward
foreign currency contracts entered into by the Company have maturities of 60
days or less.
Note 4 Research and development costs
- --------------------------------------------------------------------------------
(In thousands) 1998 1997 1996
- --------------------------------------------------------------------------------
Research and
development costs,
before capitalization $31,645 $34,138 $40,295
Costs capitalized as software
product assets (9,321) (8,272) (15,639)
Amortization of
capitalized costs 12,716 12,690 13,917
- --------------------------------------------------------------------------------
$35,040 $38,556 $38,573
- --------------------------------------------------------------------------------
Note 5 Non-recurring items
The Company has reported no non-recurring items in 1998.
Non-recurring items recorded in fiscal 1997 represented charges for
restructuring. The charges consisted of the costs associated with a reduction in
the Company's workforce of approximately 95 people, facility closures and
consolidations, and asset write-downs. All outstanding amounts due under the
restructuring were settled prior to January 31, 1998.
Non-recurring items recorded in fiscal 1996 consisted of a charge of $10,502,000
for restructuring and a credit of $1,033,000 in respect of an employer loan to
the Micro Focus Group Employee Benefit Trust 1994. Restructuring costs of
$5,031,000 incurred in the first quarter of 1996 related to employee
terminations, closure of surplus office facilities, and fixed asset write-downs.
Additional asset write-downs of $5,471,000 booked in the fourth quarter of 1996
were primarily the result of a review into the carrying value of software
product assets.
31
<PAGE> 35
Note 6 Property, plant and equipment
- --------------------------------------------------------------------------------
(In thousands) 1998 1997
- --------------------------------------------------------------------------------
Land and buildings $22,679 $21,690
Leasehold improvements 4,228 1,390
Computer and communications
equipment & software 47,239 40,236
Office equipment 8,374 8,346
Transportation equipment 268 727
- --------------------------------------------------------------------------------
Property, plant and equipment - at cost 82,788 72,389
Less: accumulated depreciation
and amortization (43,705) (38,593)
- --------------------------------------------------------------------------------
Property, plant and equipment - net $39,083 $33,796
- --------------------------------------------------------------------------------
The above figures include assets under capital leases as follows:
- --------------------------------------------------------------------------------
(In thousands) 1998 1997
- --------------------------------------------------------------------------------
Cost $47 $200
Less: accumulated depreciation
and amortization (33) (105)
- --------------------------------------------------------------------------------
$14 $95
- --------------------------------------------------------------------------------
During the years ended January 31, 1998, 1997 and 1996, depreciation expense,
including depreciation on leased assets, totalled $7,706,000, $9,410,000 and
$10,290,000, respectively.
Note 7 Lines of credit
Micro Focus has an unsecured revolving multi-currency loan facility, under the
terms of which financing of up to GBP 5,000,000 ($8,200,000 at January 31, 1998)
or its equivalent in such other currency as the Company may determine, is
available until January 2001. Borrowings under this facility bear interest at
0.75% above the London Interbank Offered Rate ("LIBOR"). Amounts outstanding
against this credit line at January 31, 1998 were the equivalent of $1,652,000
(1997: $nil), drawn in French Francs, and incurring interest at 3.6% per annum.
A second line of credit, negotiated by XDB, expired on June 30, 1997. Under the
terms of the credit line, up to $1,500,000 was available, secured by XDB's
short-term investments. The amount outstanding against this credit line at
January 31, 1997 was $1,500,000; the amount was repaid in full on February 1,
1997.
Note 8 Commitments
The Company leases certain of its facilities and equipment under operating
leases expiring at various dates through 2007. In most cases, it is anticipated
that these leases will be renewed or replaced by other leases in the normal
course of business. The Company also leases transportation equipment under
capital leases. Minimum lease commitments as of January 31, 1998 are as follows:
................................................................................
(In thousands) Capital Operating
Years ended January 31 Leases Leases
- --------------------------------------------------------------------------------
1999 $60 $6,245
2000 11 3,249
2001 23 2,271
2002 - 2,049
2003 - 2,037
Thereafter - 769
- --------------------------------------------------------------------------------
Total minimum lease payments 94 16,620
Less: amount representing interest (3) -
Present value of net minimum lease payments $91 -
- --------------------------------------------------------------------------------
During the years ended January 31, 1998, 1997 and 1996, rent expense totalled
$4,650,000, $4,594,000 and $5,309,000, respectively.
Note 9 Income taxes
- --------------------------------------------------------------------------------
(In thousands) 1998 1997 1996
- --------------------------------------------------------------------------------
Current: U.K. $5,048 $380 $237
U.S. federal 273 (1,635) 484
U.S. state 209 (242) 58
Other 1,568 369 (230)
- --------------------------------------------------------------------------------
7,098 (1,128) 549
- --------------------------------------------------------------------------------
Deferred: U.K. 110 1,489 (235)
U.S. federal - 280 (344)
U.S. state - 77 (59)
110 1,846 (638)
Total: $7,208 $718 ($89)
- --------------------------------------------------------------------------------
32
<PAGE> 36
Deferred taxes result from timing differences in the recognition of revenue and
expenses for tax and financial statement purposes. The sources of these
differences and the tax effect of each were as follows:
- --------------------------------------------------------------------------------
(In thousands) 1998 1997 1996
- --------------------------------------------------------------------------------
Software development costs
and other $249 $2,043 ($884)
Depreciation and amortization (139) (197) 246
- --------------------------------------------------------------------------------
$110 $1,846 (638)
- --------------------------------------------------------------------------------
The following table analyses the differences between the U.K. statutory tax
rate and the effective tax rate:
- --------------------------------------------------------------------------------
1998 1997 1996
- --------------------------------------------------------------------------------
U.K. statutory tax rate 31.3% 33.0% 33.0%
Tax effect of earnings of
foreign subsidiaries (1.8)% (22.4)% 6.7%
Permanent differences
and other 3.5% (15.7)% (38.9)%
- --------------------------------------------------------------------------------
Effective tax rate 33.0% (5.1)% 0.8%
- --------------------------------------------------------------------------------
Deferred income taxes, all of which are non-current, are as follows:
- --------------------------------------------------------------------------------
(In thousands) 1998 1997
- --------------------------------------------------------------------------------
Software development costs
and other $9,017 $8,475
Depreciation and amortization 142 271
- --------------------------------------------------------------------------------
$9,159 $8,746
- --------------------------------------------------------------------------------
Deferred tax relative to the different tax jurisdictions is as follows:
- --------------------------------------------------------------------------------
(In thousands) 1998 1997
- --------------------------------------------------------------------------------
U.K. $10,111 $9,983
U.S. (952) (1,237)
- --------------------------------------------------------------------------------
$9,159 $8,746
- --------------------------------------------------------------------------------
The corporate income tax returns of certain U.S. subsidiaries are under
examination by the Internal Revenue Service, which has proposed certain
adjustments. The Company believes that the outcome of the examination will not
give rise to any material adjustment to the financial statements.
Note 10 Business segment information
Micro Focus operates in one business segment - the development and marketing of
computer software products and related services. The following table analyses
worldwide operations by geographical segment, based on the location of Micro
Focus facilities.
- --------------------------------------------------------------------------------
(In thousands) 1998 1997 1996
- --------------------------------------------------------------------------------
Revenue:
United States $100,699 $75,203 $89,839
United Kingdom 72,562 55,701 56,158
Europe (excluding U.K.) 39,612 33,849 32,734
Other 12,869 3,205 2,251
- --------------------------------------------------------------------------------
225,742 $167,958 180,982
- --------------------------------------------------------------------------------
Inter-segment revenue:
United States (8,612) (8,288) (9,647)
United Kingdom (34,567) (25,265) (26,372)
Europe (excluding U.K.) (14,904) (10,331) (8,715)
Other (350) (847) (1,464)
- --------------------------------------------------------------------------------
Total net revenue 167,309 123,227 134,784
- --------------------------------------------------------------------------------
Income (loss) from operations:
United States (671) (12,374) (7,229)
United Kingdom 7,957 (4,704) 1,606
Europe (excluding U.K.) 1,577 (580) (8,568)
Other 8,731 665 (721)
- --------------------------------------------------------------------------------
17,594 (16,993) (14,912)
- --------------------------------------------------------------------------------
Total assets:
United States 48,855 26,622 45,674
United Kingdom 69,574 71,578 61,694
Europe (excluding U.K.) 70,331 62,969 63,915
Other 11,637 701 798
- --------------------------------------------------------------------------------
$200,397 $161,870 $172,081
- --------------------------------------------------------------------------------
Inter-segment revenue principally represents license fees and sub-contracted
development charges between locations.
33
<PAGE> 37
Note 11 Employee share and retirement plans
Share option plans
All references to shares and options within this note have been adjusted for the
Stock Split - see note 12 below.
The Company's share option plans provide for the grant of options to acquire
shares to persons who devote substantially all their working time to Micro Focus
and such other eligible persons as the Board may determine. The exercise price
of options issued under these plans is 100% of the fair market value at the time
such options are granted. Options are generally exercisable in five equal
cumulative annual installments commencing one year after the date of grant.
Unexercised options lapse when the optionholder ceases to be employed by Micro
Focus or at a predetermined expiry date (of up to ten years from the date of
grant), whichever occurs first.
The 1996 Share Option Plan was approved by shareholders in June 1996 and
authorised the Company to grant options up to a maximum of 3,786,845 shares
(representing 5% of the issued share capital of the Company at that time); such
authority will expire on June 18, 1999. Prior to 1996, authority to grant
options under similar terms had been granted pursuant to the 1991 Share Option
Plan and the 1983-1984 Share Option Plan. Such authorities expired in 1996 and
1991, respectively. At January 31, 1998, 8,437,900 option shares were issued and
outstanding under the plans, and a further 1,596,265 which had been approved for
grant by shareholders under the 1996 Share Option Plan were currently unissued.
In 1994, the Micro Focus Group Employee Benefit Trust 1994 ("the Trust") was
established to further the Company's policy of encouraging share ownership by
its employees. Under the terms of the Trust, Micro Focus Trustees Limited
("MFTL") is permitted to acquire ordinary shares in the Company and to issue
options for those shares to directors and employees. At January 31, 1998, MFTL
owned 3,968,565 shares, and options granted by MFTL to purchase up to 3,171,225
of these shares were outstanding. Options which had been granted for an
additional 110,000 shares prior to their acquisition by MFTL also remained
outstanding. The remaining 526,100 option shares were available for future
grant. The shares held by the Trust are shown in the balance sheet as treasury
stock within shareholders' equity.
Pursuant to the agreement to acquire XDB Systems, Inc. ("XDB"), the Company
assumed XDB's 1992 Share Option Plan and 1996 Share Option Plan. Under the
agreement, holders of XDB options are entitled to exercise their options in
return for ordinary shares in the Company. At January 20, 1998, the date of the
merger, XDB option holders held 200,210 option shares in the Company at prices
between $1.59 and $7.41 and denominated in U.S. dollars. At January 31, 1998,
150,280 of these option shares remained outstanding.
Share option activity under the plans was as follows:
- --------------------------------------------------------------------------------
Number Option price per
of shares share in G.B.POUNDS
- --------------------------------------------------------------------------------
Outstanding, January 31, 1995 8,644,370 GBP 0.44-GBP 5.77
Options granted 3,018,975 GBP 1.08-GBP 1.64
Options exercised (574,325) GBP 0.44-GBP 1.08
Options cancelled (795,175) GBP 0.44-GBP 5.77
- --------------------------------------------------------------------------------
Outstanding, January 31, 1996 10,293,845 GBP 1.08-GBP 5.77
Options granted 11,504,150 GBP 1.17-GBP 1.94
Options exercised (120,780) GBP 1.08-GBP 1.93
Options cancelled (9,202,055) GBP 1.08-GBP 5.77
- --------------------------------------------------------------------------------
Outstanding, January 31, 1997 12,475,160 GBP 1.08-GBP 4.32
Options granted 6,622,725 GBP 0.97-GBP 4.52
Options exercised (1,553,705) GBP 1.08-GBP 3.70
Options cancelled (5,674,775) GBP 0.97-GBP 4.52
- --------------------------------------------------------------------------------
Outstanding, January 31, 1998 11,869,405 GBP 0.97-GBP 4.52
- --------------------------------------------------------------------------------
The total of 11,869,405 option shares outstanding at January 31, 1998 is
represented by 8,588,180 unissued shares (8,437,900 granted under the Micro
Focus plans and 150,280 pursuant to the XDB plans) and 3,281,225 issued shares
held by MFTL.
The following tables summarize information about share options outstanding at
January 31, 1998:
Options outstanding:
- --------------------------------------------------------------------------------
Weighted Weighted
Number average average
outstanding at contractual exercise price
Ranges of exercise prices January 31, 1998 life (months) (G.B.POUNDS)
- --------------------------------------------------------------------------------
GBP 0.97-GBP 1.50 4,069,680 97 GBP 1.37
GBP 1.51-GBP 2.00 696,800 102 GBP 1.73
GBP 2.00-GBP 4.52 7,102,925 108 GBP 3.43
- --------------------------------------------------------------------------------
11,869,405 104 GBP 2.62
- --------------------------------------------------------------------------------
34
<PAGE> 38
Options exercisable:
- --------------------------------------------------------------------------------
Weighted
Number average
exercisable at exercise price
Ranges of exercise prices January 31, 1998 (G.B.POUNDS)
- --------------------------------------------------------------------------------
GBP 0.97-GBP 1.50 968,915 GBP 1.33
GBP 1.51-GBP 2.00 158,770 GBP 1.72
GBP 2.00-GBP 4.52 555,380 GBP 3.17
- --------------------------------------------------------------------------------
1,683,065 GBP 1.97
- --------------------------------------------------------------------------------
As stated in note 1, the Company has elected to follow APB 25 and related
Interpretations in accounting for its employee share options because, as
discussed below, the alternative fair value accounting provided for under SFAS
123 requires the use of option valuation models that were not developed for use
in valuing employee share options. Under APB 25, because the exercise price of
the Company's options equals the market price of the underlying shares on the
date of grant, no compensation expense is recognized.
Pro forma information regarding net income (loss) and net income (loss) per
share is required by SFAS 123, and has been determined as if the Company had
accounted for employee share options granted since January 31, 1995 under the
fair value method of that statement. The fair value for these options was
estimated at the date of grant using a Black-Scholes option pricing model with
the following weighted-average assumptions for 1998 and 1997: risk-free interest
rate based on Treasury Strip, No Principal from the Wall Street Journal for
maturity of six years, based on the date of grant; dividend yields of 0%;
volatility factors of the expected market price of 0.378; and an average
expected life of the option of six years.
The Black-Scholes valuation model was developed for use in estimating the fair
value of traded options which have no vesting restrictions and are fully
transferable. In addition, the option valuation models require the input of
highly subjective assumptions including the expected share price volatility.
Because the Company's options have characteristics significantly different from
those of traded options and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma net income and diluted net income per share in 1998 was $12,525,000 and
$0.19, respectively, pro forma net loss and net loss per share in 1997 was
$15,961,000 and $0.20, respectively, and pro forma net loss and net loss per
share in 1996 was $11,359,000 and $0.14, respectively. The effects on pro forma
disclosures of applying SFAS 123 are not likely to be representative of such
effects in future years since SFAS 123 is applicable only to options granted
since January 31, 1995. The effect will not be fully reflected in the pro forma
disclosures until 2001.
Retirement plans
Micro Focus has entered into arrangements to provide pensions for its employees
on a defined contribution basis. Contributions, which are independently
administered by insurance companies and other financial institutions, are
expensed in the year in which they become payable.
In the United States, Micro Focus' plan qualifies under Section 401(k) of the
Internal Revenue Code. Under the plan, Micro Focus matches contributions made by
participating employees up to certain predetermined thresholds. Arrangements for
employees in other countries have been established on similar bases, subject to
local conditions and practices in the countries concerned.
In the years ended January 31, 1998, 1997 and 1996, contributions totalling
$755,000, $779,000 and $1,020,000, respectively, have been expensed.
Note 12 Subsequent event - stock split
On March 12, 1998, shareholders approved a 5-for-1 sub-division of the Company's
ordinary shares. The sub-division became effective as of the close of business
on Friday, March 13, 1998, and unless otherwise stated, all data presented in
these financial statements has been restated to reflect the sub-division. The
Company's American Depository Shares ("ADSs"), which are traded on the Nasdaq
Stock Market in the United States, did not split, although the conversion rights
of such ADSs have been adjusted such that each ADS now represents 5 ordinary
shares.
35
<PAGE> 39
Note 13 Quarterly financial information (unaudited)
Quarterly financial information for the two years ended January 31, 1998 is as
follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
(In thousands - except per share and ADS data)
First Quarter Second Quarter Third Quarter Fourth Quarter Year
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
YEAR ENDED JANUARY 31, 1998:
Net revenue 32,533 39,178 43,612 51,986 167,309
Operating income 2,531 2,807 5,303 6,953 17,594
Net income 2,375 2,548 4,371 5,339 14,633
Net income per share: diluted $0.03 $0.03 $0.05 $0.06 $0.18
Net income per share: basic $0.03 $0.03 $0.06 $0.07 $0.19
Net income per ADS: basic $0.15 $0.16 $0.28 $0.34 $0.93
Net income per ADS: diluted $0.15 $0.15 $0.26 $0.32 $0.89
- ------------------------------------------------------------------------------------------------------------------------
YEAR ENDED JANUARY 31, 1997:
Net revenue 25,820 29,755 30,158 37,494 123,227
Non-recurring items (8,670) - - - (8,670)
Operating income (loss) (15,576) (3,661) 83 2,161 (16,993)
Net income (loss) (14,432) (2,437) 405 1,774 (14,690)
Net income (loss) per share: basic ($0.19) ($0.03) $0.01 $0.02 ($0.19)
Net income (loss) per share: diluted ($0.19) ($0.03) $0.01 $0.02 ($0.19)
Net income (loss) per ADS: basic ($0.93) ($0.16) $0.03 $0.11 ($0.94)
Net income (loss) per ADS: diluted ($0.93) ($0.16) $0.03 $0.11 ($0.95)
- ------------------------------------------------------------------------------------------------------------------------
Notes:
Data for all periods presented has been restated to reflect the pooling of
interest accounting in connection with the Company's acquisition of XDB Systems,
Inc. on January 20, 1998 (see note 2 to the consolidated financial statements on
page 28).
Share and per-share data for all periods presented has been restated to reflect
the 5-for-1 stock split which occurred effective as of the close of business on
March 13, 1998 (see note 12 to the consolidated financial statements on page
35). The Company's American Depository Shares ("ADSs") did not split, although
the conversion rights of such ADSs have been adjusted such that each ADS
represents five ordinary shares. Per share earnings are also shown in the
U.S.format on an ADS equivalent basis, consistent with pre-split reporting.
</TABLE>
REPORT OF THE INDEPENDENT AUDITORS (US FORMAT)
To the Board of Directors and Shareholders
of Micro Focus Group Plc
We have audited the consolidated balance sheets of Micro Focus Group Plc as of
January 31, 1998 and 1997, and the related consolidated statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended January 31, 1998 on pages 23 to 35. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements based on our audits.
We conducted our audits in accordance with United Kingdom auditing standards
which do not differ in any significant respect from those generally accepted in
the United States. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Micro Focus Group
Plc at January 31, 1998 and 1997 and the consolidated results of its operations
and its consolidated cash flows for each of the three years in the period ended
January 31, 1998 in conformity with United States generally accepted accounting
principles.
Ernst & Young
Chartered Accountants
Registered Auditor
Reading, England
May 1, 1998
36
<PAGE> 40
FINANCIAL STATEMENTS
UK FORMAT
FINANCIAL STATEMENTS PREPARED IN ACCORDANCE
WITH U.K. ACCOUNTING PRINCIPLES (IN G.B. POUNDS)
DIRECTORS' REPORT 38
- -------------------------------------------------------------------------------
EXECUTIVE REMUNERATION COMMITTEE'S REPORT 41
- -------------------------------------------------------------------------------
SELECTED CONSOLIDATED FINANCIAL DATA 44
- -------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS 45
- -------------------------------------------------------------------------------
CONSOLIDATED PROFIT AND LOSS ACCOUNT 51
- -------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET 52
- -------------------------------------------------------------------------------
CONSOLIDATED CASH FLOW STATEMENT 53
- -------------------------------------------------------------------------------
NOTES TO CONSOLIDATED CASH FLOW STATEMENT 54
COMPANY BALANCE SHEET 55
STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES 56
MOVEMENT IN SHAREHOLDERS' FUNDS 56
NOTES TO THE FINANCIAL STATEMENTS
1 Significant accounting policies 57
2 Segmental information 59
3 Acquisitions 60
4 Research and development costs 61
5 Operating profit/(loss) 61
6 Directors and employees 61
7 Interest expense 61
8 Exceptional items 62
9 Taxation 62
10 Earnings/(loss) per share 62
11 Intangible fixed assets 62
12 Tangible fixed assets 63
13 Investments 64
14 Stocks 64
15 Debtors 64
16 Creditors: amounts falling due within one year 65
17 Creditors: amounts falling due after more than one year 65
18 Lease commitments 65
19 Capital commitments 65
20 Deferred taxation 66
21 Share option plans 66
22 Post balance sheet event 67
- -------------------------------------------------------------------------------
STATEMENT OF DIRECTORS' RESPONSIBILITIES 68
- -------------------------------------------------------------------------------
REPORT OF THE AUDITORS 68
- -------------------------------------------------------------------------------
37
<PAGE> 41
DIRECTOR'S REPORT (UK FORMAT)
The directors of Micro Focus Group Plc ("the Company") present their Report
together with the audited financial statements of the Company and its subsidiary
undertakings ("Micro Focus") for the year ended January 31 1998.
Principal activities
The principal activities of Micro Focus are the design, development and
marketing of enterprise software development tools for the development,
maintenance and deployment of business applications across a wide range of
computer equipment from personal computer workstations to mainframe computers.
Trading results
The table below summarises the trading results as disclosed in the consolidated
profit and loss account.
- --------------------------------------------------------------------------------
Years ended January 31: 1998 1997 1996
GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------
Revenue 97,015 73,089 77,258
Profit/(loss) before taxation1 5,217 (5,809) (6,542)
Profit/(loss) after taxation 10,426 (7,281) (6,470)
- --------------------------------------------------------------------------------
Results for the year ended January 31 1997 included a charge for exceptional
items amounting to GBP 5,195,000 (1996: GBP 6,001,000), details of which are set
out in note 8 to the financial statements on page 62.
Dividend
Following customary practice the directors will not be recommending payment of a
dividend.
Directors' responsibilities
A statement of the directors' responsibilities in respect of the financial
statements is set out on page 68.
Future prospects
A review of the business and an indication of future prospects is given in the
Letter to Shareholders on pages 2 and 3.
Research and development
Micro Focus has a continuing commitment to a high level of investment in
research and development, and continues to develop new products whilst updating
and improving its existing products. An indication of product development
activity is given in the Letter to Shareholders. Research and development costs
are summarised in note 4 to the financial statements on page 61.
Directors
The directors who served during the year are as follows:
- --------------------------------------------------------------------------------
Non-executive directors:
J. Michael Gullard, Chairman*
Harold Hughes, Deputy Chairman*
J. Sidney Webb * (appointed December 2 1997)
Executive directors:
Martin Waters, Chief Executive Officer (appointed June 21 1997)
Paul Adams, Vice President of International Sales
Ron Forbes, Vice President of International Finance
- --------------------------------------------------------------------------------
* Member of Audit and Executive Remuneration Committees
In addition to the above, Marcelo Gumucio served as an executive director until
his resignation on June 21 1997.
Mr. Gullard was appointed a non-executive director in May 1995 and was elected
Chairman in March 1996. He is General Partner of Cornerstone Management, a
California, USA-based venture capital organisation. He is a U.S. resident.
Mr. Hughes, who was appointed a non-executive director in December 1993, is also
a U.S. resident. He is currently Chairman of Pandesic LLC, a joint venture of
Intel Corporation and SAP.
Mr. Webb, a U.S. resident, was appointed a non-executive director in December
1997. He is Chairman of Titan Corporation and holds directorships with EIP
Microwave, Inc. and Plantronics, Inc. He is also Chairman of the Doheny Eye
Institute, a non-profit organization.
In accordance with the Company's Articles of Association Mr. Forbes will retire
by rotation at the 1998 annual general meeting and, being eligible, may offer
himself for re-election. Mr. Forbes does not have a service contract with the
Company.
Mr. Waters and Mr. Webb, both having been appointed to the Board of Directors of
the Company ("the Board") since the last annual general meeting, will also
retire at the 1998 annual general meeting in accordance with the Company's
Articles of Association and, being eligible, will offer themselves for
re-appointment. Mr. Waters has an agreement that relates to his role as
President and Chief Executive Officer of the Company. Mr. Webb does not have a
service contract with the Company.
The directors' interests in the share capital of the Company are set out in the
Executive Remuneration Committee's Report on page 33. The directors also hold
options to acquire ordinary shares in the Company under the Micro Focus share
option plans. A table showing the options held by each director, together with
those granted and exercised during the year, is also set out in the Executive
Remuneration Committee's Report.
38
<PAGE> 42
Substantial shareholders
The following interests of 3% or more in the share capital of the Company have
been reported as at February 28 1998:
- --------------------------------------------------------------------------------
Ordinary Percentage
shares held holding
- --------------------------------------------------------------------------------
The Prudential Corporation Group 1,329,099 8.4%
Putnam Investments 1,091,200 6.9%
Fidelity Corporation 935,187 5.9%
Micro Focus Trustees Limited 793,521 5.0%
Paul O'Grady 529,438 3.3%
- --------------------------------------------------------------------------------
At February 28 1998 the Bank of New York, acting as Depository Bank, held
approximately 13.4% of the Company's shares in respect of which American
Depository Receipts ("ADRs") have been issued. The ADRs are traded in the United
States on the Nasdaq Stock Market. Certain of the holdings reported above are
held in the form of ADRs. With effect from the close of business on March 13
1998, the Company split its ordinary shares on a 5-for-1 basis. The Company's
American Depository Shares did not split and, for the purposes of the table
above, have been converted to ordinary shares.
Financial aspects of corporate governance
The Board has reviewed the Company's compliance with the Cadbury Committee's
Code of Best Practice ("The Code") and believes that it has complied with the
Code during the year except as noted below.
Until the appointment to the Board of Mr. Webb in December 1997 the Company had
only two non-executive directors, both of whom have been appointed for
unspecified terms. The composition of the Board is kept under review and changes
are made when appropriate and in the best interests of the Company.
The Company's Audit Committee currently comprises the three non-executive
directors. Prior to Mr. Webb's appointment to the Committee on December 2 1997,
the Audit Committee comprised the two other non-executive directors, Mr. Gullard
and Mr. Hughes.
The Company's Executive Remuneration Committee also comprises the three
non-executive directors but, prior to Mr. Webb's appointment to the Committee on
December 2 1997, comprised the two other non-executive directors, Mr.Gullard and
Mr. Hughes. With respect to the existence and operation of its Executive
Remuneration Committee, the Company has complied throughout the year with
Section A of the Best Practice Provisions annexed to the listing rules of the
London Stock Exchange. The Executive Remuneration Committee's Report to
shareholders is set out on page 41.
The directors acknowledge their responsibility for ensuring that the Company has
in place a system of internal financial controls that is appropriate for the
various business environments in which it operates. Such a system can provide
only reasonable and not absolute assurance against material misstatement or
loss.
Control is exercised through an organisational structure with clearly defined
levels of responsibility, authorisation and approval and appropriate segregation
of duties and reporting procedures to ensure that assets are safeguarded against
material loss and that transactions are properly authorised, processed and
reported. Financial performance data is regularly prepared, reviewed and
compared with budgeted targets. The Board has reviewed the effectiveness of the
system of internal financial control as it operated during the year.
After making enquiries, the directors have a reasonable expectation that Micro
Focus has adequate resources to continue in operational existence for the
foreseeable future. For this reason they continue to adopt the going concern
basis in preparing the financial statements.
Ernst & Young, the Company's auditors, have confirmed that, in their opinion:
with respect to the directors' statements on internal financial control and
going concern in the preceding paragraphs, the directors have provided the
disclosures required by the Listing Rules of the London Stock Exchange and such
statements are consistent with the information of which they are aware from
their audit work on the financial statements; and the directors' other
statements in the preceding paragraphs appropriately reflect the Company's
compliance with the other aspects of the Code specified for their review by
Listing Rule 12.43(j).
Ernst & Young was not required to perform the additional work necessary to, and
did not, express any opinion on the effectiveness of either the Company's system
of internal financial control or its corporate governance procedures nor the
ability of Micro Focus to continue in operational existence.
39
<PAGE> 43
Employee involvement
Micro Focus places considerable value on the involvement of its employees and on
good relations and communication with them.
Wide employee consultation takes place on matters affecting their interests.
Employee involvement in the business is encouraged in many ways, including the
holding of regular company-wide meetings and, specifically, awareness of Micro
Focus' financial performance is maintained through the participation of
employees in various Micro Focus bonus schemes which are measured upon the
financial performance of the Company.
At Micro Focus, many employees are eligible to become a shareholder through the
ownership of options to acquire ordinary shares in the Company under the Micro
Focus share option plans (see note 21 to the financial statements on page 66).
Disabled employees
Micro Focus gives consideration to applications for employment from disabled
persons where the requirement of the job may be adequately covered by a
handicapped or disabled person. If necessary Micro Focus endeavours to retrain
any member of staff who develops a disability during employment with Micro Focus
and to provide career development and promotion opportunities wherever
appropriate.
Supplier payment policy and practice
It is the policy of the Company to settle the terms of payment with suppliers
when agreeing the terms of transactions, to ensure that suppliers are made aware
of the terms of payment, and to comply with those contractual arrangements. At
January 31 1998 the Company had an average of 36 days purchases outstanding in
trade creditors.
Special business at the annual general meeting
Under Section 80 of the U.K. Companies Act 1985 ("the Companies Act") the
directors are not allowed to allot shares unless authorised to do so by
shareholders. A resolution was passed at the 1996 annual general meeting
renewing the directors' authority until June 18 2001 to allot the authorised but
unissued shares as at May 17 1996. The directors consider this authority
necessary to preserve maximum flexibility for the future.
Section 89 of the Companies Act gives shareholders the right to participate on a
pro-rata basis in all issues of equity shares for cash, unless they agree that
this right should be excluded. A special resolution will be proposed at the 1998
annual general meeting renewing the directors authority until the following
annual general meeting, to allot equity shares for cash, otherwise than by an
issue pro-rata to existing shareholders, up to an aggregate number of shares
equal to 5% of the share capital in issue at the time of the notice of meeting.
The Company is permitted by its Articles of Association to purchase its own
shares in accordance with the Companies Act. A special resolution will be
proposed at the 1998 annual general meeting renewing the directors' authority
until the following annual general meeting to purchase up to an aggregate number
of shares equal to 10% of the share capital in issue at the time of the notice
convening the meeting. The Board had no occasion to use this power during the
year, but believes it should have this facility, in line with current standard
practice.
Equivalent resolutions were passed at last year's annual general meeting. The
full text of all resolutions will be set out in the notice of annual general
meeting which will be distributed to shareholders in due course.
Auditors
Ernst & Young have expressed their willingness to continue in office as auditors
and a resolution proposing their re-appointment will be submitted at the annual
general meeting.
By Order of the Board
/s/ Loren E. Hillberg
Loren E Hillberg
Secretary
May 1 1998
40
<PAGE> 44
EXECUTIVE REMUNERATION COMMITTEE'S REPORT (UK FORMAT)
The Micro Focus Executive Remuneration Committee was established in December
1993. At present the Committee members are J. Michael Gullard, Harold Hughes and
J. Sidney Webb.
The remuneration of the executive directors is determined by the Committee. The
Committee ensures that remuneration is appropriate to each executive director's
responsibilities, taking into consideration the overall financial and business
position of the Company, the highly competitive industry of which Micro Focus is
part, and the importance of recruiting and retaining management of the
appropriate calibre. The Company has complied with Section A of the Best
Practice Provisions annexed to the Listing Rules of the London Stock Exchange.
Directors' Remuneration Policy
In framing its remuneration policy, the Committee has given full consideration
to Section B of the Best Practice Provisions annexed to the Listing Rules of the
London Stock Exchange. The chief components of remuneration are as follows:
Basic salary: Salary rates for the executive directors are determined by
reference to relevant market data for the countries in which the directors
perform their duties, and are normally reviewed on an annual basis. In general,
the Committee's philosophy is to have base salary rates lower than those of
others in the market, with higher rates of pay for performance.
Fees: Non-executive directors receive an annual retainer and earn additional
fees for attendance at Board meetings and for time spent on other
company-related business. Such fees are determined in advance by the executive
directors and not by the Committee.
Performance-related pay: Executive directors are eligible for annual
performance-related bonuses, which are calculated based on fixed formulae
measuring Micro Focus' performance against targets set at the beginning of each
year. Such bonuses are earned on a pro-rata basis in proportion to the level of
achievement relative to the performance targets set, subject to certain minimum
thresholds.
The philosophy is to offer greater than market opportunities in terms of bonus
compensation, scaling upwards if the performance of Micro Focus exceeds the
targets set out at the beginning of the year.
In the current year such bonuses were based on targets measuring achievement
against performance, measured in terms of audited earnings per share.
Compensation for loss of office: The Company provides nominal amounts of
compensation to its non-executive officers for loss of office. Compensation for
loss of office for executive officers may exceed such nominal amounts as a
result of the Company needing to provide such executive directors with
competitive packages in accordance with the criteria described elsewhere in this
"Directors' Remuneration Policy" section.
Pension contributions: The Company does not operate a pension scheme for its
directors, but does make contributions to a director's own personal pension in
lieu of salary entitlement.
Other: Other emoluments relate to an amount received by Mr. Waters in respect of
acceptance of office, and benefits principally related to the use of corporate
communications facilities by, and personal travel provided to, a former
director.
Share options: All of the directors are eligible to participate in the Micro
Focus share option plans, details of which are set out in note 21 to the
financial statements on page 66. The grant of share options to directors is
designed to ensure that an element of their remuneration is directly related to
long-term growth in shareholder value.
Long-term incentives: None of the directors is eligible for any long-term
incentive payments.
Service agreements: Except as noted below, none of the directors has a service
contract with a notice period in excess of one year, or with provision for
predetermined compensation on termination of an amount which equals or exceeds
one year's salary and benefits.
In the event of a change of control of the Company, Mr. Waters would be entitled
to predetermined compensation on termination of his employment of an amount
which exceeds one year's salary and benefits, provided that the termination
occurs within one year from the effective date of the change of control.
41
<PAGE> 45
Directors' Remuneration
The following table analyses the remuneration earned by each director in each of
the last two years.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
Performance Pension Compensation
Salary Fees related pay contributions for loss of office Other TOTAL
Years ended January 31 GBP'000 GBP'000 GBP'000 GBP'000 GBP'000 GBP'000 GBP'000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1998: J. Michael Gullard - 50 - - - - 50
Harold Hughes - 18 - - - - 18
J. Sidney Webb
(appointed December 2 1997) - 5 - - - - 5
Martin Waters
(appointed June 21 1997) 105 - 201 - - 183 489
Paul Adams 85 - 125 - - - 210
Ron Forbes 82 - 76 6 - - 164
Marcelo Gumucio
(resigned June 21 1997) 53 - 31 - 545 - 629
- ------------------------------------------------------------------------------------------------------------------------------------
325 73 433 6 545 183 1,565
- ------------------------------------------------------------------------------------------------------------------------------------
1997: J. Michael Gullard - 63 - - - - 63
Harold Hughes - 20 - - - - 20
Marcelo Gumucio 101 1 129 - - - 231
Paul Adams 79 - 50 - - - 129
Ron Forbes 79 - 16 6 - - 101
Brian Reynolds
(resigned March 24 1996) - - - - - 29 29
Paul O'Grady
(resigned April 1 1996) 24 - - - 30 - 54
- ------------------------------------------------------------------------------------------------------------------------------------
283 84 195 6 30 29 627
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Upon the resignation of Marcelo Gumucio, the Company entered into a settlement
agreement and release with Mr. Gumucio, pursuant to which Mr.Gumucio was paid an
amount of $225,000 (GBP 136,000) for loss of office, Mr. Gumucio agreed to
provide six months of consulting services to the Company in exchange for a
payment of $200,000 (GBP 120,00) and vesting for 138,440 option shares held by
Mr. Gumucio was accelerated and the exercise period extended. As expected, the
services that were intended to be performed under the agreement were performed
during fiscal 1998.
The following additional information is provided in accordance with the
requirements of the Companies Act.
- --------------------------------------------------------------------------------
1998 1997
GBP'000 GBP'000
- --------------------------------------------------------------------------------
All directors:
Aggregate emoluments 1,559 621
Pension contributions 6 6
Gain on exercise of share options 889 -
- --------------------------------------------------------------------------------
2,454 627
- --------------------------------------------------------------------------------
Highest paid director:
Aggregate emoluments 629 231
Gain on exercise of share options 889 -
- --------------------------------------------------------------------------------
1,518 231
- --------------------------------------------------------------------------------
Gains on exercise of share options are calculated as at the date of exercise
although the shares may have been retained.
42
<PAGE> 46
Directors' shareholdings
The interests of the directors in the share capital of the Company are as
follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
January 31 1998 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
J. Michael Gullard, Chairman 1,000 1,000
Harold Hughes, Deputy Chairman 20,000 20,000
J. Sidney Webb 100 100 *
Martin Waters, Chief Executive Officer - - *
Paul Adams 106,600 106,600
Ron Forbes 17,676 23,676
- ---------------------------------------------------------------------------------------------------------------------------
* At date of appointment in the cases of Mr. Webb and Mr. Waters
</TABLE>
On March 6 1998 Mr Webb increased his holding by 1,000 shares. There have been
no other changes in these holdings since the year end.
The shareholdings quoted above have not been restated to give effect to the
sub-division of the Company's ordinary shares which took effect from the close
of business on March 13 1998 (see note 22 to the financial statements on page
67).
Directors' share options
The following table sets out the numbers of options held by each director,
including the changes in holdings during the year.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
Number of options
Option January 31 January 31
Date of option grant price 1997 Granted Exercised Lapsed 1998 Latest exercise date
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
J Michael Gullard June 2 1994 GBP 10.67 10,000 10,000 June 2 2004
June 21 1996 GBP 8.35 50,000 50,000 June 21 2006
Harold Hughes August 19 1992 GBP 14.98 10,000 10,000 August 19 2002
June 16 1994 GBP 11.98 2,000 2,000 June 16 2004
Martin Waters September 16 1997 GBP 21.01 237,500 237,500 September 16 2004
September 16 1997 GBP 21.01 362,500 362,500 September 16 2007
Marcelo Gumucio January 30 1996 GBP 6.05 10,000 (2,000) (8,000) - n/a
(resigned
June 21 1997) April 1 1996 GBP 6.53 362,500 (72,500) (262,313) 27,687* n/a
June 21 1996 GBP 8.35 362,500 (353,438) 9,062* n/a
Paul Adams May 8 1990 GBP 5.42 1,600 1,600 August 8 1998
April 10 1996 GBP 6.85 57,300 57,300 April 10 2003
March 5 1997 GBP10.59 10,000 10,000 March 5 2007
Ron Forbes April 10 1996 GBP 6.85 51,300 51,300 April 10 2000
- ------------------------------------------------------------------------------------------------------------------------------------
* Number of option shares held at date of resignation in the case of Mr. Gumucio.
</TABLE>
At the date of exercise, the Company's share price was GBP 18.45 per share.
Consequently, the exercise of options by Mr. Gumucio gave rise to a gain of GBP
889,000. As set out above, no other director exercised options during the year.
The market price of the shares at January 31 1998 was GBP 27.37 and the range
during the year was GBP 10.35 to GBP 28.30.
The option prices and holdings quoted above have not been restated to give
effect to the sub-division of the Company's ordinary shares which took effect
from the close of business on March 13 1998 (see note 22 to the financial
statements on page 67).
On behalf of the Committee
/s/ J. Sidney Webb
J. Sidney Webb
Chairman of the Executive Remuneration Committee
May 1 1998
43
<PAGE> 47
SELECTED CONSOLIDATED FINANCIAL DATA (UK FORMAT)
The following selected financial data should be read in conjunction with, and is
qualified in its entirety by reference to, the financial statements of Micro
Focus, expressed in G.B. POUNDS, set out on pages 51 to 67 of this report.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
(In thousands of G.B. POUNDS - except per share data,
percentages and employee information)
Years ended January 31 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operating results for the year:
Revenue 97,015 73,089 77,258 89,885 83,842
Profit/(loss) before taxation and exceptional items* 15,217 (614) (541) 12,871 21,761
Exceptional items* - (5,195) (6,001) (4,148) -
Profit/(loss) before taxation 15,217 (5,809) (6,542) 8,723 21,761
Retained profit/(loss) for the year 10,426 (7,281) (6,470) 4,590 14,747
Earnings/(loss) per share: basic 67.8p (48.0p) (43.6p) 32.0p 104.3p
Earnings/(loss) per share: diluted 65.0p (48.0p) (43.6p) 32.0p 101.2p
Average number of shares in issue (thousands) 15,373 15,156 14,843 14,336 14,138
Financial position at end of year:
Cash and bank deposits 51,518 44,725 38,972 55,823 57,544
Total assets 123,824 100,204 111,828 124,302 109,915
Creditors: amounts falling due after more than one year 12 15 66 193 404
Total shareholders funds 70,892 61,124 70,187 72,856 75,100
Financial condition:
Working capital 36,195 26,611 27,306 36,554 48,686
Current ratio 1.78 1.81 1.76 1.80 2.38
Return on revenue: excluding exceptional items* 11% n/a n/a 10% 18%
Return on average equity: excluding exceptional items* 16% n/a n/a 12% 28%
Employee information:
Average number of employees 719 646 735 751 667
Year end number of employees 847 626 708 788 698
Revenue per employee 135 113 105 120 126
Profit/(loss) after taxation per employee:
excluding exceptional items * 14 (3) (2) 12 22
- ---------------------------------------------------------------------------------------------------------------------------
* Details of the exceptional items are set out in note 8 to the financial
statements on page 62.
</TABLE>
44
<PAGE> 48
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION (UK FORMAT)
This discussion has been prepared in accordance with U.S. reporting practice and
is presented here so that readers of the U.K. format financial statements have
the same information as readers of the U.S. format financial statements. It
should be read in conjunction with the financial statements of Micro Focus Group
Plc and its subsidiary undertakings ("Micro Focus") in G.B. pounds, on pages 51
to 67.
The Company has previously referred to its current financial year ending January
31 1998 as "financial year 1997." In the future, the Company will designate each
financial year by reference to the calendar year in which the last month of the
financial year occurs. Accordingly, the Company's current year ending January 31
1998 is referred to as "financial year 1998" or "1998" in this report, and prior
financial years are also referenced accordingly.
Results of Operations
Micro Focus has reported a profit for the year of GBP 10.4m compared to a loss
of GBP 7.3m in 1997. Results for the prior year included non-recurring charges
of GBP 5.2m.
The table below sets forth operating results as a percentage of revenue for each
of last three years and the percentage changes relative to the previous year for
each of the last two years.
<TABLE>
- -------------------------------------------------------------------------------------------------------------------------------
Year to year
Percentage of net revenue percentage change
Years ended January 31 1997 1996
1998 1997 1996 to 1998 to 1997
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenue
Product revenue 62 57 57 44 (4)
Service revenue 38 43 43 18 (7)
- --------------------------------------------------------------------------------------------------------------------------------
Total revenue 100 100 100 33 (5)
- --------------------------------------------------------------------------------------------------------------------------------
Costs and expenses
Cost of product revenue 7 9 11 9 (28)
Cost of service revenue 17 16 16 33 (4)
- --------------------------------------------------------------------------------------------------------------------------------
Total cost of revenue 24 25 27 25 (14)
- --------------------------------------------------------------------------------------------------------------------------------
Operating expenses
Research and development 20 33 35 (19) (10)
Sales and marketing 36 41 43 17 (8)
General and administrative 7 11 6 (18) 58
- --------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 63 85 84 (2) (4)
- --------------------------------------------------------------------------------------------------------------------------------
Operating profit (loss) 13 (10) (11) n/a 13
Interest income 3 2 3 48 (21)
Interest expense - - - 238 (72)
................................................................................................................................
Profit/(loss) before taxation 16 (8) (8) n/a (11)
Taxation (5) (2) - 227 n/a
- --------------------------------------------------------------------------------------------------------------------------------
Retained profit/(loss) for the year 11 (10) (8) n/a 13
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Revenue
Micro Focus derives its revenue from the licence of software products and
related support, maintenance and consulting ("direct revenue") and from the
licencing of distribution rights to software products to original equipment
manufacturers ("OEM revenue"). Direct revenue represents approximately 90% of
total revenue.
Net revenue is analysed between product revenue, which consists of the licensing
of software product to end-users and OEMs, and service revenue, consisting of
maintenance and other support services, including training and consulting.
Revenue increased by GBP 23.9m or 33% to GBP 97.0m in 1998 having decreased by
GBP 4.2m or 5% to GBP 73.1m in 1997. The increase in 1998 reflected initial
worldwide sales of the Company's SoftFactory/2000 and NetExpress products,
increased UNIX product sales and revenue from consulting services. The decrease
in revenue in 1997 arose during the first two quarters with relatively flat
sales in comparison to the third and fourth quarters. Factors contributing to
the decline in the first two quarters of 1997 included slow conversion to 32-bit
products of Micro Focus installed base and continuing uncertainties arising from
the fundamental changes caused by the Internet. The improved performance in the
second half of 1997 reflected increased sales of products to address the "Year
2000" problem.
45
<PAGE> 49
Product revenue increased by GBP 18.5m or 44% to GBP 60.5m in 1998, having
previously decreased by GBP 2.0m or 4% to GBP 42.0m in 1997. The increase in
product licencing revenue in 1998 reflected higher sales of Year 2000 products,
UNIX products, NetExpress and other product lines.
Service revenue increased by GBP 5.5m or 18% to GBP 36.5m in 1998, having
previously decreased by GBP 2.2m or 7% to GBP 31.1m in 1997. The increase in
service revenue resulted from increased software maintenance revenue and from
consulting revenue.
Revenue by customer location is analysed in note 2 to the financial statements
on page 59. In 1998 United Kingdom revenue grew by 74%, United States revenue by
27% and revenue from other countries by 31%.
In 1997 U.S. revenue decreased by 10%, while non-U.S. territories showed a 1%
increase, with growth in the United Kingdom, France and Japan being offset by
decreased sales to certain distributors, notably in Italy and Brazil.
There can be no assurance that the market for the Company's products will grow
in future periods at its historical rate of growth, that certain segments will
not decline, or that the Company will be able to increase or maintain its market
share in the future or achieve its historical revenue growth rates.
Cost of product revenue
Cost of product revenue is comprised principally of the cost of product
materials (including the purchase of disks and CDs, transfer of data to
electronic media, and printing of manuals), packaging and distribution costs,
and royalties to third party
software developers for the licensing of certain add-on software products.
Such costs increased by GBP 0.6m or 9% to GBP 7.0m in 1998, having previously
decreased by $2.4m in 1997 and represented 12% of product revenue in 1998 (15%
in 1997). Decreases in product costs as a percentage of product revenue
principally reflected savings in product materials arising from the
documentation being supplied on CD-ROM.
Cost of service revenue
Cost of service revenue is comprised principally of compensation for technical
support personnel, plus the costs associated with training and consulting.
Such costs increased by GBP 4.0m or 33% to GBP 15.8m in 1998, having previously
decreased by $0.5m in 1997 and represented 43% of service revenue in 1998 (38%
in 1997). The increase in such costs in 1998 arose mainly from the expansion of
the consulting organization, including the acquisition of Millennium UK Limited.
The decrease in 1997 reflected cost reductions taken to align expenses with
anticipated revenue.
Gross profit
Gross profit represented 76% of net revenue (1997: 75%). The improvement
primarily reflected proportionately higher product sales which carry higher
margins and savings attributable to the replacement of printed software
documentation with
electronic versions.
The Company's gross margin can be affected by a number of factors, including
changes in product or distribution channel mix, the mix of product and service
revenue, and competitive pressures on pricing. Gross margin is also dependent on
discounts selectively provided to customers in competitive sales situations. In
addition, gross margin may be adversely affected by expansion of the Company's
consulting organization and the ability to deploy its capacity to revenue
generating projects. As a result of the above factors, gross margin fluctuations
are difficult to predict, and gross margins may decline from current levels in
future periods.
Research and development
Research and development costs consist principally of compensation for software
developers and related costs expended, less the development costs capitalised,
plus amortisation of previously capitalised costs. Research and development
spending supports the development and enhancement of new and existing products
and is consistent with the Company's strategy of
investing heavily to improve and expand its product lines.
Research and development spending in 1998 was directed principally towards
further development of SoftFactory/2000 products which address the Year 2000
problem; NetExpress, a complete set of tools for developing business
applications targeted at graphical PC workstations, distributed computer
environments and the Internet; and tools to enhance the functionality and
capability of the COBOL Workbench product line for workstation development of
IBM mainframe applications.
Research and development spending in 1997 and 1996 was directed towards
SoftFactory/2000 and NetExpress, development of new 32-bit products; further
development of client/server solutions; object oriented programming in COBOL;
and tools for downsizing from IBM mainframes.
Expenditure on internal software research and development before capitalisation,
decreased by GBP 1.6m to GBP 17.6m in 1998 and by GBP 4.2m to GBP 19.2m in 1997
and represented 18% of net revenue in 1998 (1997: 26%; 1996: 30%). The decrease
in research and development costs reflects a lower relative cost structure
following last year's restructuring of operations.
46
<PAGE> 50
In 1998 GBP 5.7m, representing 32% of these costs were capitalised as
software product assets (1997: 27%, 1996: 42%). Provisions for amortisation
amounted to GBP 7.8m (1997: GBP 8.1m; 1996: GBP 8.8m) resulting in a net charge
to profit and loss in 1998 of GBP 2.1m (1997: charge of GBP 2.7m; 1996: credit
of GBP 1.1m).
The Company believes that ongoing development of new products and features is
required to maintain and enhance its competitive position. Accordingly, while
the Company will continue to control expenses where possible, the Company
anticipates that aggregate research and development expenses will increase over
time, and may not be directly related to the level of revenue realized in future
quarters.
Sales and marketing
Sales and marketing costs include compensation, travel and facility costs for
sales, pre-sales and marketing personnel, and publicity costs such as
advertising and trade shows.
Such costs increased by GBP 5.1m or 17% to GBP 35.3m in 1998, having decreased
by GBP 2.7m or 8% to GBP 30.1m in 1997 and represented 36% of net revenue in
1998 (1997: 41%; 1996: 43%). The increase in sales and marketing costs reflected
sales force expansion, higher commissions and higher advertising and marketing
expenses, including those associated with new product launches. The decrease in
fiscal 1997 reflected the worldwide cost reduction initiatives implemented in
the first quarter of that year.
The Company believes that continued investments in sales, marketing, customer
support and promotional activities are essential to maintaining its competitive
position. The Company is expanding its sales and support staffs and,
accordingly, anticipates that aggregate sales and marketing expenses will be
higher in future periods, but as a function of revenue will remain about the
same.
General and administrative
General and administrative costs include the corporate management, finance,
legal and human resources operations of Micro Focus.
Such costs decreased by GBP 1.4m or 18% to GBP 6.5m in 1998, having increased by
GBP 2.9m or 58% to GBP 7.9m in 1997 and represented 7% of net revenue in 1998
(1997: 11%; 1996: 6%). The total for 1997 included GBP 1.9m of restructuring
costs (see "Non-recurring items" below). The underlying increase in 1998
reflected higher bonus accruals and staff additions and related recruitment
expenses. The increase in 1997 resulted principally from the strengthening of
the Micro Focus management team.
The Company is investing to strengthen its infrastructure and anticipates that
aggregate general and administrative expenses will increase in future quarters,
but decrease as a percentage of revenue.
Non-recurring items
No non-recurring items were separately reported in 1998.
In 1997 Micro Focus incurred a restructuring charge of GBP 5.2m. The charge
consisted of the costs associated with a reduction in the Company's workforce of
approximately 65 people, facility closures and consolidations, and asset
write-downs.
Non-recurring items recorded in 1996 consisted of a charge of GBP 6.7m for
restructuring and a credit of GBP 0.7m in respect of an employer loan to the
Micro Focus Group Employee Benefit Trust 1994. Restructuring costs of GBP 3.1m
incurred in the first quarter of 1996 principally related to employee
terminations (including salary, benefit continuation and outplacement costs for
approximately 75 employees), closure of surplus office facilities, and
write-downs of related fixed assets. An additional charge of GBP 3.6m, booked in
the fourth quarter of 1996, reflected a reduction in the carrying values of
software product assets in line with future revenue expectations from certain
products.
Interest income
Interest earned on cash and short-term investments increased by GBP0.8m or 48%
to GBP 2.6m in 1998, having decreased by GBP 0.4m or 21% to GBP 1.7m in 1997,
and represented 3% of revenue in 1998 (1997: 2%; 1996: 3%). The increase in 1998
reflected higher average cash balances and higher investment yields resulting
from the investment of funds in money market instruments instead of bank
certificates of deposit. The decrease in 1997 reflected lower average cash
balances and, to a lesser degree, lower interest rates.
Taxation
The Company's tax rate in 1998 was 31.5%, which compares to the statutory U.K.
rate applicable to the Company of 31.3%.
The tax rate in both 1997 and 1996 was significantly affected by the
distribution of taxable profits and losses among the tax jurisdictions in which
the Company operates and by restructuring charges, certain of which were not
deductible for tax
purposes.
An analysis of the charge for income taxes is given in note 9 to the
consolidated financial statements on page 63.
47
<PAGE> 51
Acquisitions
During the current year Micro Focus completed two acquisitions.
On April 30 1997 the Company acquired all of the share capital of Millennium UK
Limited ("Millennium"), a privately-held consulting firm, for a consideration of
GBP4.0m paid in a combination of GBP2.0m in cash and the issue of 149,142
ordinary shares in the Company. Millennium provided consulting and
projectmanagement services and had specialized expertise in the estimating,
planning and management of Year 2000 compliance projects for large scale
systems, as well as development expertise in Web-based applications. With effect
from January 31 1998 Millennium's consulting services were integrated with the
professional services operations of the Company.
On January 20 1998 the Company acquired all of the share capital of XDB Systems,
Inc ("XDB") in exchange for 378,395 ordinary shares in the Company, which
represented a value of GBP8.7m on the date of the acquisition. XDB, a
privately-held corporation based in Maryland, USA, is a provider of DB2 database
development, maintenance and connectivity solutions.
Both transactions have been accounted for as acquisitions. Accordingly, the
excess of the purchase price over the estimated fair value of the net tangible
assets has been allocated to goodwill, and the results of the acquired companies
have been combined with those of Micro Focus with effect from the acquisition
dates. Goodwill has been written off directly to reserves. Where appropriate the
accounting policies of Millennium and XDB have been amended to conform with
those of Micro Focus. The effects of the resulting changes are summarised in
note 3 to the financial statements on page 60.
Risk factors that may influence future operating results
Micro Focus operates in a rapidly changing environment that involves a number of
risks, some of which are beyond the Company's control. This section of the
discussion highlights some of these risks and the possible impact of these
factors on future results from operations.
The following comments are included in both the U.S. and U.K. format of the
Management's Discussion and Analysis in this Annual Report in accordance with
the Private Securities Litigation Reform Act 1995, which became effective in the
U.S. on January 1 1996. For more information on U.S. Securities Law Matters see
page 13.
The factors set forth below as well as statements made elsewhere in this Report
contain certain forward-looking statements that are based on the beliefs of the
Company's management, as well as assumptions made by, and information currently
available to, the Company's management. The Company's actual results,
performance or achievements in financial year 1999 and beyond could differ
materially from those expressed in, or implied by, any such forward-looking
statements. Factors that could cause or contribute to such material differences
include, but are not limited to, those discussed in this section as well as
those in the Letter to Shareholders and those discussed elsewhere in this Annual
Report. The Company undertakes no obligation to release publicly any updates or
revisions to any such forward-looking statements that may reflect events or
circumstances occurring after the date of this Annual Report. For more
information regarding forward-looking statements, see "Further Information for
Shareholders - Special Note on Forward-Looking Statements" on page 13.
The Company's future operating results are subject to quarterly and annual
fluctuations due to a variety of factors, including demand for the Company's
products, the size and timing of customer orders, product life cycles, the
ability of the Company to develop, introduce and market new and enhanced
versions of the Companys products on a timely basis, the introduction and
acceptance of new products and product enhancements by the Company or its
competitors, customer order deferrals in anticipation of enhancements or new
products, changes in the mix of distribution channels through which the
Company's products are offered, purchasing patterns of distributors and
retailers, quality control of products sold, price and other competitive
conditions in the industry, changes in the Company's level of operating
expenses, changes in the Company's sales incentive plans, budgeting cycles of
its customers, the cancellation of licenses during the warranty period,
nonrenewal of maintenance agreements, economic conditions generally or in
various geographic areas, and other factors discussed in this section.
A high percentage of Micro Focus' operating expenses is fixed over the short
term and if anticipated revenue does not occur or is delayed, the operating
results for that quarter will be immediately and adversely affected. In
addition, a substantial portion of the Company's revenue for most quarters is
booked and shipped in the last month of the quarter such that the magnitude of
the quarterly fluctuations may not become evident until late in or even at the
end of the particular quarter. Furthermore, the Company's customers tend to make
product purchase decisions in the fourth quarter of the Company's year as a
result of purchase cycles related to expiration of budgetary authorizations. As
a result, the Company has historically experienced lower revenue for the first
quarter of a financial year than in the fourth quarter of the prior year.
The Company's revenue is also affected by seasonal fluctuations resulting from
lower sales that typically occur during the summer months in Europe and other
parts of the world. Due to all of the foregoing factors, it is possible that in
some future quarters the Company's operating results will be below the
expectations of stock market analysts and investors and that the share price
could be materially adversely affected.
Micro Focus is in a market that is subject to rapid technological change. The
Company must continually adapt to that change by improving its products and
introducing new products and technologies. The growth and financial performance
48
<PAGE> 52
of Micro Focus will depend upon its ability, on a timely and cost-effective
basis, to develop and introduce enhancements of existing products and new
products that accommodate the latest technological advances and standards,
customer requirements and market conditions. The Company's ability to develop
and market enhancements of existing products and new products depends upon its
ability to attract and retain qualified employees. In the past, Micro Focus has
experienced delays and increased expenses in developing new products. Any
failure by the Company to anticipate or respond adequately to changes in
technology and market conditions, to complete product development and introduce
new products on a timely basis or to attract and retain qualified employees,
could materially adversely affect the Companys business, results of operations
and financial condition.
Substantially all of the Company's revenue is currently, and is expected to
continue in the future to be, derived from products and services related to
applications development in the COBOL language. As a result, the Company's
future operating results depend upon market acceptance of the COBOL language.
Any decline in the demand for or market acceptance of the COBOL language or
mainframe computers where COBOL is a dominant language as a result of
competition, technological change or other factors would have a material adverse
effect on Micro Focus' business, financial condition and results of operations.
The markets in which the Company competes are characterized by rapid
technological change and aggressive competition. The Company believes that the
principal competitive factors in the Company's markets are product performance
and reliability, functionality, product quality, application portability,
product enhancement, price, training, support and the quality of service
offerings. The Company expects competition to increase in the future from
existing competitors and from other companies that may enter the Company's
existing or future markets with similar or substitute solutions including
database vendors of tools and other programming languages that may be less
costly or provide better performance or functionality. Some of the Company's
current and prospective competitors in the products and services markets have
greater financial, marketing or technical resources than Micro Focus and may be
able to adapt more quickly to new or emerging technologies, or devote greater
resources to the promotion and sale of their products than can Micro Focus.
There can be no assurance that other companies will not develop competitive
products in the future. In addition, the software industry is characterized
generally by low barriers to entry, as a result of which new competitors
possessing technological, marketing or other competitive advantages may emerge
and rapidly acquire market share. Furthermore, there can be no assurance that
the Company will be able to compete effectively in the future in the
professional services market and, particularly, the Year 2000 professional
services market.
The market price of the Company's securities has experienced significant price
volatility and such volatility may occur in the future. Factors such as actual
or anticipated fluctuations in the Company's operating results, announcements of
technological innovations, new products or new contracts by the Company or its
competitors, conditions and trends in the software and other technology
industries, adoption of new accounting standards affecting the software
industry, general market conditions and other factors may have a significant
impact on the market price of the Company's securities. Furthermore, the stock
market has experienced extreme volatility that has particularly affected the
market prices of equity securities of many high technology companies. These
market fluctuations, as well as general economic, political and market
conditions, may adversely affect the market price of the Company's securities.
Micro Focus is subject to the general economic climate in the various areas of
the world in which it does business. The risks inherent in conducting
international business generally include exposure to exchange rate fluctuations
(see "Exchange rate fluctuations" below), longer payment cycles, greater
difficulties in accounts receivable collection and enforcing agreements, tariffs
and other restrictions on foreign trade, export requirements, economic and
political instability, withholding and other tax consequences, restrictions on
repatriation of earnings and the burdens of complying with a wide variety of
foreign laws. There can be no assurance that the factors described above will
not have an adverse effect on the Company's future international revenue and
expenses.
The Company markets certain of its products and services to customers for
managing development and maintenance of mission-critical computer software
systems. In addition, an increasing portion of the Company's business is devoted
to addressing the Year 2000 problem which affects the performance and
reliability of many mission-critical systems. The Company's agreements with its
customers typically contain provisions designed to limit the Company's exposure
to potential product and service liability claims. It is possible, however, that
the limitation of liability provisions contained in the Company's customer
agreements may not be effective as a result of existing or future domestic or
foreign laws or ordinances or unfavourable judicial decisions. Although the
Company has not experienced any product or service liability claims to date, the
sale and support of its products and services may entail the risk of such
claims, particularly in the Year 2000 market. A successful product or service
liability claim brought against the Company could have a material adverse effect
upon the Company's business, operating results and financial condition.
Furthermore, the Company anticipates that demand in the Year 2000 market will
decline, perhaps rapidly, following the year 2000 and the demand for the
Company's Year 2000 solutions, products and services may also decline as a
result of new technologies, competition or other factors. If this decline in
demand were to occur, the Company's license revenues and professional services
fees could be materially and adversely affected.
49
<PAGE> 53
Micro Focus is in the process of reviewing its major internal corporate systems
for potential Year 2000 compliance issues and intends to take appropriate
corrective action based on the results of such review. Micro Focus does not
currently anticipate that it will incur material operating expenses or be
required to invest heavily in internal system improvements as a result of Year
2000 compliance issues. In addition, Micro Focus believes that the current
versions of its software products are Year 2000 compliant. Notwithstanding the
foregoing, there can be no assurance that the Year 2000 problem will not have an
adverse effect on the Company's business, financial condition or results of
operations, due to external factors relating to the Year 2000 problem which are
not controlled by Micro Focus, but on which Micro Focus may rely with respect to
its business and operations.
Micro Focus completed two significant corporate acquisitions in the current
year, as noted above. The Company is in the process of integrating the
operations acquired in these transactions with its own. There can be no
assurance that the anticipated benefits of recently concluded business
combinations will be realised. In addition, these acquisitions could require
significant additional management attention. The Company expects to continue
growing its business through acquisitions. If Micro Focus is unsuccessful in
integrating and managing the recently acquired businesses or other businesses it
may acquire in the future, the Company's business, results of operations and
financial condition could be adversely affected in future periods.
Exchange rate fluctuations
Micro Focus prepares separate consolidated financial statements expressed in
U.S. dollars and G.B. pounds. Revenue, costs and expenses arising in currencies
other than the reporting currency are translated using average exchange rates.
Assets and liabilities denominated in currencies other than the reporting
currency are translated at exchange rates in effect at the balance sheet date.
The majority of the Company's revenue arises in U.S. dollars (approximately
two-thirds in 1998), whereas its costs are incurred approximately equally in
U.S. dollars and other currencies, predominately G.B. pounds. Consequently,
fluctuations in exchange rates, particularly between the U.S. dollar and the
G.B. pound, may have a significant impact on the Company's operating results,
notably when expressed in G.B. pounds. In 1998 and 1997, fluctuations between
the U.S. dollar and the G.B. pounds have not been significant, and net exchange
rate gains or losses on operational transactions have been immaterial.
Liquidity and capital resources
Micro Focus continues to fund its activities through cash from operating
activities. In 1998 cash provided by operating activities was GBP 17.8m (1997:
GBP 12.1m).
In 1998 Micro Focus invested GBP 8.3m (1997: GBP 2.5m) in property, plant and
equipment and GBP 5.7m (1997: GBP 5.3m) in software product assets. Investment
in 1998 included $2.7m in connection with the relocation of the Company to new
U.S. facilities in Mountain View, California and Wayne, Pennsylvania, and $3.2m
for communications and enterprise systems. In 1998 the Company also paid GBP
2.0m in cash in connection with the acquisition of Millennium.
Net of these expenditures, cash and short-term investments increased by GBP 6.8m
to GBP 51.5m (1997: increased by GBP 5.8m toGBP 44.7m).
The Company has in place a line of credit under the terms of which unsecured
financing of up to GBP 5.0m is available until January 2001. At January 31 1998
borrowings totalling GBP1.0m had been made against this line of credit (1997:
GBPnil).
Micro Focus believes it is important to maintain a conservative capital
structure and a strong cash position. Cash is primarily invested in liquid money
market investments. The Company's investment policy is designed to minimize risk
while maximizing return on cash given such levels of risk, and to keep
uninvested cash at a minimum. Cash management is centralized, although some cash
is held at various subsidiaries around the world to meet local operating
requirements.
The Company believes that existing cash balances in combination with internally
generated funds and its available bank lines of credit will be more than
sufficient to meet cash requirements in its 1999 financial year.
50
<PAGE> 54
CONSOLIDATED PROFIT AND LOSS ACCOUNT (UK FORMAT)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
Continuing Acquisitions Year ended Year ended Year ended
operations (note 3) January 31 January 31 January 31
1998 1997 1996
Notes GBP'000 GBP'000 GBP'000 GBP'000 GBP'000
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenue
Product revenue 60,323 157 60,480 42,020 43,991
Service revenue 34,274 2,261 36,535 31,069 33,267
- ---------------------------------------------------------------------------------------------------------------------------
Total revenue 2 94,597 2,418 97,015 73,089 77,258
- ---------------------------------------------------------------------------------------------------------------------------
Costs and expenses
Cost of product revenue 6,987 3 6,990 6,406 8,855
Cost of service revenue 13,742 2,103 15,845 11,892 12,343
- ---------------------------------------------------------------------------------------------------------------------------
Total cost of revenue 20,729 2,106 22,835 18,298 21,198
- ---------------------------------------------------------------------------------------------------------------------------
Gross profit 73,868 312 74,180 54,791 56,060
- ---------------------------------------------------------------------------------------------------------------------------
Operating expenses
Research and development 4 19,625 54 19,679 24,299 26,851
Sales and marketing 35,222 67 35,289 30,146 32,857
General and adminisive 6,091 385 6,476 7,854 4,986
- --------------------------------------------------------------------------------------------------------------------------
Total operating expenses 60,938 506 61,444 62,299 64,694
- --------------------------------------------------------------------------------------------------------------------------
Operating profit/(loss) 5 12,930 (194) 12,736 (7,508) (8,634)
- ---------------------------------------------------------------------------------------------------------------------------
Interest income 2,551 1,720 2,166
Interest expense (70) (21) (74)
...........................................................................................................................
Profit/(loss) before taxation 15,217 (5,809) (6,542)
Taxation 9 (4,791) (1,472) 72
- ---------------------------------------------------------------------------------------------------------------------------
Retained profit/(loss) for the year 10,426 (7,281) (6,470)
- ---------------------------------------------------------------------------------------------------------------------------
Earnings/(loss) per share: basic 10 67.8p (48.0p) (43.6p)
- ---------------------------------------------------------------------------------------------------------------------------
Earnings/(loss) per share: diluted 10 65.0p (48.0p) (43.6p)
- ---------------------------------------------------------------------------------------------------------------------------
Earnings per share after 5-for-1 stock split (see note 22 to the financial
statements on page 67):
- ---------------------------------------------------------------------------------------------------------------------------
Earnings/(loss) per share: basic 13.6p (9.6p) (8.7p)
- ---------------------------------------------------------------------------------------------------------------------------
Earnings/(loss) per share: diluted 13.0p (9.6p) (8.7p)
- ---------------------------------------------------------------------------------------------------------------------------
The notes on pages 57 to 67 form part of these financial statements.
</TABLE>
51
<PAGE> 55
CONSOLIDATED BALANCE SHEET (UK FORMAT)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
January 31 January 31
1998 1997
Notes GBP'000 GBP'000
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Fixed assets
Intangible fixed assets 11 12,394 14,590
Tangible fixed assets 12 23,836 20,543
Investments 13 4,886 5,634
- ---------------------------------------------------------------------------------------------------------------------------
Total fixed assets 41,116 40,767
- ---------------------------------------------------------------------------------------------------------------------------
Current assets
Stocks 14 317 484
Debtors 15 30,873 14,228
Cash and bank deposits 51,518 44,725
- ---------------------------------------------------------------------------------------------------------------------------
Total current assets 82,708 59,437
- ---------------------------------------------------------------------------------------------------------------------------
Creditors: amounts falling due within one year 16 26,483 16,180
Deferred revenue 20,030 16,646
Net current assets 36,195 26,611
Total assets less current liabilities 77,311 67,378
Creditors: amounts falling due after more than one year 17 12 15
Provisions for liabilities and charges:
Deferred taxation 20 6,407 6,239
- ---------------------------------------------------------------------------------------------------------------------------
Net assets 70,892 61,124
- ---------------------------------------------------------------------------------------------------------------------------
Capital and reserves
Called up share capital 1,588 1,517
Share premium account 30,196 18,071
Profit and loss account 39,108 41,536
- ---------------------------------------------------------------------------------------------------------------------------
Total shareholders' funds 70,892 61,124
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
The financial statements on pages 51 to 67 were approved by the Board of
Directors on May 1 1998
/s/ Martin Waters /s/ Ron Forbes
Martin Waters Ron Forbes
Director Director
The notes on pages 51 to 67 form part of these financial statements.
52
<PAGE> 56
CONSOLIDATED CASH FLOW STATEMENT (UK FORMAT)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
January 31 January 31 January 31
1998 1997 1996
GBP'000 GBP'000 GBP'000
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net cash inflow from operating activities 17,767 12,135 9,725
- ---------------------------------------------------------------------------------------------------------------------------
Returns on investments and servicing of finance
Interest received 2,519 1,803 2,082
Interest paid (70) (21) (74)
- ---------------------------------------------------------------------------------------------------------------------------
Net cash inflow from returns on investments and servicing of finance 2,449 1,782 2,008
- ---------------------------------------------------------------------------------------------------------------------------
Taxation
U.K. corporation tax (paid) (599) (88) (1,562)
Overseas tax refunded/(paid) (262) 70 (1,362)
- ---------------------------------------------------------------------------------------------------------------------------
Tax paid (861) (18) (2,924)
- ---------------------------------------------------------------------------------------------------------------------------
Capital expenditure and financial investment
Purchase of tangible fixed assets (8,263) (2,500) (8,643)
Purchase of software product assets - - (226)
Capitalised software product assets (5,688) (5,258) (9,882)
Purchase of own shares - - (5,002)
Disposal of own shares 748 - -
Disposal of tangible fixed assets 447 546 298
- ---------------------------------------------------------------------------------------------------------------------------
Net cash outflow from capital expenditure and financial investment (12,756) (7,212) (23,455)
- ---------------------------------------------------------------------------------------------------------------------------
Acquisitions and disposals
Purchase of subsidiary undertaking (2,000) - (3,892)
Net cash acquired with subsidiary undertakings 961 - -
- ---------------------------------------------------------------------------------------------------------------------------
Net cash outflow from acquisitions and disposals (1,039) - (3,892)
- ---------------------------------------------------------------------------------------------------------------------------
Cash inflow/(outflow) before financing (6,546) 6,687 (18,538)
- ---------------------------------------------------------------------------------------------------------------------------
Financing
Issue of ordinary shares, net of expenses 1,517 138 278
Capital element of finance lease obligations (65) (131) (295)
Bank loan 1,007 - -
- ---------------------------------------------------------------------------------------------------------------------------
Net cash inflow/(outflow) from financing 2,459 - (17)
- ---------------------------------------------------------------------------------------------------------------------------
Increase/(decrease) in cash 8,019 6,694 (18,555)
- ---------------------------------------------------------------------------------------------------------------------------
The notes on pages 57 to 67 form part of these financial statements.
</TABLE>
53
<PAGE> 57
NOTES TO CONSOLIDATED CASH FLOW STATEMENT (UK FORMAT)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
Year ended Year ended Year ended
January 31 January 31 January 31
1998 1997 1996
GBP'000 GBP'000 GBP'000
- ---------------------------------------------------------------------------------------------------------------------------
(i) Reconciliation of operating profit to "Net cash inflow from operating activities"
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating profit/(loss) 12,736 (7,508) (8,634)
Depreciation charges 4,534 5,655 6,186
Amortisation charges 7,765 8,067 12,639
Loss on sale of tangible fixed assets 72 221 70
Decrease in stocks 154 1,171 117
(Increase)/decrease in debtors (14,460) 8,012 2,174
Increase/(decrease) in creditors 3,942 (790) (690)
Increase/(decrease) in deferred revenue 3,024 (2,693) (2,137)
- ---------------------------------------------------------------------------------------------------------------------------
Net cash inflow from operating activities 17,767 12,135 9,725
- ---------------------------------------------------------------------------------------------------------------------------
(ii) Reconciliation of net cash flow to movement in net funds
- ---------------------------------------------------------------------------------------------------------------------------
Increase/(decrease) in cash 8,019 6,694 (18,555)
Net cash inflow/(outflow) from financing (942) 131 295
7,077 6,825 (18,260)
Translation difference (1,226) (941) 1,704
- ---------------------------------------------------------------------------------------------------------------------------
5,851 5,884 (16,556)
Net debt, beginning of year 44,642 38,758 55,314
- ---------------------------------------------------------------------------------------------------------------------------
Net debt, end of year 50,493 44,642 38,758
- ---------------------------------------------------------------------------------------------------------------------------
(iii) Analysis of net funds
- ---------------------------------------------------------------------------------------------------------------------------
Balances at Balances at
January 31 Exchange January 31
1997 Cash flow differences 1998
GBP'000 GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------------------------------------------------
Cash 44,725 8,019 (1,226) 51,518
Short term loans - (1,007) - (1,007)
Finance lease obligations (83) 65 - (18)
- ---------------------------------------------------------------------------------------------------------------------------
Balance, end of year 44,642 7,077 (1,226) 50,493
- ---------------------------------------------------------------------------------------------------------------------------
The notes on pages 57 to 67 form part of these financial statements.
</TABLE>
54
<PAGE> 58
COMPANY BALANCE SHEET (UK FORMAT)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
January 31 January 31
1998 1997
Notes GBP'000 GBP'000
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Fixed assets
Tangible fixed assets 12 2,971 2,992
Investments 13 45,086 32,809
- ---------------------------------------------------------------------------------------------------------------------------
Total fixed assets 48,057 35,801
- ---------------------------------------------------------------------------------------------------------------------------
Current assets
Amounts owed by subsidiary undertakings 8,989 11,214
Other debtors 40 2
Cash and bank deposits 738 18
- ---------------------------------------------------------------------------------------------------------------------------
Total current assets 9,767 11,234
- ---------------------------------------------------------------------------------------------------------------------------
Creditors: amounts falling due within one year
Amounts owed to subsidiary undertakings 9,153 11,469
Trade creditors 69 9
Corporation tax 63 178
Accrued expenses 206 47
- ---------------------------------------------------------------------------------------------------------------------------
Net current assets/(liabilities) 276 (469)
- ---------------------------------------------------------------------------------------------------------------------------
Total assets less current liabilities 48,333 35,332
Provisions for liabilities and charges:
Deferred taxation 20 19 19
- ---------------------------------------------------------------------------------------------------------------------------
Net assets 48,314 35,313
- ---------------------------------------------------------------------------------------------------------------------------
Capital and reserves
Called up share capital 1,588 1,517
Share premium account 30,196 18,071
Profit and loss account 16,530 15,725
- ---------------------------------------------------------------------------------------------------------------------------
Total shareholders' funds 48,314 35,313
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
The financial statements on pages 51 to 67 were approved by the Board of
Directors on May 1 1998.
/s/Martin Waters /s/Ronald Forbes
Martin Waters Ron Forbes
Director Director
This is the balance sheet of Micro Focus Group Plc, the holding company of the
Micro Focus group of companies, which is presented in accordance with section
226 of the Companies Act 1985 of Great Britain. No profit or loss account is
presented for Micro Focus Group Plc as provided by section 230 of the same Act.
The notes on pages 51 to 67 form part of these financial statements.
55
<PAGE> 59
STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES/MOVEMENT IN SHAREHOLDERS' FUNDS
(UK FORMAT)
STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
Year ended Year ended Year ended
January 31 January 31 January 31
1998 1997 1996
GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Profit/(loss) for the year 10,426 (7,281) (6,470)
Currency translation adjustment (1,122) (1,920) 2,275
- ---------------------------------------------------------------------------------------------------------------------------
Total recognised gains and losses for the year 9,304 (9,201) (4,195)
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
MOVEMENT IN SHAREHOLDERS' FUNDS
<TABLE>
<CAPTION>
....................................................................................................................................
Ordinary shares of 10p each:
Share Deferred Retained
Authorised Issued Amount premium consideration earnings Total
'000 '000 GBP'000 GBP'000 GBP'000 GBP'000 GBP'000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 31 1995 16,500 14,364 1,437 13,147 3,340 54,932 72,856
Share options exercised - 115 11 297 - - 308
Shares issued to complete Burl acquisition - 665 66 4,492 (3,340) - 1,218
(Loss) for the year - - - - - 6,470) (6,470)
Currency translation adjustment - - - - - 2,275 2,275
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, JANUARY 31 1996 16,500 15,144 1,514 17,936 - 50,737 70,187
Increase in authorised share capital 6,000 - - - - - -
Share options exercised - 24 3 135 - - 138
(Loss) for the year - - - - - (7,281) (7,281)
Currency translation adjustment - - - - - (1,920) (1,920)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, JANUARY 31 1997 22,500 15,168 1,517 18,071 - 41,536 61,124
Issued on acquisitions - 527 52 10,627 - - 10,679
Goodwill arising on acquisitions - - - - - (11,732) (11,732)
Share options exercised - 188 19 1,498 - - 1,517
Profit for the year - - - - - 10,426 10,426
Currency translation adjustment - - - - - (1,122) (1,122)
BALANCE, JANUARY 31 1998 22,500 15,883 1,588 30,196 - 39,108 70,892
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The issued ordinary shares are allotted, called up and fully paid (see also note
22 on page 67).
Micro Focus Group Plc has been authorised by its members to make market
purchases of its own shares (within the meaning of section 163(3) of the
Companies Act 1985). The cumulative value of goodwill written off on
acquisitions between December 23 1989 and January 31 1998 was GBP 11,732,000
(January 31 1997: GBPnil).
The notes on pages 57 to 67 form part of these financial statements.
56
<PAGE> 60
NOTES TO THE FINANCIAL STATEMENTS (UK FORMAT)
The statutory financial statements of Micro Focus, within the meaning of section
240 of the Companies Act 1985 of Great Britain, for the year ended January 31
1998 are contained on pages 43 to 59.
The Company has previously referred to its current financial year ending January
31 1998 as "1997." In the future, the Company will designate each financial year
as the calendar year in which the last month of the financial year occurs.
Accordingly, the Company's current year ending January 31 1998 is referred to as
"financial year 1998" and "1998" in this report, and prior financial years are
referenced accordingly.
Note 1 Significant accounting policies
To enable the reader to see immediately any information provided in addition to
the common policy statements, the text of this note and the corresponding note 1
to the financial statements in U.S. format on page 19 is italicised where the
text is identical.
Basis of preparation
The financial statements have been prepared under the historical cost convention
and in accordance with applicable U.K. Accounting Standards which, as applied by
Micro Focus, do not differ in any significant respect from US generally accepted
accounting principles ("GAAP") except with regard to acquisitions and goodwill
and the presentation of certain items in the financial statements. In order to
comply with the provisions of FRS 1 (Revised) the Consolidated Cash Flow
Statement has been restated for the years ended January 31 1997 and January 31
1996.
Basis of consolidation
The consolidated financial statements are those of Micro Focus Group Plc ("the
Company") and all of its subsidiary undertakings ("Micro Focus") for the year
ended January 31 1998. All significant inter-company balances and transactions
have been eliminated on consolidation.
The presentation of data presented in the profit and loss account has been
revised in order to segregate costs of revenue from operating costs. The
presentation of prior year numbers has been similarly revised to conform with
the current presentation. The results of operations of the Company are not
affected by this changed presentation.
Acquisitions are accounted for using the acquisition method of accounting.
Accordingly the Consolidated Profit and Loss Account and Consolidated Cash Flow
Statement include the results and cash flows for the period of ownership. The
cost of acquisition represents the cash value of the consideration and/or the
market value of the shares issued on the date the offer became unconditional,
plus expenses. The purchase consideration is allocated to assets and liabilities
on the basis of fair value at the date of acquisition.
Revenue recognition
Revenue represents the amounts derived from the provision of goods and services
which fall within Micro Focus' ordinary activities, stated net of applicable
sales taxes.
Revenue from licencing software packaged products to end users and resellers is
recognised on delivery, provided that no significant vendor obligations exist
and collection of the resulting debt is deemed probable.
Revenue from sales to original equipment manufacturers ("OEM's") under
non-cancellable licence agreements generally provide for development fees and
initial licence fees, which are recognised at the later of: (a) the date product
is delivered to the OEM; (b) the date payment becomes due within twelve months;
and (c) the date of receipt of monies if collection cannot be assessed with
reasonable assurance. When sales by the OEM exceed the initial licence fee
commitment, revenue is recognised as unit shipments are reported by the OEM.
Revenue from maintenance agreements is recognised pro-rata over the life of the
agreement corresponding to notional delivery of the service.
Software product assets - development costs
Costs related to the initial development and design of new software products
prior to the establishment of technological feasibility are written off as
research and development costs. Once technological feasibility has been
reasonably established, either by the completion and successful testing of a
detailed program design, or by the creation and testing of an operative working
model, further development costs incurred are capitalised as software product
assets.
Software licenced for inclusion in the Micro Focus product set, including
software acquired through acquisitions, is also included in software product
assets.
Software product assets are amortised using the straight line method over the
estimated economic life of the products, which in most cases is assumed to be
four years. Where a shortfall in future revenue from a product is anticipated,
amortisation is accelerated.
Amortisation of software product assets is included in research and development
costs.
57
<PAGE> 61
Goodwill
Goodwill represents the excess of the amount paid on the acquisition of a
business over the aggregate fair value of the net assets acquired. Such amounts
are set off against reserves as incurred.
Tangible fixed assets
Tangible fixed assets are stated at cost less accumulated depreciation and
amortisation. Depreciation and amortisation is computed using the straight-line
method over estimated economic lives from the time the asset is put into use.
Present estimated economic lives are as follows:
Freehold office buildings 40 years
Leasehold improvements over the lease term
Computer equipment 3 - 5 years
Office equipment 7 years
Transportation equipment 3 - 4 years
Leasing
Leases which transfer substantially all the benefits and risks of ownership of
an asset to Micro Focus are capitalised as fixed assets. The amount capitalised
is that sum for which the leased asset could be purchased at the start of the
lease, this sum also being treated as a liability.
Depreciation on such leased assets is provided at rates calculated to write off
the capitalised cost over the shorter of the lease term and the asset's economic
life. Lease payments are apportioned between finance charges (computed on the
basis of implicit interest rates) and a reduction in the original liability.
Rentals paid under operating leases are charged to income on a straight-line
basis over the lease term.
Deferred taxation
Deferred taxation is provided on the liability method on all timing differences
to the extent that they are expected to reverse in the future without being
replaced, calculated at the rate at which it is anticipated the timing
differences will reverse.
Stocks
Stocks, consisting principally of diskettes and technical manuals, are stated at
the lower of cost and net realisable value, using the first-in, first-out
method. Contracts in progress, representing engineering costs associated with
non-cancellable licence agreements prior to delivery, are included in stocks and
charged to income when the related revenue is recognised.
Cash and bank deposits
Cash and bank deposits includes cash placed on deposit where the maturity date
is between three and twelve months from the initial date of deposit. All such
cash balances are repayable on demand and can be withdrawn at any time without
notice or penalty.
Investments
Investments are recorded at cost less any provision for permanent diminution in
value.
Translation of foreign currencies
Micro Focus' policy on foreign currency translation complies with U.K. Statement
of Standard Accounting Practice No. 20 "Foreign Currency Translation".
Assets and liabilities denominated in currencies other than G.B. pounds are
translated at exchange rates in effect at the balance sheet date. Closing G.B.
pounds to U.S. dollar rates at January 31 1998, 1997 and 1996 were GBP 1 =
$1.64, GBP 1 = $1.60 and GBP 1 = $1.51 respectively. Revenue, costs and expenses
are translated using average rates. Monthly average G.B. pounds to U.S. dollar
rates used during 1998 range between GBP 1 = $1.60 and GBP 1 = $1.67, and
average GBP 1 = $1.64, GBP 1 = $1.58 and GBP 1 = $1.58 in 1998, 1997 and 1996
respectively. Translation adjustments resulting from the process of translating
financial statements denominated in currencies other than G.B. pounds are dealt
with through reserves. All other differences are charged through the profit and
loss account.
Earnings/(loss) per share
Earnings/(loss) per share are based on the profit/(loss) for the year after
taxation, and on the weighted average number of ordinary shares outstanding
during the period.
Fully diluted earnings per share are based on the profit for the year after
taxation, and on the weighted average number of ordinary shares outstanding
during the period as adjusted for shares issuable upon exercise of share
options. The computation assumes the proceeds from the exercise of share options
are invested in 2.5% Consolidated Stock.
58
<PAGE> 62
Pensions
Micro Focus has entered into arrangements under which it makes defined
contributions to personal pension schemes operated by its employees.
Contributions, which are independently administered by insurance companies and
other financial institutions, are charged to income in the year in which they
become payable.
Related party transactions
The Company is exempt under the provisions of FRS 8 from disclosing related
party transactions which are eliminated on consolidation.
New accounting standards
Financial Reporting Standards No. 9 - Associates and Joint Ventures and No. 10
- - Goodwill and Intangible Assets, were issued by the Accounting Standards Board
in 1997, and will apply to the Company in 1999.
Note 2 Segmental information
Micro Focus operates in one business segment - the development and marketing of
computer software products and related services. The following table analyses
revenue by geographical area, based on customer location:
1998 1997 1996
- --------------------------------------------------------------------------------
GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------
United Kingdom 11,864 6,811 7,178
United States 49,037 38,640 42,824
Europe (excluding U.K.) 18,498 19,297 19,400
Japan 3,964 3,519 2,720
Other 13,652 4,822 5,136
- --------------------------------------------------------------------------------
97,015 73,089 77,258
- --------------------------------------------------------------------------------
The following table analyses worldwide operations by geographical area, based on
the location of Micro Focus facilities.
1998 1997 1996
- --------------------------------------------------------------------------------
GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------
Revenue:
United Kingdom 43,249 33,974 33,988
United States 56,846 42,856 49,503
Europe (excluding U.K.) 23,554 20,588 20,196
Other 7,859 1,910 1,300
- --------------------------------------------------------------------------------
131,507 99,328 104,987
- --------------------------------------------------------------------------------
Inter-segment revenue:
United Kingdom (21,003) (15,900) (16,728)
United States (4,199) (3,501) (4,790)
Europe (excluding U.K.) (9,077) (6,381) (5,362)
Other (213) (457) (849)
- --------------------------------------------------------------------------------
97,015 73,089 77,258
- --------------------------------------------------------------------------------
Operating profit/(loss):
United Kingdom 5,498 (2,960) 1,350
United States 1,041 (4,699) (4,429)
Europe (excluding U.K.) 896 (220) (5,097)
Other 5,301 371 (458)
- --------------------------------------------------------------------------------
12,736 (7,508) (8,634)
- --------------------------------------------------------------------------------
Net operating assets/(liabilities):
United States 14,174 16,075 20,264
United Kingdom 2,930 (8,199) (3,087)
Europe (excluding U.K.) (4,122) 2,988 9,176
Other 2,521 (16) (558)
- --------------------------------------------------------------------------------
15,513 10,848 25,795
- --------------------------------------------------------------------------------
Inter-segment revenue principally represents licence fees and charges for
research and development between locations. Operating profit/(loss) excludes
interest income and expense and, correspondingly, net operating
assets/(liabilities) exclude interest-bearing assets and liabilities. A
reconciliation of the net operating assets/(liabilities) as shown above to net
assets as shown in the balance sheet is as follows:
1998 1997 1996
- --------------------------------------------------------------------------------
GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------
Net operating assets 15,513 10,848 25,795
Cash and bank loans 50,511 44,725 38,972
Investment in own shares 4,886 5,634 5,634
Finance lease obligations (18) (83) (214)
- --------------------------------------------------------------------------------
Net assets 70,892 61,124 70,187
- --------------------------------------------------------------------------------
59
<PAGE> 63
Note 3 Acquisitions
In the current year Micro Focus completed two acquisitions for a total
consideration of GBP 12,679,000 in cash and shares.
On April 30 1997 the Company acquired all of the share capital of Millennium UK
Limited ("Millennium"), a provider of consulting and project management
services, for a consideration of GBP 4,000,000 paid in a combination of GBP
2,000,000 in cash and the issuance of 149,142 ordinary shares in the Company.
The transaction has been accounted for as an acquisition and, accordingly, the
results of operations and cash flows of Millennium have been combined with those
of Micro Focus for the nine-month period subsequent to April 30 1997.
The acquisition cost has been allocated between the identifiable tangible assets
and liabilities of Millennium based on their respective fair values, and the
excess has been allocated to goodwill, as shown in the following table.
- --------------------------------------------------------------------------------
Net assets Fair value Fair values on
acquired adjustments acquisition
GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------
Cash (31) - (31)
Accounts receivable 379 - 379
Other current assets 45 - 45
Tangible fixed assets 20 - 20
Current liabilities (570) - (570)
- --------------------------------------------------------------------------------
Total net assets (157) - (157)
- --------------------------------------------------------------------------------
Goodwill arising 4,157
- --------------------------------------------------------------------------------
4,000
- --------------------------------------------------------------------------------
Purchase consideration payable to vendors 4,000
- --------------------------------------------------------------------------------
Goodwill arising on the acquisition has been charged to reserves.
Millennium reported a loss after taxation of GBP 229,000 in its financial year
ended December 31 1996. In the subsequent four month period to April 30 1997
Millennium recorded a profit after taxation of GBP 19,000. In the period since
acquisition, Millennium contributed GBP 48,000 to the group's net operating cash
flows and utilised GBP 44,000 for capital expenditure.
Subsequent to the acquisition, costs amounting to GBP 200,000 have been incurred
in connection with a reorganisation of the business of Millennium. These costs
are included in general and administrative costs in the current year.
On January 20 1998 the Company completed the acquisition of XDB Systems, Inc
("XDB"). XDB was acquired in exchange for 378,395 ordinary shares in the Company
and the exchange of XDB stock options for Micro Focus options, which represented
a total value of GBP 8,679,000 on the date the acquisition was completed. XDB, a
privately-held corporation based in Maryland, USA, is a provider of DB2 database
development, maintenance and connectivity solutions. The transaction has been
accounted for as an acquisition. Accordingly, the results of operations and cash
flows of XDB have been combined with those of Micro Focus for the period
subsequent to January 20 1998.
The acquisition cost has been allocated between the identifiable tangible assets
and liabilities of XDB based on their respective fair values, and the excess has
been allocated to goodwill, as shown in the following table.
- --------------------------------------------------------------------------------
Fair value adjustments
- --------------------------------------------------------------------------------
Accounting
Net assets policy Fair values on
acquired changes acquisition
GBP'000 GBP'000 Other GBP'000
- --------------------------------------------------------------------------------
Cash 992 - - 992
Accounts receivable 2,442 (707) - 1,735
Other current assets 116 - - 116
Tangible fixed assets 276 - - 276
Current liabilities (2,093) - 78 (2,015)
Deferred taxation 754 - (754) -
- --------------------------------------------------------------------------------
Total net assets 2,487 (707) (676) 1,104
- --------------------------------------------------------------------------------
Goodwill arising 7,575
- --------------------------------------------------------------------------------
8,679
- --------------------------------------------------------------------------------
Purchase consideration payable to vendors 8,679
- --------------------------------------------------------------------------------
The fair value adjustments relate to: - the deferral of previously recognised
revenue totalling GBP 707,000 to reflect compliance with the Company's existing
revenue recognition policy - reductions of GBP 78,000 to accruals established by
XDB to provide for costs incurred during 1998 - the elimination of a deferred
tax asset amounting to GBP 754,000 which had been established in accordance with
U.S. accounting principles.
The acquisition of XDB was completed shortly before the end of the current
financial year and consequently fair values on acquisition have been estimated
based on information currently available. Any additional adjustments to fair
values arising on final review will be disclosed in the Company's financial
statements for the year ended January 31 1999.
60
<PAGE> 64
In addition to the above adjustments, provisions amounting to GBP 122,000 have
been recorded for the estimated costs of rationalisation and reorganisation of
the acquired business, and charged to general and administrative costs in the
profit and loss account.
Goodwill arising on the acquisition has been charged to reserves.
XDB's loss after taxation in its financial year ended January 31 1997 was GBP
2,642,000. In the subsequent pre-acquisition period from February 1 1997 to
January 20 1998 XDB recorded a loss after taxation of GBP 671,000. XDB's cash
flows for the period of ownership were not material.
Note 4 Research and development costs
- --------------------------------------------------------------------------------
1998 1997 1996
GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------
Research and
development costs,
before capitalization 17,602 19,235 23,423
Costs capitalized as
software product assets (5,688) (5,258) (9,882)
Amortisation of
capitalized costs 7,765 8,067 8,805
................................................................................
19,679 22,044 22,346
Exceptional items (note 8): 17,602 19,235 23,423
Restructuring costs:
- accelerated amortisation - - 3,834
- other costs - 2,255 671
- --------------------------------------------------------------------------------
19,679 24,299 26,851
- --------------------------------------------------------------------------------
Note 5 Operating profit/(loss)
Operating profit/(loss) is stated after charging:
- --------------------------------------------------------------------------------
1998 1997 1996
GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------
Auditors' remuneration:
audit services: U.K. 117 105 96
audit services: overseas 110 93 100
non-audit services: U.K. 230 181 141
non-audit services: overseas289 218 179
Operating lease rentals
equipment 756 743 903
land and buildings 1,780 1,811 2,137
Depreciation to leased assets 39 39 118
Other depreciation and
amortisation 4,534 5,616 6,068
- --------------------------------------------------------------------------------
The profit attributable to the ordinary shareholders of Micro Focus Group Plc,
dealt with in the financial statements of Micro Focus, is GBP 805,000 (1997: GBP
716,000; 1996: GBP 1,449,000). There were no other movements on reserves other
than the movement on share premium shown on page 56.
Note 6 Directors and employees
An analysis of the directors' remuneration pension entitlements and share
options is set out in the Executive Remuneration Committee's Report on pages 42
and 43.
The average weekly number of staff employed by Micro Focus during the year was:
- --------------------------------------------------------------------------------
1998 1997 1996
number number number
- --------------------------------------------------------------------------------
U.K. 252 255 302
U.S. 355 310 355
Other 112 81 78
- --------------------------------------------------------------------------------
719 646 735
- --------------------------------------------------------------------------------
Staff costs, which include salaries, bonus and commissions, amounted to:
- --------------------------------------------------------------------------------
1998 1997 1996
GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------
U.K. 10,324 9,173 10,167
U.S. 22,803 16,758 17,801
Other 5,184 3,554 3,856
- --------------------------------------------------------------------------------
38,311 29,485 31,824
Social security costs 2,979 2,797 2,884
Other pension costs 432 437 596
- --------------------------------------------------------------------------------
41,722 32,719 35,304
- --------------------------------------------------------------------------------
Other pension costs principally represent amounts paid by Micro Focus to
personal pension schemes operated by its employees. In the United Kingdom, Micro
Focus matches contributions made by participating employees up to
certainpredetermined thresholds. Arrangements for employees in other countries
have been established on similar bases, subject to local regulations and
practices in the countries concerned.
Note 7 Interest expense
- --------------------------------------------------------------------------------
1998 1997 1996
GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------
Finance charges payable under
finance leases 5 18 74
On bank loans and overdrafts 65 3 -
- --------------------------------------------------------------------------------
70 21 74
- --------------------------------------------------------------------------------
61
<PAGE> 65
Note 8 Exceptional items
Exceptional items recorded in the year ended January 31 1997 represented a
charge of GBP 5,195,000 for restructuring. The charge consists of the costs
associated with a reduction in the Company's workforce of approximately 65
people, facility closures and consolidations, and asset write-downs. All
outstanding amounts due under the restructuring were settled prior to January 31
1998.
Exceptional items recorded in the year ended January 31 1996 consisted of a
charge of GBP 6,667,000 for restructuring and a credit of GBP 666,000 resulting
from the adoption of Abstract 13 "Accounting for ESOP Trusts" which was issued
by the Urgent Issues Task Force of the Accounting Standards Board in June 1995.
Restructuring costs of GBP 3,125,000 announced in May 1995 related to employee
terminations, closure of surplus office facilities, and fixed asset write-downs.
Additional asset write-downs of GBP 3,542,000 booked in January 1996 were
primarily the result of a review into the carrying value of software product
assets.
Note 9 Taxation
The taxation charge for the year consists of the following:
- --------------------------------------------------------------------------------
1998 1997 1996
GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------
U.K. corporation tax 3,244 237 133
Deferred taxation (71) 870 (458)
Double taxation relief (162) (174) 105
Overseas taxation:
U.S. federal 542 4 5
U.S. state 128 1 -
Other 958 276 (118)
................................................................................
4,639 1,214 (543)
Taxation underprovided/
(overprovided)
in previous years
Corporation tax - 258 -
Deferred taxation 152 - 202
Overseas taxation:
U.S. federal - - 193
U.S. state - - (2)
Other - - 78
- --------------------------------------------------------------------------------
4,791 1,472 (72)
- --------------------------------------------------------------------------------
The effective tax rate in 1998 is 31.5%, which compares to the applicable U.K.
corporate tax rate of 31.3%.
In prior years the effective tax rate was significantly distorted, principally
as a result of losses incurred in the United States which can only be offset
against profits arising in future periods, and the impact of disallowable
exceptional items. The corporation tax returns of certain U.S. subsidiary
undertakings are under examination by the U.S. Internal Revenue Service, which
has proposed certain adjustments. The Company believes that the outcome of the
examination will not give rise to any material adjustment to the financial
statements.
Note 10 Earnings/(loss) per share
Earnings/(loss) per share is computed on the bases set out in note 1.
- --------------------------------------------------------------------------------
1998 1997 1996
- --------------------------------------------------------------------------------
Basic earnings per share:
Profit/(loss) after taxation 10,426 (7,281) (6,470)
Ordinary shares
(weighted average) 15,373 15,156 14,843
Diluted earnings per share:
Adjusted profit/(loss)
after taxation 11,180 (7,281) (6,470)
Ordinary shares
(weighted average) 17,199 15,156 14,843
Pro-forma earnings per share data, based on ordinary shares in issue following
the 5-for-1 sub-division of the Company's ordinary shares on March 13 1998 (see
note 22 to the financial statements on page 67) are also shown on the profit and
loss account.
Note 11 Intangible fixed assets
Intangible fixed assets consist of software product assets, as follows:
- -------------------------------------------------------------------------------
Net book
Cost Amortisation value
GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------
At January 31 1997 74,216 59,626 14,590
Currency fluctuations (755) (636) (119)
Additions 5,688 - 5,688
Amortisation for the year - 7,765 (7,765)
- --------------------------------------------------------------------------------
At January 31 1998 79,149 66,755 12,394
- --------------------------------------------------------------------------------
62
<PAGE> 66
Note 12 Tangible fixed assets
<TABLE>
<CAPTION>
(a) Micro Focus:
- -------------------------------------------------------------------------------------------------------------------------------
Computer and
Freehold communications
land and Leasehold Office equipment Transportation
buildings Improvements equipment and software equipment Total
GBP'000 GBP'000 GBP'000 GBP'000 GBP'000 GBP'000
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Cost:
At January 31 1997 13,556 840 4,690 23,954 292 43,332
Currency fluctuations - (60) (101) (457) (2) (600)
Additions 272 1,795 1,308 5,157 27 8,560
Disposals - - (1,246) (834) (191) (2,271)
- ---------------------------------------------------------------------------------------------------------------------------
At January 31 1998 13,828 2,575 4,651 27,820 126 49,021
- ---------------------------------------------------------------------------------------------------------------------------
Depreciation:
At January 31 1997 436 760 3,312 18,118 163 22,789
Currency fluctuations - (28) (52) (347) (2) (415)
Provision for the year 223 85 403 3,810 9 4,534
Disposals - - (965) (659) (100) (1,724)
At January 31 1998 659 817 2,698 20,922 70 25,184
Net book values:
At January 31 1997 13,120 80 1,378 5,836 129 20,543
At January 31 1998 13,169 1,758 1,955 6,898 56 23,837
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
Freehold land and buildings includes capitalised interest of GBP 385,000.
Transportation equipment includes assets held under finance leases as follows:
- --------------------------------------------------------------------------------
Cost Netbook
depreciation value
GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------
At January 31 1997 125 66 59
Provision for the year - - -
Disposals - - -
- --------------------------------------------------------------------------------
At January 31 1998 125 66 59
- --------------------------------------------------------------------------------
(b) Company:
The Company's tangible fixed assets consist of freehold land and buildings,
valued at cost which includes capitalised interest of GBP 385,000.
- --------------------------------------------------------------------------------
Cost Netbook
depreciation value
GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------
At January 31 1997 3,088 96 2,992
Provision for the year - 21 (21)
- --------------------------------------------------------------------------------
At January 31 1998 3,088 117 2,971
- --------------------------------------------------------------------------------
63
<PAGE> 67
Note 13 Investments
(a) Micro Focus:
Investment in own shares represents the Company's ordinary shares acquired by
Micro Focus Trustees Limited on behalf of the Micro Focus Group Employee Benefit
Trust 1994 ("the Trust"), at cost:
- --------------------------------------------------------------------------------
1998 1997
GBP'000 GBP'000
- --------------------------------------------------------------------------------
Beginning of year 5,634 5,634
Sold on exercise of options (748) -
- --------------------------------------------------------------------------------
End of year 4,886 5,634
- --------------------------------------------------------------------------------
As at January 31 1998 the Trust owned 757,369 shares with a nominal value of GBP
75,737, and options have been granted to employees to purchase up to 634,245 of
such shares (see note 21 to the financial statements on page 66). The market
value of these shares was GBP 20,729,000 (January 31 1997: GBP 9,656,000); if
they had been sold at this value a liability to corporation tax of approximately
GBP 4,500,000 (January 31 1997: GBP 1,100,000) would have arisen. The Trust has
not waived its right to dividends in respect of this shareholding.The assets and
liabilities of the Trust, as well as its operating costs, are included in Micro
Focus' consolidated financial statements.
(b) Company:
- --------------------------------------------------------------------------------
1998 1997
GBP'000 GBP'000
- --------------------------------------------------------------------------------
Investments in subsidiary undertakings:
Beginning of year 27,175 27, 685
Acquisitions (note 3): 12,679 -
Additions 309 -
Effect of exchange rate changes 37 (510)
- --------------------------------------------------------------------------------
End of year 40,200 27,175
Investment in own shares (see (a) above):
End of year 4,886 5,634
- --------------------------------------------------------------------------------
45,086 32, 809
- --------------------------------------------------------------------------------
The principal subsidiary undertakings, all of which are wholly-owned, are:
- --------------------------------------------------------------------------------
Country of incorporation
- --------------------------------------------------------------------------------
Micro Focus Limited U.K. (1)
Micro Focus International Limited U.K. (2)
Micro Focus Holdings Limited U.K. (1)
Micro Focus Incorporated U.S.A. (2)
XDB Systems, Inc. U.S.A. (1)
Micro Focus Japan Japan (2)
Micro Focus GmbH Germany (2)
Micro Focus SARL France (2)
Micro Focus SA Spain (2)
Micro Focus Investments Limited Jersey (3)
System Focus BV Netherlands (2)
Micro Focus Technology NV Netherlands Antilles (2)
- --------------------------------------------------------------------------------
(1) Held directly by the Company
(2) Held by a subsidiary undertaking
(3) Held directly by the Company, operating as a financing company. The
activities of the other subsidiary undertakings are described in the
Directors' Report.
Note 14 Stocks
The replacement value of stocks is not considered to be materially different
from their balance sheet values.
Note 15 Debtors
- --------------------------------------------------------------------------------
1998 1997
GBP'000 GBP'000
- --------------------------------------------------------------------------------
Trade debtors 29,145 12,672
Other debtors and prepaid expenses 1,728 1,556
- --------------------------------------------------------------------------------
30,873 14,228
- --------------------------------------------------------------------------------
Trade debtors include GBPnil (1997: GBP 1,693,000) which is due more than twelve
months from the balance sheet date. Other debtors and prepaid expenses include
loans to an officer of Micro Focus totalling GBP nil (1997: GBP 57,000), and
amounts due more than twelve months from the balance sheet date totalling GBP
74,000 (1997: GBP 164,000).
64
<PAGE> 68
Note 16 Creditors: amounts falling due within one year
- --------------------------------------------------------------------------------
1998 1997
GBP'000 GBP'000
- --------------------------------------------------------------------------------
Bank loans 1,007 -
Obligations under finance leases (note 18) 6 68
Trade creditors 4,241 3,054
Current corporation tax 6,428 2,590
Other taxes and social security costs 1,725 1,129
Product royalties and purchases 845 602
Accrued employees compensation
and commissions 7,481 3,632
Accrued expenses 4,750 1,556
- --------------------------------------------------------------------------------
26,483 16,180
- --------------------------------------------------------------------------------
The bank loan represents borrowings against an unsecured revolving
multi-currency loan facility, under the terms of which financing of up to
GBP 5,000,000, or its equivalent in such other currency as the Company may
determine, is available until January 2001. Borrowings under this facility bear
interest at 0.75% above the London Interbank Offered Rate ("LIBOR"). The amount
outstanding against this credit line at January 31 1998 was drawn in French
Francs, and was incurring interest at 3.6% per annum.
Accrued expenses includes GBP 116,000 (1997: GBP 123,000) in respect of an
unfunded defined benefit scheme operated by a foreign subsidiary undertaking,
and other outstanding contributions payable by Micro Focus in connection with
employees' pension arrangements.
Note 17 Creditors: amounts falling due after more than one year
Creditors due after more than one year represent obligations under lease
commitments (see note 18).
Note 18 Lease commitments
Financial commitments for future periods under lease agreements existing at
January 31 1998 are as follows:
Finance leases:
- --------------------------------------------------------------------------------
1998 1997
GBP'000 GBP'000
- --------------------------------------------------------------------------------
Amounts payable within one year 6 71
Amounts payable from one to two years 15 15
- --------------------------------------------------------------------------------
21 86
Less finance charges allocated to
future periods - (3)
- --------------------------------------------------------------------------------
21 83
- --------------------------------------------------------------------------------
Finance leases are shown as:
Amounts due within one years (note 16) 6 68
Amounts due after more than one year 12 15
- --------------------------------------------------------------------------------
18 83
- --------------------------------------------------------------------------------
Operating leases:
- --------------------------------------------------------------------------------
Land and buildings Other
1998 1997 1998 1997
GBP'000 GBP'000 GBP'000 GBP'000
- --------------------------------------------------------------------------------
Annual commitment
under leases which expire:
within one year 263 1,117 4 114
in the second to fifth
years inclusive 1,576 648 541 462
thereafter 469 168 - -
- --------------------------------------------------------------------------------
2,308 1,933 545 576
- --------------------------------------------------------------------------------
Note 19 Capital commitments
At January 31 1998 and January 31 1997 Micro Focus had no material capital
expenditure commitments.
65
<PAGE> 69
Note 20 Deferred taxation
Deferred taxation has been fully provided as follows:
(a) Micro Focus:
- --------------------------------------------------------------------------------
1998 1997
GBP'000 GBP'000
- --------------------------------------------------------------------------------
Capital allowances in advance
of depreciation and amortisation 89 169
Other timing differences 6,318 6,070
- --------------------------------------------------------------------------------
6,407 6,239
- --------------------------------------------------------------------------------
The movement of deferred taxation during the year is as follows:
- --------------------------------------------------------------------------------
1998 1997
GBP'000 GBP'000
- --------------------------------------------------------------------------------
Balances, beginning of year 6,239 5,454
Movement on captital allowances
in advance of depreciation
and amortisation (80) (140)
Movement in other timing differences 248 925
- --------------------------------------------------------------------------------
Balances, end of year 6,407 6,239
- --------------------------------------------------------------------------------
(b) Company:
- --------------------------------------------------------------------------------
1998 1997
GBP'000 GBP'000
- --------------------------------------------------------------------------------
Capital allowances in advance
of depreciation and amortisation 19 19
- --------------------------------------------------------------------------------
19 19
- --------------------------------------------------------------------------------
Note 21 Share option plans
The Company's share option plans provide for the grant of options to acquire
shares to persons who devote substantially all their working time to Micro Focus
and such other eligible persons as the Board may determine. The exercise price
of options issued under these plans is 100% of the fair market value at the time
such options are granted. Options are generally exercisable in five equal
cumulative annual installments commencing one year after the date of grant.
Unexercised options lapse when the optionholder ceases to be employed by Micro
Focus or at a predetermined expiry date (of up to ten years from the date of
grant), whichever occurs first.
The 1996 Share Option Plan was approved by shareholders in June 1996 and
authorised the Company to grant options for up to a maximum of 757,369 shares
(representing 5% of the issued share capital of the Company at that time); such
authority will expire on June 18 1999. Prior to 1996, authority to issue options
under similar terms had been granted pursuant to the 1991 Share Option Plan and
the 1983-1984 Share Option Plan. Such authorities expired in1996 and 1991
respectively. At January 31 1998 1,687,580 options were issued and outstanding
under the plans, and a further 319,253 which had been approved for grant by
shareholders under the 1996 Share Option Plan were currently unissued.
In 1994 the Micro Focus Group Employee Benefit Trust 1994 ("the Trust") was
established to further the Company's policy of encouraging share ownership by
its employees. Under the terms of the Trust, Micro Focus Trustees Limited
("MFTL") is permitted to acquire ordinary shares in the Company and to issue
options for those shares to directors and employees. At January 31 1998 MFTL
owned 793,713 shares, and options granted by MFTL to purchase 634,245 of these
shares were outstanding. Options which had been granted for an additional 22,000
shares prior to their acquisition by MFTL also remained outstanding. The
remaining 105,220 option shares were available for future grant. The shares held
by the Trust are included in Investments (see note 13 to the financial
statements on page 64).
Pursuant to the agreement to acquire XDB Systems, Inc. ("XDB"), the Company
assumed XDB's 1992 Share Option Plan and 1996 Share Option Plan. Under the
agreement, holders of XDB options are entitled to exercise their option shares
in return for ordinary shares in the Company. At January 20 1998, the date of
the merger, XDB option holders held 40,042 options in the Company at prices
between $7.95 and $37.06 and denominated in U.S. dollars. At January 31 1998
30,056 of these option shares remained outstanding.
66
<PAGE> 70
Share option activity under the plans was as follows:
- --------------------------------------------------------------------------------
Number Option price
of shares per share
- --------------------------------------------------------------------------------
Outstanding, January 31, 1995 1,728,874 GBP 2.20-GBP 28.83
Options granted 603,795 GBP 5.42-GBP 8.20
Options exercised (114,865) GBP 2.20-GBP 5.42
Options cancelled (159,035) GBP 2.20-GBP 28.83
- --------------------------------------------------------------------------------
Outstanding, January 31, 1996 2,058,769 GBP 5.42-GBP 28.83
Options granted 2,300,830 GBP 5.83-GBP 9.70
Options exercised (24,156) GBP 5.42-GBP 9.66
Options cancelled (1,840,411) GBP 5.42-GBP 28.83
- --------------------------------------------------------------------------------
Outstanding, January 31, 1997 2,495,032 GBP 5.42-GBP 21.61
Options granted 1,324,545 GBP 4.85-GBP 22.60
Options exercised (310,741) GBP 5.42-GBP 18.52
Options cancelled (1,134,955) GBP 4.85-GBP 22.60
- --------------------------------------------------------------------------------
Outstanding, January 31, 1998 2,373,881 GBP 4.85-GBP 22.60
- --------------------------------------------------------------------------------
The total of 2,373,881 options outstanding at January 31 1998 is represented by
1,717,636 unissued shares (1,687,580 issued under the Micro Focus plans and
30,056 pursuant to the XDB plans) and 656,245 issued shares held by MFTL.
The outstanding options are exercisable between 1998 and 2007; the proceeds on
exercise at January 31 1998 would be GBP 21,579,000 (January 31 1997:GBP
19,790,000).
At January 31 1998 options for 254,000 shares (January 311997: 168,000 shares)
were currently exercisable at prices per share of between GBP 5.42 and GBP
22.60; the proceeds on exercise of such options at January 31 1998 would be GBP
2,586,000 (January 31 1997: GBP 2,095,000).
67
<PAGE> 71
Note 22 Post-balance sheet event
On March 12 1998 shareholders approved a 5-for-1 sub-division of the Company's
ordinary shares ("the Stock Split".) The sub-division became effective as of the
close of business on Friday, March 13 1998. The Company's American Depository
Shares ("ADSs"), which are traded on the Nasdaq Stock Market in the United
States, did not split, although the conversion rights of such ADSs have been
adjusted such that each ADS now represents 5 ordinary shares.
STATEMENT OF THE DIRECTORS' RESPONSIBILITIES IN RESPECT OF THE FINANCIAL
STATEMENTS (UK FORMAT)
Company law requires the directors to prepare financial statements for each
financial year which give a true and fair view of the state of affairs of the
Company and of the group and of the profit or loss of the group for that year.
In preparing those financial statements the directors are required to:
a) select suitable accounting policies and then apply them consistently;
b) make judgments and estimates that are reasonable and prudent; and
c) state whether applicable accounting standards have been followed, subject to
any material departures disclosed and explained in the financial statements.
The directors confirm that they have complied with the above requirements in
preparing the financial statements.
The directors are responsible for keeping proper accounting records which
disclose with reasonable accuracy at any time the financial position of the
group and to enable them to ensure that the financial statements comply with the
U.K. Companies Act 1985. They are also responsible for safeguarding the assets
of the group and hence for taking reasonable steps for the prevention and
detection of fraud and other irregularities.
REPORT OF THE AUDITORS (UK FORMAT)
To the members of Micro Focus Group Plc
We have audited the financial statements on pages 51 to 67, which have been
prepared under the historical cost convention and on the basis of the accounting
policies set out in note 1 to the financial statements on pages 57 to 5.
Respective responsibilities of directors and auditors
As described above, the Company's directors are responsible for the preparation
of the financial statements. It is our responsibility to form an independent
opinion, based on our audit, on those financial statements and to report our
opinion to you.
Basis of opinion
We conducted our audit in accordance with Auditing Standards issued by the
Auditing Practices Board. An audit includes examination, on a test basis, of
evidence relevant to the amounts and disclosures in the financial statements. It
also includes an assessment of the significant estimates and judgments made by
the directors in the preparation of the financial statements, and of whether the
accounting policies are appropriate to the group's circumstances, consistently
applied and adequately disclosed.
We planned and performed our audit so as to obtain all the information and
explanations which we considered necessary in order to provide us with
sufficient evidence to give reasonable assurance that the financial statements
are free from material mis-statement, whether caused by fraud or other
irregularity or error. In forming our opinion we also evaluated the overall
adequacy of the presentation of information in the financial statements.
Opinion
In our opinion the financial statements give a true and fair view of the state
of affairs of the Company and of the group as at January 31 1998 and of the
profit of the group for the year then ended and have been properly prepared in
accordance with the U.K. Companies Act 1985.
Ernst & Young
Chartered Accountants
Registered Auditor
Reading
May 1 1998
68
<PAGE> 72
[back cover of annual report]
BOARD OF DIRECTORS:
J. Michael Gullard
Chairman of the Board
General Partner, Cornerstone Management
Martin Waters
President and Chief Executive Officer
Paul Aldous Adams
Vice President, International Sales
Ronald Harold Forbes
Vice President, International Finance
Harold Hughes
Chairman, Pandesic LLC
J. Sidney Webb
Chairman, Titan Corporation
COMPANY SECRETARY:
Loren E. Hillberg
COMPANY OFFICERS:
Martin Waters
President and Chief Executive Officer
Richard Van Hoesen
Senior Vice President and
Chief Financial Officer
Chris Sanders
Senior Vice President, Product Operations
Buff Jones
Senior Vice President,
Business Development
Paul Aldous Adams
Vice President, International Sales
Chris Christides
Senior Vice President, North American Sales
Richard C. Butts
Vice President, Human Resources
Loren E. Hillberg
Vice President and General Counsel
Stanley J. Blaustein
Vice President and Chief Information Officer
REGISTERED OFFICE
Micro Focus Group Plc
The Lawn
22-30 Old Bath Road
Newbury
Berkshire RG14 1QN, UK
BANKERS
Midland Bank Plc
1 Mansion House Street
Newbury
Berkshire RG14 5ET, UK
STOCKBROKERS
SBC Warburg 1 Finsbury
Avenue London EC2M 2PA,
UK and The Stock Exchange London
EC2N 1HP, UK
Registrars and Transfer Office
Lloyds Bank Registrars
The Causeway, Worthing
West Sussex BN99 6DA, UK
ADR DEPOSITORY
Bank of New York
ADR Division
101 Barclay Street, 22nd Floor
New York, New York 10286, USA
AUDITORS
Ernst & Young, Chartered
Accountants
Apex Plaza
Reading,
Berkshire RG1 1YE, UK
SOLICITORS
Jonathan Philip Davies, Solicitor
Memery Crystal
31 Southampton Row
London WC1B 5HT, UK
REGIONAL SALES OFFICES
UK
Micro Focus Limited
The Lawn
22-30 Old Bath Road
Newbury
Berkshire RG14 1QN, UK
Tel: (+44) 1635 32646
Fax: (+44) 1635 33966
USA
Micro Focus Incorporated
701 East Middlefield Road
Mountain View, CA 94043
Tel: (+1) (650) 938 3700
Fax: (+1) (650) 404 7414
Micro Focus Incorporated (Philadelphia)
500 East Swedesford Road
2nd Floor
Wayne, PA 19087
Tel: (+1) (610) 263 3400
Fax: (+1) (610) 263 3700
Micro Focus Incorporated (New York)
Two Wall Street
7th Floor
New York, NY 10005
Tel: (+1) (212) 312 2200
Fax: (+1) (212) 312 2222
CANADA
Micro Focus (Canada) Limited
One City Centre Drive
Suite 301
Mississauga, Ontario L5B 1M2
Canada
Tel: (+1) (905) 306 7280
Fax: (+1) (905) 306 7530
JAPAN
Micro Focus Japan Ltd
Nishi Azabu Matsui Building 4F
17-30 Nishi Azabu 4-Chome
Minato-ku, Tokyo 106
Japan
Tel: (+81) 3 3486 7791
Fax: (+81) 3 3486 5055
GERMANY
Micro Focus GmbH
Am Moosfeld 11
81829 Munchen
Germany
Tel: (+49) 89 42094-0
Fax: (+49) 89 42094-211
FRANCE
Micro Focus SARL
Tour Franklin
Defense 8
92042 Paris-La Defense Cedex
France
Tel: (+33) 1 4775 7575
Fax: (+33) 1 4775 7580
SPAIN
Micro Focus S.A.
Corsega 541 4a Planta
08025 Barcelona
Spain
Tel: (+34) 3 435 7001
Fax: (+34) 3 435 6733
INDIA
Micro Focus India Pvt/Ltd
#1/a Church Street
TNA Chambers, First Floor
Bangalore 560001
India
Tel: (+91) 80 509 1215
Fax: (+91) 80 559 2647
Micro Focus Worldwide Web Site - http://www.microfocus.com
<PAGE> 73
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.
Micro Focus Group Public Limited Company
----------------------------------------
(Registrant)
Date: May 28, 1998 By: /s/ Richard Van Hoesen
----------------------------------------
Richard Van Hoesen, Sr. Vice President,
Chief Financial Officer and Secretary
